Legal Updates

Employment Law – Controlling Shareholder and Director Treated as an Employee? Employee Contract of Employment

In the recent case of Neufeld and another v Secretary of State for Business, Enterprise and Regulatory Reform [2009] the court of appeal clarified the approach that should be adopted by employment tribunals when determining whether an 'employee' of an insolvent company enjoys the protection given under s.182 of the Employment Rights Act 1996 (“the Act”) in circumstances where the 'employee' was the controlling shareholder and a director of the company.

According to s.182 of the Act:

”If, on an application made to him in writing by an employee, the Secretary of State is satisfied that:

(a) The employee's employer has become insolvent;

(b) The employee's employment has been terminated; and

(c) On the appropriate date the employee was entitled to be paid the whole or part of any debt to which this Part applies,

The Secretary of State shall, subject to section 186, pay the employee out of the National Insurance Fund the amount to which, in the opinion of the Secretary of State, the employee is entitled in respect of the debt”.

The claimants in this case were involved with a number of companies that went into insolvency. In each case, the only issue to be determined was whether each claimant was to be considered an 'employee' of the failed company in question.

In the event that the claimant was held to be an ‘employee’ they enjoyed the protection provided by s.182 of the Act. However, in each case under appeal the claimant in question was also the controlling shareholder and a director of the company. The Secretary of State requested the court to clarify the approach that should be adopted by employment tribunals when determining cases of these circumstances.

A number of issues arose:

• Whether a controlling shareholder and director of a trading company could become an employee of the trading company by entering a contract of employment; and
• If so, whether any guidelines existed to assist tribunals in deciding if such an individual had become an employee.

The appeals were dismissed.

It was held that, in principle, there was no reason why an individual who was both a shareholder and a director of a company could not simultaneously be an employee of the company under a contract of employment.

Furthermore, it was also held that, in principle, there was no reason why an individual whose shareholding in the company gave him control of it, even 100% control, could also not be an employee of the company under a contract of employment. Therefore, an individual whose economic interest in a company meant that he was in practice properly to be regarded as the 'owner' could also be an employee of that company.

In the event that such an individual brought a claim as an employee, it could not be argued against him that:

• The extent of his control of the company meant that the control condition of a contract of employment could not be satisfied; or
• The practical control he had over his circumstances, including that he could not be dismissed from his employment without his consent, had the effect in law that he could not be an employee at all.

The court also stated that whether or not such an individual was an employee of the company was a question of fact for the court or tribunal dealing with a particular case to decide. There could only be two issues, although, the courts were of the opinion that in practice the evidence relating to the resolution of either issue would be likely to overlap:

• The first issue would be whether the putative contract was a genuine contract.
• The second issue would be whether, in the event it was a genuine contract, it amounted to a contract of employment (it might, for example, instead amount to a contract for services).

Where cases involve an alleged sham contract, the court held that there would almost certainly exists a document purporting to be a formal written employment contract, a board minute or a memorandum purporting to evidence the creation of such a contract. It would then be the task of the court or tribunal hearing the case to establish whether any such document amounted to a sham contract.

Such an inquiry would typically require an investigation into the circumstances surrounding the creation of the document as well as an investigation into the party's purported conduct under it. This would provide an indication as to whether the purported contract was genuine or not.

It should be noted that the fact that any employee in such circumstances had control over the company in question and its board, and was therefore instrumental in the creation of the contract he was asserting, would clearly be a relevant matter in the court's determination as to whether the contract was a sham or not. The court was of the opinion that such circumstances would probably initiate the inquiry in the first place.

Any inquiry into what the party had carried out under the purported contract could demonstrate a number of issues:

• That the party had not acted in accordance with the purported contract, which would support the conclusion that it had been a sham contract;
• That the party had acted in accordance with it, which would support the conclusion that it had been a genuine contract;
• That although the party had acted in a way consistent with a genuine service contract arrangement, what the party had done suggested the making of a variation of the terms of the original purported contract; or
• That there had came a point when the party had ceased to conduct himself in a way consistent with the purported contract or any variation of it, which could mean that although the contract had originally been genuine, it had been impliedly discharged.

Ultimately, the court held that it would be a question of fact regarding what conclusions were to be drawn as a result of any such investigation.

Where the court or tribunal was presented with a case in which no allegation of a sham contract was made, or in which the claimant had proved that no question of sham contract existed, the court or tribunal would have to determine whether the claimed contract amounted to a true contract of employment.

In addition, the court stated that in deciding whether a valid contract of employment had been in existence, the court or tribunal would have to consider the requisite conditions for the creation of such a contract and be satisfied that the contract in question met them.

The court was aware that in cases involving small companies it might be a difficult question as to whether or not the correct conclusion from the facts of the case was that the individual had been an employee as he claimed. For example, a director of a small company was the holder of an office and would not, merely by virtue of such office, be considered to be an employee. The individual in question would have to show more than his appointment as a director to be deemed an employee.

In such circumstances, it would be necessary to consider how he had been paid. If the individual received payment in the form of a salary, the argument for his employment would be strengthened, and if he received payment in the form of director’s fees, the argument for his employment would be weakened. Further consideration should also be given to whether the putative employee had been acting merely in his capacity as a director of the company, or whether he had been acting as an employee.

The putative employee's shareholding in the company would obviously influence the assessment that would be made of the actions carried out under the putative employment contract in question. However, the court stated that it would not typically be of any special relevance in deciding whether or not the contract was valid.

It should be noted that the following facts would not be of any special relevance in deciding whether the contract was valid:

• The fact that the party would most likely have share capital invested in the company;
• The fact that the party might have made loans to the company;
• The fact that the party may have personally guaranteed the company’s obligations;
• The fact that the party’s personal investment in the company would increase in value proportionately to the company's prosperity; or
• The fact that the party had carried out any of the activities that the 'owner' of a business would usually do on the company’s behalf.

The court was of the opinion that all of the above considerations were usual features of the company giving rise to the type of issue as featured in these appeals. However, they would ordinarily be irrelevant with regards to whether a valid contract of employment had been created, and therefore the court stated that they could (and should) be ignored. The above considerations show an 'owner' of a company can act as an 'owner' of a company, which was obviously inevitable. However, they did not show that the 'owner' of a company could not also be deemed an employee of that company.

If you require further information please contact us at [email protected] or Visit http://www.rtcoopers.com/practice_employment.php.

• To obtain further information on redundancy - http://www.rtcoopers.com/faq-redundancyemployee.php
• A video on compromise agreements - http://www.employmentlawyersinlondon.com/video.php
• A website dealing specifically with compromise agreements-  http://www.employmentlawyersinlondon.com
• A blog on compromise agreements http://www.adviceoncompromiseagreements.com .

© RT COOPERS, 2009. This Briefing Note does not provide a comprehensive or complete statement of the law relating to the issues discussed nor does it constitute legal advice. It is intended only to highlight general issues. Specialist legal advice should always be sought in relation to particular circumstances.