What should employers do about the overtime holiday pay ruling?

Earlier this month, the Employment Appeal Tribunal (EAT) handed down its decision in three highly-anticipated cases concerning holiday pay arrangements for employees paid overtime. 

This article explains the key facts about the ruling and gives practical advice for employers as to how to approach these changes.

The law – how has it changed?

Entitlement to paid holiday leave is provided for by the Working Time Regulations, which implements the European Working Time Directive.  The position prior to the EAT’s ruling was that holiday pay for employees paid according to the hours they work was calculated by reference to an employees’ basic weekly pay only.  

However, the EAT has now ruled that holiday pay should be equivalent to a worker’s “normal” pay.  In particular, where an employee works regular overtime as part of his contractual conditions, the overtime should count as part of their “normal” pay when calculating the employee’s holiday pay.  

Whilst not specifically dealt with in this case, other elements such as commission, shift allowances and any other payment the employee is normally paid for doing his job (as opposed to reimbursement of expenses) will fall within the EAT’s definition of “normal” pay. 

If employers are uncertain as to whether a particular payment to the employer should be included for the purposes of holiday pay, the question to be asked is whether the pay is “normal” i.e. has it been paid for a sufficient period of time to be considered part of that employee’s normal remuneration.  It is also worth noting that at this stage bonuses are unlikely to be included as, for the most part, they are defined as discretionary and unlikely to form part of “normal” remuneration.

Is there any good news?!

Fortunately for employers, there are caveats to the ruling. 

Firstly, the ruling only applies to the mandatory four week holiday entitlement provided for by the European Working Time Directive, which for full-time workers is 20 days.  It does not apply to the additional 1.6 weeks given to workers in the UK (8 days for full-time workers) or for any additional holiday entitlement provided for by the employee’s contract of employment.  Essentially, employers will continue to pay employees their basic salary for the additional holiday, unless their contract says otherwise.

Also, and perhaps of most significance for employers, is that the EAT placed a time limit on claims that can be made by employees for back pay.  Employees who, as a result of the ruling, have been underpaid historically may have a claim for unlawful deductions from wages.  The employee must bring a claim for unlawful deductions in the Tribunal within three months of the date of the deduction or, where there has been a series of deductions, within three months of the last deduction.  However, the EAT held that only deductions made within three months of each other count as part of a series. 

To put this into practice, if an employee was paid holiday pay in April this year and then again in September they would only be able to make an unlawful deductions claim in respect of the September payment as there is more than three months between the deductions.   This will significantly reduce the number of retrospective holiday days for which a worker will be able to claim underpayment and it means the vast majority of workers will only be able to recover underpayments in the last three months. 

What should we do now?

Technically, now the ruling has been made, employers should start to factor in regular overtime into holiday pay from now on.  In terms of the calculation of holiday pay, this will continue to be by way of reference to a “week’s pay” as set out in the Employment Rights Act 1996.  This means that where a worker’s pay fluctuates on each pay date, the calculation of a week’s pay will be the average amount the worker was paid in the 12 weeks immediately preceding the holiday period.  This may cause difficulties for businesses and workers who, for example, have a short seasonal spike in activity.

Practically, employers need to be communicating with their payroll providers or investigating whether their current payroll systems are able to deal with this change.  Consideration will need to be given as to whether it is simpler to pay at the enhanced rate for all holiday pay going forward or whether there is the facility to differentiate between the four weeks’ under the Working Time Directive and the additional holiday an employee receives under the UK statutory leave and any contractual entitlements.

Employers will likely also need to look at their employment contracts and employee handbooks to ensure that these are up to date.  In respect of new starters, it may be that employers wish to consider what overtime arrangements, if any, they will be offering to new employees.

The biggest consideration for employers will be their potential exposure to claims from existing employees.  It may be beneficial for employers to spend some time calculating the maximum potential liability for all employees (bearing in mind the three month time limits) in order to budget accordingly. 

Finally, it is important to note that the EAT has given permission for it’s decision to be appealed to the Court of Appeal (and potentially to the European Court of Justice after that) and so we may not have a definitive decision for some time.  If employees do issue Tribunal claims for unlawful deductions then it is likely that these will be suspended if and until there is a further decision made on appeal. 

If you have any queries regarding this or any other employment law issue please contact James on 01332 225271.