Employees fearing job cuts may be dressing more smartly - as increased sales of certain items of clothing show - but just in case the new tie fails to save you from the axe, it could pay to smarten up on your knowledge of redundancy rights. If you are shown the door, employers do have certain financial obligations. But what if your employer goes bust?

With a rising number of UK companies closing for business, and bleak economic times ahead, read our guide to ensure that you are prepared for the worst.

What is redundancy?

Redundancy, despite its generic use to describe all types of sacking, is a dismissal that occurs because the employer needs fewer employees. Workers are most at risk when an employer has gone bust and cannot find a buyer for the business.

Your rights

There are two sets of rights: those governed by contract and those governed by statute.

Contractual compensation is due when an employee is dismissed without notice or justification. Compensation should start at an amount equal to the value of the salary that would have been received during the notice period, as well as fringe benefits, such as pension contributions or the use of a company car. However, this is subject to a duty placed on employees to seek to reduce their potential loss by looking for alternative employment.

Some employment contracts include additional terms, such as a month's pay for each completed year of service, or, if nearing retirement age, early receipt of a full pension.

With statutory compensation, employees who have completed more than two years' continuous service are entitled to receive from the employer a statutory redundancy payment of between a week and a week and a half's pay for each completed year of employment. The calculation of a week's pay is capped (now £330) and can be deemed to be already included in a contractual redundancy payment that exceeds this amount.

What if an employer goes bust?

A struggling company will often pour all its resources into trying to keep the business afloat. If this fails, it may not have enough money to pay employees what it owes them.

An insolvency practitioner will be called in to make special arrangements with a view to meeting the debts out of the employer's remaining assets. Employees normally rank as unsecured creditors, but certain parts of an employee's claim have a higher priority and are paid before claims of other unsecured creditors but after the payment of insolvency expenses.

These priority claims are known as preferential debts and include all accrued holiday pay and wages, such as salary arrears, contractual bonuses, commission and overtime. However, in relation to wages, employees are treated as preferred creditors up to only £800 for the four months immediately before the insolvency date. This means that they may recover only a small proportion, if any, of the money owed.

They will be treated as unsecured creditors on amounts above the cap. Consequently, after secured creditors have been paid, they will share what is left - if anything - equally with the other creditors.

State insolvency compensation

If an employer is insolvent, an employee can claim certain outstanding amounts from the State. These payments are made from the National Insurance Fund and include statutory redundancy payments, statutory notice pay, arrears of wages for up to eight weeks and up to six weeks of holiday pay.

Under statute, during the first two years of employment, an employee is entitled to one week's notice. After this, the entitlement is one week for each completed year, up to a maximum of 12 weeks.

A further constraint is that a week's pay is capped at a statutory maximum (now £330) and income tax and national insurance contributions can be deducted, too.

Making a claim

Employees can claim by completing form RP1, which can be downloaded from the Insolvency Service website at www.insolvency.gov.uk, and sending it to the appropriate redundancy payments office. However, where an insolvency practitioner has been appointed, the redundancy payments office will not normally make a payment from the National Insurance Fund until the insolvency practitioner has put in a statement of what is due to the employee. Alternatively, employees can submit their claims to the insolvency practitioner when one has been appointed.

Making a complaint

Employees who want to make a complaint about the insolvency practitioner, or the way in which the redundancy is being treated, should first raise the issue with the insolvency practitioner concerned.

If the employee remains dissatisfied after following this procedure, the issue can then be taken up with the insolvency practitioner's authorising body, details of which can be obtained from the Insolvency Service.

Ian Hunter is head of employment at Bird & Bird, the City law firm

How to protect yourself

The only insurance that will cover your income in the event of redundancy is stand-alone payment protection insurance (PPI).

PPI is often taken out alongside a mortgage, personal loan or credit card to cover repayments. But it can also be bought as a stand-alone policy to cover monthly income up to £2,500. Emma Walker, of moneysupermarket.com, the comparison website, says: “Stand-alone PPI usually costs about £4 a month for every £100 of cover.”

Stand-alone PPI will pay out if you lose your income through accident, sickness or unemployment (including redundancy). However, there are limits on the cover provided.

Matt Morris, of Lifesearch, the insurance broker, says: “In the event of unemployment, a stand-alone policy will pay out for only a short time, usually about 12 months. You can choose the period at which it starts to pay out; usually 30, 60 or 90 days after you lose your job. The sooner it pays, the more expensive the premiums.”

PPI sold with loans is often criticised for having too many exclusions on its sickness and accident cover. For example, it will not pay out for backache or stress. However, the unemployment cover could be invaluable if you lose your job through no fault of your own. But be aware that insurers will not pay out if you knew when you took out the policy that your employer was poised to make redundancies.

Those who are seeking more comprehensive accident and sickness cover should consider an income protection policy. This does not cover redundancy, but it will pay part of your salary - usually 50 per cent - in the event of accident or illness until you return to work or retire.