What Happens When a Company Cannot Pay Its Employees?
Being unable to pay employees is one of the clearest signs that a company is experiencing serious financial pressure. Payroll is usually treated as a priority, so when the money is no longer available to meet it, the problem may extend beyond a temporary shortage of cash.
For directors, this creates an immediate and difficult situation. Employees depend on receiving their wages, but directors must also consider the company’s wider financial position and their responsibilities towards all creditors.
Missing payroll does not automatically mean that a company must close. There may still be options to stabilise or restructure the business. However, it is important to establish quickly whether the problem is temporary or evidence that the company can no longer pay its debts as they fall due.
Are employees still entitled to be paid?
Financial difficulties do not remove a company’s obligation to pay its employees.
Wages, salaries, overtime, commission and other contractual payments must generally be paid in accordance with the employee’s contract. A company cannot simply decide to delay or reduce wages without considering the contractual and employment law implications.
Employees who are not paid may raise a formal grievance, pursue a claim for unlawful deduction from wages or, in some circumstances, resign and argue that the employer has fundamentally breached their contract.
Unpaid employees also become creditors of the company. This means that the amount owed to them forms part of the company’s overall liabilities and must be considered alongside amounts due to HMRC, lenders, landlords, suppliers and other creditors.
The immediate effects can extend beyond the legal position. Employees may be unable or unwilling to continue working, morale may fall and the company could struggle to fulfil customer orders or maintain essential services. This may place further pressure on an already fragile business.
What should directors do before payroll is missed?
Directors should act as soon as they become aware that the next payroll may not be affordable. Waiting until payday can reduce the options available and leave employees with no warning.
The first step is to obtain an accurate picture of the company’s financial position. This should include an up-to-date cash-flow forecast, details of money owed to the company, forthcoming liabilities and realistic expectations about future income.
Directors should consider why the shortage has arisen. A delayed customer payment or unexpected expense may have caused a temporary gap. Alternatively, falling sales, the loss of an important contract, increasing tax arrears or persistent creditor pressure may point to a deeper problem.
Communication with employees should also be handled carefully. Where a delay appears unavoidable, employees should usually be informed as early as reasonably possible. Directors should avoid making promises about payment dates unless they are confident those promises can be met.
Any decisions should be properly documented. Board minutes, forecasts and professional advice can help demonstrate that the directors considered the company’s position and took reasonable steps in response.
Does missing payroll mean the company is insolvent?
A company may be insolvent if it cannot pay its debts when they become due or if the value of its liabilities exceeds its assets.
An inability to pay wages when they fall due is therefore a significant warning sign of possible cash-flow insolvency. However, it should be considered alongside the company’s complete financial position.
If insolvency is likely, directors must give proper consideration to the interests of creditors as a whole. Employees are part of that creditor group once wages remain unpaid. Directors should avoid decisions that unnecessarily worsen losses, favour selected parties or create liabilities that the company has little realistic prospect of paying.
Continuing to trade is not automatically improper simply because the company is experiencing financial difficulty. The concern arises when directors continue taking on obligations without a reasonable basis for believing that the company can meet them, or when doing so leaves creditors in a worse position.
Taking professional advice at this stage can help directors understand whether continued trading is reasonable and what protective steps should be taken.
Can a temporary payroll problem be resolved?
Where the underlying business remains viable, there may be ways to address a short-term cash-flow shortage.
The company might be able to accelerate the collection of outstanding invoices, agree revised terms with creditors, reduce non-essential expenditure or arrange suitable funding. Invoice finance may be relevant where a profitable company is waiting for customers to pay, although any new borrowing must be considered carefully.
If HMRC arrears are contributing to the problem, a Time to Pay arrangement may provide additional breathing space. Whether HMRC agrees will depend on the company’s circumstances, payment history and ability to maintain the proposed arrangement.
More significant restructuring may be required where the company has a viable core business but an unsustainable level of debt. A Company Voluntary Arrangement could allow the company to reach a binding agreement with unsecured creditors while continuing to trade. Administration may be considered where it can rescue the company, protect value or produce a better result for creditors than an immediate liquidation.
These options are highly dependent on timing. Once employees have left, customers have lost confidence or key assets have been lost, preserving the business can become considerably more difficult.
What happens to employees if the company enters liquidation?
Where the company has no realistic prospect of recovery, a Creditors’ Voluntary Liquidation may provide an orderly way to close it.
In most cases, employees will be dismissed and made redundant when the company stops trading. Employees may then be able to claim certain statutory payments from the Redundancy Payments Service, which makes payments from the National Insurance Fund when an insolvent employer cannot meet its obligations.
Depending on their circumstances, eligible employees may be able to claim:
- Statutory redundancy pay
- Up to eight weeks of unpaid wages
- Up to six weeks of holiday pay
- Statutory notice pay
Eligibility conditions and payment limits apply. For redundancies, the weekly rate used for these statutory claims is capped at £751. Statutory redundancy pay is generally available to employees with at least two years’ continuous service and is calculated by reference to age, length of service and weekly pay.
Employees normally need a case reference from the insolvency practitioner or Official Receiver before submitting their claim. A claim for statutory redundancy pay must generally be made within six months of dismissal.
If the amount owed exceeds what can be paid through the statutory scheme, the employee may be able to submit a claim in the insolvency for the balance. Some employee debts are given preferential status, while other amounts may rank as unsecured claims.
The position is broadly similar in a compulsory liquidation, although that process is normally initiated following a winding-up petition rather than being commenced voluntarily by the directors.
What happens to employees during administration?
Administration does not always mean the immediate closure of the business. An administrator may continue trading while exploring a rescue, sale or restructuring.
Some employees may be retained to support ongoing operations, while others may be made redundant. Their position will depend on when employment liabilities arose, whether their contracts were adopted by the administrator and what happens to the business.
Where the company or part of its operations is sold, employees may transfer to the purchaser under the Transfer of Undertakings (Protection of Employment) Regulations, commonly known as TUPE. These rules can preserve continuity of employment and existing contractual rights, although special provisions apply to insolvent businesses and the precise position will depend on the type of insolvency procedure and transaction.
Directors should therefore avoid giving employees firm assurances about redundancies, transfers or unpaid entitlements until the proposed route has been reviewed by the relevant professional advisers.
Do directors need to consider pension contributions?
Payroll difficulties may also affect workplace pension payments.
Employers must account correctly for contributions deducted from employees and pay the required employer contributions into the pension scheme. Missing or withholding pension contributions can create additional liabilities and may attract scrutiny from the pension provider or The Pensions Regulator.
Directors should establish whether deductions have been made from employee wages but not passed to the pension scheme. Complete payroll and pension records should be retained and provided to any subsequently appointed insolvency practitioner or Official Receiver.
How Bretts Business Recovery can help
When a company cannot pay its employees, the immediate concern is understandably the effect on the workforce. However, missed payroll may also indicate that the business is approaching insolvency and that directors need to reconsider how decisions are made.
Early advice can help establish whether the company is facing a temporary cash-flow gap or a more fundamental problem. It also allows directors to explore rescue, restructuring and closure options before the position deteriorates further.
Bretts Business Recovery can review the company’s circumstances, explain the implications for employees and creditors, and help directors understand the most appropriate next steps.