UK: European Court of Justice Ruling Indicates that ‘Rolled-Up’ Holiday Pay is Unlawful

Originally published 16^th March, 2006*

A ruling today* by the European Court of Justice (ECJ) in the case Caulfield v Hanson Clay Products Ltd (formerly Marshalls Clay Products Ltd) indicates ‘rolled-up’ holiday pay is unlawful even if it is clear in the contract of employment what proportion or amount of the rolled-up pay is holiday pay. Pinsent Masons is acting for the employer in this case.

What is rolled-up 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. It is a practice used by many employers in the UK, particularly in the construction, manufacturing and education sectors.

Although there are many variations, essentially the issue arises when employers pay workers by the hour and agree to 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 they earn during the year.

The ECJ has decided that the practice of rolling up holiday pay 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. This is a harder line than was taken by the Advocate General in her Opinion last year. The Advocate General's Opinion suggested that rolled-up holiday pay could be lawful subject to the employer putting in place safeguards to ensure that workers can take the leave to which they are entitled under the Directive. In most cases the ECJ follows the Advocate General's Opinion but it does not have to. The ECJ's Judgment is likely to mean that the practice of paying holiday pay as part of a rolled-up rate will have to stop.

Many employers 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, the ECJ Judgment says that holiday payments made as part of a rolled-up rate in a transparent and comprehensible way may be set off against payment for specific leave.

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.

Because the rolled up holiday pay system has been found to be unlawful by the ECJ, employers are likely to 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 that there would also be the 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.

In practical terms, it would seem that the practice of paying rolled-up holiday pay is going to have to stop because the ECJ has decided that it can lead to workers not taking their 4 weeks annual leave entitlement under the Working Time Regulations. Employers who use systems of rolled-up holiday pay would be best advised to change to a system which ensures that workers are paid in respect of specific periods of leave.

Employers who have already paid sums to workers in respect of holiday pay in a transparent and comprehensible way as part of a rolled-up rate, will be entitled to credit for such sums against payment due for a specific period of leave. This means that there is only likely to be a financial exposure as a result of the ECJ's Judgment for those employers who have paid rolled-up holiday pay in a way which lacks transparency.