Europe: EU employers face significant financial risk due to holiday pay ruling

In May 2014 the European Court of Justice ruled that pay for statutory holiday entitlement under the EU Working Time Directive must reflect 'normal remuneration' (Lock v British Gas Trading C-539/12).  The implications of the ruling (not least a potentially significant claim for back pay) and the remaining uncertainties represent a major headache for employers both in the UK and potentially elsewhere in Europe.

UK

Until this ruling, UK legislation had been interpreted as requiring only payment of basic pay during the 4 weeks' EU-derived statutory holiday entitlement, with no requirement to include commission that a worker would normally generate when working and no need to reflect bonuses or overtime pay (save where overtime is guaranteed and compulsory). 

The Working Time Directive requires pay for holiday but leaves it up to member states to specify how to calculate the pay. However, in Lock, the ECJ ruled that this must represent 'normal' pay and include all elements of pay which are “intrinsically linked” to the performance of the tasks which the worker is required to carry out under their contract. 

Then in November 2014 the UK Employment Appeal Tribunal (in Fulton v Bear Scotland) decided that (i) the UK regulations could be interpreted to comply with the EU ruling, thereby applying it against private as well as state employers, and (ii) that overtime pay must also be reflected in statutory holiday pay, at least where the worker is contractually required to perform it if offered and where it is worked regularly.  On the upside, the EAT limited the scope for claims for back pay (which it was feared might be capable of going back 6 years or longer), by deciding that a gap of 3 months without an underpayment breaks a 'series of deductions' (thereby limiting claims as they must be brought within 3 months of the end of each series).  It was widely considered that this novel approach was unlikely to survive challenge.  However, the UK Government has now taken steps to reduce the potential exposure to historic liabilities, imposing a two-year limit on claims for retrospective holiday pay, in force from July 2015.

The EAT left open whether the calculation of holiday pay should also include purely voluntary overtime pay if regularly worked, although there are strong arguments that it should.  Similar issues may arise over some bonuses. There is also uncertainty as to the appropriate period over which to average the pay and further cases are expected.

Germany

German law provides for holiday pay to be calculated using the worker's average remuneration  over the 13 weeks prior to the holiday.  German case law had already established that average remuneration should include compensation for commission which cannot be earned due to the worker taking holiday. 

However, German law provides expressly that overtime work is not to be included in the calculation of average remuneration.  Instead, German employees are entitled to be paid for the number of overtime hours which would have been worked had they not been on holiday, based on the level of overtime their colleagues worked during that holiday period.  The failure to reflect averaged overtime pay could therefore be challenged as contrary to EU law, although this would require a reference to the ECJ and employers are likely to be protected from claims for periods predating the release of the ECJ's judgment in May 2014.

In relation to bonuses, those paid monthly are included in the calculation of holiday pay, but annual bonuses are not, even where based on individual targets.  There is a potential to claim that employees are disadvantaged by taking holiday if taking fewer holidays would give them the opportunity to perform better and achieve a higher bonus.

Spain

The ECJ ruling in Lock was considered in a recent Spanish National High Court ruling (Audiencia Nacional Resolution 17 September 2014).  As a result, it ruled that the Spanish requirement to pay average remuneration for holiday must include variable remuneration averaged over 12 months (such as commission) and all remuneration for ordinary working time (meaning night working time, holiday working time, Sunday working time, and part-time allowance).  There have not been any legal challenges seeking to include other types of payment – as yet.

France

In contrast, French law already expressly provides for holiday pay to take into account commission, performance bonus and overtime payments.  In France holiday pay must be calculated using the more favourable of two methods:  (i) a tenth of the total remuneration received by the worker in the reference holiday year, including all remuneration paid for the work undertaken (including overtime payments, commission and performance bonuses), or more favourable provisions applicable under a collective bargaining agreement;  or (ii) the remuneration the employee would have received had he not been on holiday for the period.  So French law has not been affected by the ECJ ruling.

Actions for employers

UK employers should assess their potential liability for back-pay and consider steps to reduce risk.  They may also need to revise their future holiday pay strategy and potentially consider changes to work or remuneration structure to reduce overtime and/or restructure commission and bonus plans.  For example, target based bonus rules could provide that only a period of time excluding the holiday entitlement will be taken into account in assessing achievement of targets, regardless of how many days are worked. 

Similarly, employers in Germany and Spain may wish to review their potential liabilities in relation to overtime pay and annual performance bonuses.

A detailed client briefing analysing the Employment Appeal Tribunal decision in the UK is available from Anna Henderson.  Summaries of ongoing developments in this area are posted on our blog.