Emma Renke is an experienced employment law litigator who heads up the MidlandHR employment law consultancy team.

Since the introduction of the Working Time Regulations 1998 employers have been calculating the meaning of a weeks’ pay, for the purpose of making holiday pay payments, within the definition contained in the Employment Rights Act 1996. This method has been backed by the courts in cases such as Bamsy v Albion and Evans v Malley Organisation. So, where exactly do we stand on this issue now and how should HR teams deal with this problem?

In practice, basic salary (as opposed to voluntary overtime, commission payments, or other supplementary bonuses) has been the basis for calculating a week’s pay for most employees. In a series of cases, starting with a class action of British Airways pilots in the case of Williams v British Airways, the European Court of Justice has disagreed with this approach.

The European Court of Justice (ECJ) has confirmed that all payments intrinsically linked to an employee’s performance on their contract of employment, are payable as a portion of holiday pay. Consequently, holiday pay should be reflective of an employee’s normal remuneration. The rationale behind this approach is that failing to make such payments reduces an employee’s earnings whilst on annual leave. This acts as a disincentive to take holiday, and is not in line with the objective of the Working Time Directive.

The down side for employers is that they face huge financial penalties for this inadvertent underpayment of holiday pay. The issue is compounded by the fact that, for claims brought in the Employment Tribunal, employees can plead that the last deduction from holiday pay was one in a series of deductions, going back several years. This makes this type of litigation a huge, financial headache for businesses.

With the claimant litigation industry already gearing up to take on such claims, what assistance can a prudent HR professional offer their organisation’s management team? The first step is clear, to get one’s head around the scale of the problem. As time consuming as it might be, a review of the existing payroll records, to determine the worst case scenario, is the sensible first step. Following this, several options exist for consideration.

Within the legal arena several different responses have been suggested, although no consensus found. These responses range from awaiting the outcome of the European Appeal Tribunal appeals, to settling back pay claims now, or even to adjusting the way holiday payments are made in an effort to avoid both future costs and back pay claims.

Each approach comes with its own positives and negatives, as well as its own level of risk.  Regardless of the path taken, HR professionals need to be clear on the issue, and work with their legal service provider to get things right for the future to limit costs risk to the business and so that employees are treated fairly.