European Court rules ‘rolled-up’ holiday pay is unlawful

A ruling by the European Court of Justice (ECJ) in the case Caulfield v. Hanson Clay Products Ltd (formerly Marshalls Clay Products Ltd) indicates that 'rolled-up' holiday is unlawful even if it is clear in the contract of employment what proportion or amount of the rolled-up pay is holiday pay.

'Rolled-up' holiday pay refers to the practice of an employer agreeing with workers that their pay for annual leave is included in their hourly remuneration and paid as part of remuneration for working time but not paid in respect of a specific period of leave actually taken.

The ECJ has decided that the practice is not lawful under the Working Time Directive - holiday pay must be paid in respect of a specific period during which the worker actually takes leave. That is a harder line than was taken by Advocate General in her Opinion last year. The Advocate General's Opinion suggested that rolled-up holiday pay could be lawful subject to certain safeguards being in place to ensure that workers can take the leave to which they are entitled under the Directive. In most cases, the Advocate General's Opinion is followed by the ECJ but it does not have to be.

The ECJ's Judgement points out that Member States are required to take the measures appropriate to ensure that practices incompatible with the provisions of the Directive relating to the entitlement to annual leave are not continued – that is likely to mean that the practice of paying rolled-up holiday pay used by many employers in the UK will have to stop.

Many employers, particularly in the construction, manufacturing and education sectors, will be wondering what the effect of this decision is likely to be on sums already paid to workers in respect of holiday through a system of rolled-up holiday pay. Helpfully for employers, the ECJ Judgment says that holiday payments made as part of a rolled-up rate in a transparent and comprehensible way may, as a rule, be set off against payment for specific leave.

Commenting on the ruling Philip Titchmarsh, Employment Senior Associate at Pinsent Masons, said:

"The ECJ have decided that payment for annual leave through rolled-up holiday pay is contrary to the Working Time Directive. Holiday pay must be paid in respect of a specific period during which the worker actually takes leave. The good news for employers who have paid workers for holiday through a system of rolled-up holiday pay, is that payments made transparently and comprehensibly may be set off against the payment due for specific leave.

"In practical terms, it would seem that the practice of paying rolled-up holiday pay will have to stop because it can lead to workers not taking their 4 weeks annual leave entitlement under the Working Time Regulations. But employers who have already paid sums to workers in respect of holiday pay in a transparent and comprehensible way as part of rolled-up rate, will be entitled to credit for such sums against payment due for a specific period of leave. There is only likely to be a financial exposure for those employers who have paid rolled-up holiday pay in a way which lacks transparency."

The ECJ Judgment is particularly significant because of the conflicting case law in the UK - in the Marshalls case the EAT and the Court of Appeal were inclined to allow employers to use rolled up hourly rates of pay, but there is a Scottish Court of Session case (MPB Structures Limited v. Munro) which ruled that these practices were unlawful.

Essentially, the issue of 'rolled' up pay arises when employers pay workers by the hour and add to their hourly rate of pay a specified percentage for holiday pay. The worker therefore receives holiday pay on an ongoing basis throughout the year but does not receive a separate payment as and when leave is taken - indeed the worker may not formally take any particular period of leave, but is treated as being on holiday when he or she is not working. Payment of holiday pay through this rolled up hourly pay system is administratively convenient for employers as they do not have to specifically calculate holiday pay every time a worker takes leave, which is especially beneficial for the employer in circumstances where hours of work (and therefore amounts of pay) fluctuate throughout the year. However the system has been criticised as discouraging workers from taking holiday, particularly as the more work the individual carries out the more pay given during the year.

Because the rolled up holiday pay system has been found to be unlawful by the ECJ, employers will face administrative inconvenience. They could also potentially have faced the problem of not being given credit for the holiday element of the rolled-up rate so as to set this off against the entitlement to holiday pay under the Directive. The Munro case established that, if the employer has not been paying for holiday pay validly under the Working Time Regulations, any payments made to the employee do not count. It is good news for employers that the ECJ Judgment allows for off-setting where the rolled-up holiday pay system has been operated in a transparent and comprehensible manner.

It had been thought there would also be potential for large claims for backdated holiday pay going back as far as 1 October 1998 when the Working Time Directive was implemented in to domestic law by the Working Time Regulations. However, in 2005 the Court of Appeal held in Inland Revenue v. Ainsworth that claims to enforce entitlement to holiday pay can only be brought under the Working Time Regulations and not as a claim for unauthorised deductions from wages. The effect of this is to limit a claim for backdated holiday entitlement to the most recent holiday year.