Holiday pay – a further blow for employers?

Posted: 07/06/2023

Workers’ rights in respect of holiday pay appear to have been further strengthened following a recent case in the Employment Appeal Tribunal (EAT), Connor v Chief Constable of the South Yorkshire Police.

There has been much case law in recent years concerning how employers should calculate pay for holiday that has been taken. Over time, it has become clear that workers are entitled to what they would typically expect to receive in a normal working week, including salary, overtime, commission and any other regular payments.

This is to ensure that employees are not dis-incentivised from taking holiday and that they can take adequate breaks for the benefit of their health. Health and safety concerns were the main driver behind the EU Working Time Directive (WTD), which was implemented in the UK by the Working Time Regulations 1998 (WTR).

However, until now, the case law has focused almost exclusively on pay for breaks actually taken. There has been a grey area over how pay in lieu of accrued but untaken holiday should be calculated at the end of employment or an engagement. Ostensibly, the WTR provide some flexibility here. The rules around calculating pay on termination of employment – which is the only point at which it is permitted for a payment in lieu of holiday to be made – are expressed differently from the formula for payment for leave actually taken. Pay in lieu may be calculated in the same way as pay for leave taken.

However, if employers have in place a ‘relevant agreement’ (which can simply be a clause in the employment contract), they may pay such sum as is determined by that agreement. On the face of it, this appears to allow employers to make payments on termination that do not precisely reflect what the worker would have been paid had they actually taken the leave during their employment. Although EU case law suggests that the sum paid should be more than nominal, there has until now been no binding guidance from the domestic courts on what should be paid in these situations. Many employers will therefore have been making use of the ‘relevant agreement’ to agree something different with their staff.

This is what happened in the Connor case. Mr Connor worked regular hours for a salary and was paid on a monthly basis. When he booked a week's holiday, he was paid based on what he would have earned by way of salary in that working week. However, his contract included a clause providing that, on the termination of his employment, he would be paid any accrued but outstanding holiday, with a day’s pay being calculated as 1/365 of his annual salary. This calendar approach to payment resulted in a lower entitlement on termination as compared with what he would have received had he taken the leave during his employment. However, it appeared to be permitted by the WTR as it was contained in a relevant agreement.

Mr Connor brought a claim in the Employment Tribunal, which was unsuccessful, but appealed to the EAT, which found in his favour. The EAT held that the purpose of Regulation 14 WTR (which is the regulation that deals with payments on termination of employment) was to ‘provide a formula of calculation which promotes the right to leave and the attendant payment for holiday’.

In those circumstances, the court found that a ‘relevant agreement’ cannot provide for a payment that results in the worker receiving less than they would have been paid for having worked during that period. Mr Connor had therefore been underpaid.

Many employers will be unaffected by this case as they will be paying out on termination in the same way as they would for employees who take holiday during employment. This is particularly the case where employees are working regular hours for an annual salary.

However, some employers will be taking advantage of the greater flexibility that Regulation 14 has appeared to offer, particularly for short-term part-year workers. Following the Supreme Court decision in Harper Trust v Brazel in July 2022, such workers have been entitled to a disproportionately high weekly pay rate when calculating holiday pay, because of the requirement to ignore weeks in which no work has been done when carrying out the calculation.

In order to avoid the evident mismatch between the amount of work done and the amount of holiday pay to which someone would be entitled, employers may be making use of Regulation 14 to pay in lieu by using some other formula, commonly 12.07%. This can be particularly helpful where the engagement is for less than a year, and where casual arrangements mean that workers are not typically seeking to book and take leave during an engagement, so there will be a relatively large payment in lieu of annual leave at the end of it.

Employers should note that this is the first binding UK judgment on the calculation of holiday pay for accrued leave. However, it could be open to challenge on a number of grounds. It is worth noting that the only reference in the WTD to payments in lieu is to ban them, save in circumstances where the employment relationship is terminated. The thrust of that statement is clearly not to set out the rationale for how payments in lieu should be calculated, but to make it explicit that they are not the norm. This is presumably why Regulation 14 was drafted in a different way from the rules governing pay taken during employment.

It begs the question why Regulation 14 was framed in the way it was (ie with the option to pay using a different formula) if it were not envisaged that some other calculation might be made. By requiring employers to pay at least a normal week’s pay, it may actually result in workers not taking the leave they are entitled to during their employment, if they know they are about to leave. Arguably, therefore, the EAT in this case went too far in trying to interpret UK law in the light of EU law.

It is also worth pointing out that the EAT in this case was dealing with a straightforward salaried employment. It did not have to grapple with the issues that arise with part-year workers. If it had done so, it would have needed to consider EU case law, which adopts a more straightforward approach to the calculation of a week’s pay, in contrast to the Harpur Trust v Brazel case. Any employer wanting to challenge the findings in this case could therefore have good arguments to do so, but will need to be prepared to take things to the EAT or beyond.

Employers may well take a pragmatic approach bearing in mind the likelihood of legislative changes in the near future. A consultation has already taken place, which proposes effectively to allow the use of 12.07% to calculate holiday entitlement, including for part-year workers. This would allow non-worked weeks to be taken into account when calculating a week's pay.

Although it does not specifically address the question of payments in lieu upon termination of employment, it seems likely that this issue would be dealt with at the same time. Employers may also take a view based on the level of possible liability in these cases – claims in relation to pay in lieu of untaken holiday will necessarily be limited because, in most cases, workers will not be able to look back further than the existing holiday year. However, workers are a principled group: Mr Connor’s case was worth only £53.90. 

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