In a case in which it ultimately decided that a claimant did not
qualify for employee protection, the EAT outlined how such issues
should be decided.
Employees receive certain protections not available to people
who are solely business owners or controlling shareholders.
Employment Tribunals can only rule on disputes involving people who
have been employees for 12 continuous months.
In the case of J.E. Clark and Clark Construction Initiatives
(CCI), a company he founded and passed on to business partners, an
Employment Tribunal found that for one month in the year before his
dismissal Clark had been a controlling shareholder but not an
employee of the firm.
It said, then, that it had no jurisdiction to hear the claim of
unfair dismissal.
Though the EAT agreed with that assessment of Clark's position,
it also outlined the factors companies should keep in mind when
deciding whether a shareholder is entitled to employee
protection.
"Classically, when the courts are faced with the situation
whether someone is an employee or not, the alternative is that he
is an independent contractor. The distinction between the two is
often hard to draw, and cases are highly fact sensitive, but in
general the purpose of the exercise is designed to determine how
fully the individual is integrated into the business and,
conversely, how far he can be said to be working for himself," said
Mr Justice Elias in the EAT ruling.
"When the question is whether a controlling shareholder is also
an employee, the task is generally a very different one," he said.
"In practice the individual will almost always be fully integrated
into the business, frequently as the managing director or some
other executive director. It is not the lack of control of the
company over the individual but rather the extent of the control of
the individual over the company which sometimes creates doubts as
to whether the contract of employment truly reflects the nature of
the relationship."
Clark was working as a builder for his own firm but was paid a
very small salary while he paid for his living expenses through the
firm in the form of loans.
Clark went into business with a Mr and Mrs Grew and, while going
through a divorce, transferred the company to them.
The Tribunal found that for a period within 12 months of his
dismissal, Clark was not an employee of CCI.
"The majority of the claimant's income came from his borrowings
from the company," said the Tribunal ruling. "The ability to pay
back those borrowings would depend upon the success of the company.
A substantial risk had, as the claimant acknowledged ruefully in
tribunal, been taken."
"He was paying himself in a way that no normal employee would be
paid. He was by all accounts during that second phase the
controlling shareholder of the company that bore his name. The
evidence would seem to establish that it was he that structured the
financial arrangement for tax efficiency with his accountant- again
not something an ordinary employee would do," it said.
The EAT agreed, saying that the Tribunal was perfectly within
its rights to make that ruling. It said that there were three
situations in which a supposed employment contract would be found
not to be binding.
They were: when the company is a sham; when the contract is
entered into for an ulterior purpose, such as receiving state
payments; and when the employee and employer do not behave in the
way described in the contract.
Employment law expert Ben Doherty of Pinsent Masons, the law
firm behind OUT-LAW.COM, said that such decisions are specific to
each case.
"It has already established that there is nothing stopping a
controlling shareholder from being an employee, however it will
depend upon the individual facts and circumstances of each case,"
he said. "An Employment Tribunal will consider any contract that is
in place between a company and the alleged employee and will then
examine what has actually happened in practice."
"For example, if the contract provides for 30 days' paid holiday
a year but the controlling shareholder/employee has actually taken
40 days' paid holiday in a year then it would be indicative that
they are not actually an employee," he said.
The EAT issued guidance on what companies should take into
account if this question arises, which we reprint here in full:
"How should a Tribunal approach the task of determining whether
the contract of employment should be given effect or not? We would
suggest that a consideration of the following factors, whilst not
exhaustive, may be of assistance:
- Where there is a contract ostensibly in place, the onus is on
the party seeking to deny its effect to satisfy the court that it
is not what it appears to be. This is particularly so where the
individual has paid tax and national insurance as an employee; he
has on the face of it earned the right to take advantage of the
benefits which employees may derive from such payments.
- The mere fact that the individual has a controlling
shareholding does not of itself prevent a contract of employment
arising. Nor does the fact that he in practice is able to exercise
real or sole control over what the company does ([from the case of]
Lee).
- Similarly, the fact that he is an entrepreneur, or has built
the company up, or will profit from its success, will not be
factors militating against a finding that there is a contract in
place. Indeed, any controlling shareholder will inevitably benefit
from the company's success, as will many employees with share
option schemes (Arascene).
- If the conduct of the parties is in accordance with the
contract that would be a strong pointer towards the contract being
valid and binding. For example, this would be so if the individual
works the hours stipulated or does not take more than the
stipulated holidays.
- Conversely, if the conduct of the parties is either
inconsistent with the contract (in the sense described in para.96
[of the judgment at the link below]) or in certain key areas where
one might expect it to be governed by the contract is in fact not
so governed, that would be a factor, and potentially a very
important one, militating against a finding that the controlling
shareholder is in reality an employee.
- In that context, the assertion that there is a genuine contract
will be undermined if the terms have not been identified or reduced
into writing (Fleming). This will be powerful evidence
that the contract was not really intended to regulate the
relationship in any way.
- The fact that the individual takes loans from the company or
guarantees its debts could exceptionally have some relevance in
analysing the true nature of the relationship, but in most cases
such factors are unlikely to carry any weight. There is nothing
intrinsically inconsistent in a person who is an employee doing
these things. Indeed, in many small companies it will be necessary
for the controlling shareholder personally to have to give bank
guarantees precisely because the company assets are small and no
funding will be forthcoming without them. It would wholly undermine
the Lee approach if this were to be sufficient to deny the
controlling shareholder the right to enter into a contract of
employment.
- Although the courts have said that the fact of there being a
controlling shareholding is always relevant and may be decisive,
that does not mean that the fact alone will ever justify a Tribunal
in finding that there was no contract in place. That would be to
apply the Buchan test which has been decisively rejected.
The fact that there is a controlling shareholding is what may raise
doubts as to whether that individual is truly an employee, but of
itself that fact alone does not resolve those doubts one way or
another."
