Commission and holiday pay: another piece in the jigsaw

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The Leicester Employment Tribunal (ET) has ruled that words should be added to the Working Time Regulations 1998, effectively bringing commission and other similar payments into the calculation of holiday pay.

What did the Leicester ET decide?

This latest ruling in the case of Lock v British Gas Trading Limited has clarified that the Working Time Regulations 1998 ('the Regulations') can be brought into line with European law on holiday pay by including additional wording to clarify that commission or similar payments should be included in the calculation of holiday pay. Furthermore, the effect of the wording chosen is that it will generally be calculated on a worker's average pay in the 12 weeks before they took holiday. However, it was accepted by the parties in the case that this decision only applied to the 4 weeks' EU-derived holiday entitlement, and not the additional 1.6 weeks' leave provided for by the UK.

It is perhaps surprising, and appears to have been missed by many commentators, that in adopting the additional wording that it has, the ET has effectively dealt with the question of what the reference period should be, despite appearing to suggest that this question might be dealt with at a later date.

What did the Leicester ET not decide?

The ET made it clear it was not deciding whether commission should be included in holiday pay. The European Court of Justice (ECJ) had already decided last year that it should. The ET also made it clear it was not considering whether any other form of remuneration, such as discretionary bonuses, should be taken into account in holiday pay.

There are still a number of issues in Lock that will be determined at a later hearing, such as whether Mr Lock's commission structure already took account of holiday, thereby ensuring that he in fact suffered no financial loss. Another issue that may well be considered at the next hearing is how to address the lower pay a worker will receive after a period of holiday if they cannot generate commission during the time they are on leave.

The judgement also leaves employers no further forward on questions such as:

  • Whether 'voluntary overtime' should be included in holiday pay – this case purely concerned commission; and
  • How the 4 weeks' EU-derived entitlement may be allocated – is it the first 4 weeks taken, or can it be determined by the employer or employee?

It is worth remembering that, whilst very important, this decision is at ET level only and could be subject to appeal.

Why did commission not have to be included in holiday pay previously?

Under the Regulations, if a person has normal working hours, and their pay does not vary with the amount of work done in those hours, their holiday pay is the amount payable under the contract for their normal working hours. However, case law in the UK had established that where an individual earns commission, for example on sales achieved, that is not considered to be pay which varies with the amount of work done. Rather it varies with the success or otherwise of the work. Therefore their holiday pay may be based on basic salary.

Mr Lock’s remuneration was made up two elements: fixed basic salary per month and variable commission based on sales achieved which was paid weeks or months later. Mr Lock's contract only provided for basic salary to be paid during his holiday, but commission represented over 60% of his remuneration. When Mr Lock was on paid annual leave from 19 December 2011 to 3 January 2012, although he received payments for commission he had generated in previous weeks, he could not make any new sales or follow up on potential sales and was not able to generate commission. Since this had adverse effects on his salary in the months following his annual leave, Mr Lock brought proceedings for outstanding holiday pay in respect of that period.

Mr Lock argued that the Regulations and related UK legislation were wrong, because (rather like the arguments concerning non-guaranteed overtime) European law required workers to receive 'normal remuneration' for periods of annual leave, which is comparable to periods of work. He argued it should include commission. The ECJ agreed with Mr Lock, and the case was referred back the Leicester Employment Tribunal to determine how his holiday pay should be calculated.

How have the Working Time Regulations been changed?

The ET had to determine whether the Regulations could be read compatibly with the ECJ's decision, and whether words could and should be added to make the Regulations compatible. The ET concluded that it could read the Regulations compatibly by adding in words, because the Regulations had been drafted by Parliament to implement the Working Time Directive.

The ET concluded that Regulation 16, which refers to pay for annual leave being calculated in the same way as a 'week's pay' under the Employment Rights Act 1996, should specify that, for the 4 weeks' EU-derived holiday only, 'a worker with normal working hours whose remuneration includes commission or similar payment shall be deemed to have remuneration which varies with the amount of work done for the purpose of section 221.'

This has the effect of requiring holiday pay for many workers to be calculated based on the provisions of s221 of the Employment Right Act 1996, which provides for using average pay for the 12 weeks before their holiday.

Furthermore, it only concerns the amount of pay a worker must receive when they take annual leave, and does not appear to deal with the lower pay a worker will receive after a period of holiday through not generating sales etc (and therefore commission), which the ECJ had stressed could deter a worker from taking holiday. It remains unclear whether Mr Lock and others will be compensated for that notional loss or whether it would be enough that a worker such as Mr Lock would now receive during holiday their average pay (including commission averaged over the previous 12 week period) as well as actual commission earned in respect of previous months.

What are the key points for employers who pay commission?

It is now clear that employers will need to pay workers who earn commission (based on results, such as sales achieved) holiday pay for their EU-derived 4 weeks' holiday. Providing they have normal working hours and do not do shift work, this will be calculated by reference to the average hourly pay over the 12 week period (working back from the first day the holiday is taken). 

Employers who have already calculated holiday pay based on a 12-week average pay reference period may well be able to prevent costly backdated claims depending on how long they have been making the correct payments.

As the period over which commission should be calculated was not clear until this decision (indeed an Advocate-General of the ECJ had suggested 12 months might be a suitable reference period), many employers may not have been calculating and paying holiday pay correctly. In these circumstances:

  • Claims which are brought on or after 1 July 2015 will not be able to go further back than 2 years; 
  • Claims which are brought before 1 July 2015 could potentially be backdated as far back as the introduction of the Working Time Regulations, but
  • In either case, according to the recent case of Bear Scotland v Fulton, a claim for backdated holiday pay should not be able to go back further than the point where the series of underpayments of holiday pay is broken by a period of more than three months. As in the overtime cases, it will be relevant whether an employer can argue that certain holiday dates were the UK's additional 1.6 weeks' leave (where there is no requirement to include commission) rather than EU-derived 4 weeks' leave to which Lock applies.

Commission structures may well need to be reviewed, although until we have a further ruling on this issue in Mr Lock's case there are limits as to how useful this will be.

This decision could well be the subject of an appeal. It is unlikely that an appeal would challenge the ruling that the Regulations must be interpreted compatibly with the ECJ's decision. What is more likely is a challenge to the words the ET has added to the Regulations. This is because it results in a 12 week reference period, which, in many roles and industries, could be entirely unrepresentative of an individual's normal pay, resulting in artificially high or low holiday pay depending on when holiday is taken.

We recommend that all organisations immediately review their position in relation to staff whose pay may be affected by the Lock decision. This review will be essential in assessing the potential liability for holiday pay. For instance, how many staff earn commission and how significant is it in their remuneration package? What are the contractual or other arrangements already in place? How long have the affected staff worked at the organisation? Could it be established that there has been a gap of more than three months in historic underpayments? These will all be relevant factors to take into account.

The risk assessment will give an indication of the extent of the potential financial liability facing you which, will in turn, help in deciding the most appropriate strategy.

We have a dedicated Employment Team at Blake Morgan who would be happy to discuss these issues further with you.