The Court of Appeal has held that in principle there is no reason why someone who is a shareholder and director of a company cannot also be an employee of a company.

Issue

The matter concerned two appeals, both raising similar questions, from the Employment Appeal Tribunal (“EAT”). Mr Neufeld was the respondent to the first appeal and Mr Howe the respondent to the second appeal.

The main issue in the cases before the Court of Appeal was whether Mr Neufeld and Mr Howe had been employees of the failed companies. If they were employees, they would benefit from the protection of section 182 of the Employment Rights Act 1996 (“ERA”) given to employees whose employer has become insolvent. This section of the ERA provides that if an employee makes an application – which satisfies the Secretary of State that the employee’s employer has become insolvent, the employee’s employment has been terminated and the employee was entitled to be paid the whole or part of a debt – then the Secretary of State shall pay the employee out of the National Insurance Fund.

Background Facts: Mr Neufeld

Mr Neufeld began working at Newfeld Press Limited (“NPL”) in 1982 as a salesman and in 1998 he became a director and shareholder in NPL. In July 2001, NPL was transferred to A & N Communications in Print Ltd (“A & N”). Mr Neufeld was a director of A & N and held 90% of its shares; another two directors each held 5% of A & N’s shares respectively. At the time of the transfer it was agreed by all three directors that Mr Neufeld would be A & N’s managing director and also be employed by A & N as part of its sales team. According to Mr Neufeld’s evidence, he worked an average of 60 hours per week carrying out sales and managerial duties for which he was paid a weekly wage subject to PAYE and National Insurance; such evidence pointing to the fact that he was an employee.

Pointing against Mr Neufeld’s employee status was that he had given two guarantees for machinery and sales financing and made a personal loan of £20,000 to A & N. Mr Neufeld made a claim under the ERA for a redundancy payment, notice pay and holiday pay after A & N became insolvent in October 2005. This claim was disputed by the Secretary for Trade and Industry (now the Secretary of State for Business, Enterprise and Regulatory Reform).

The first instance decision of the Employment Tribunal (“ET”) found that Mr Neufeld was not an employee and as such his claim should be dismissed. Mr Neufeld appealed this decision; the appeal being upheld by the EAT who concluded that Mr Neufeld was an employee. The Secretary of State appealed this decision.
 
Background Facts: Mr Howe

In 1979 Mr Howe started Track Records, which at that stage was only a trading name. In December 2004, Mr Howe transferred Track Record’s assets to the newly incorporated TRM. Mr Howe held 100% of TRM’s shares and was the sole director. He arranged to pay himself a weekly salary of which tax and National Insurance was deducted as an employed person. The profits that TRM made were invested back into it. Mr Howe gave a number of guarantees for TRM’s liabilities including one to the landlords of TRM’s shop. Mr Howe also arranged for TRM to borrow £50,000 from the bank, for which he gave a guarantee secured on his own house. By the end of 2006, TRM was experiencing financial difficulties and so, upon the advice of insolvency practitioners, he ran the business down. By August 2007 he had disposed of TRM’s stock and the shop’s fixtures and fitting. Mr Howe put TRM into voluntary liquidation and claimed that his employment had been brought to an end. Mr Howe subsequently made a claim under the ERA for a statutory redundancy payment.

At the ET, the judge found that Mr Howe was an employee of TRM and, therefore, was entitled to be paid the claimed statutory redundancy payment. The Secretary of State appealed this decision. The appeal was dismissed, however, the EAT gave the Secretary of State permission to appeal to the Court of Appeal.

The Court of Appeal Decision

The general questions raised by both appeals were:-

1)         Can a controlling shareholder and director of a company become an employee of that company under a contract of employment?

2)         Are there any guidelines that assist tribunals in deciding whether a shareholder/director has become an employee?

Having reviewed the conflicting case law in this area, the Court of Appeal dismissed both of the appeals. It held that there is no reason in principle why someone who is a director and shareholder, even if they have total control of a company, cannot be an employee of the company under a contract of employment. Further, it will be no answer to such a claim to argue that:-

1)         the extent of the employee’s control of the company is such that the contractual requirement for an employer to control the employee cannot be satisfied; or

2)         that the practical control that the employee has over his own destiny, including the fact that he cannot be dismissed from his own employment except with his consent, prevents him from being an employee.

The Court of Appeal went on to note that whether or not a shareholder or director is an employee is a question of fact for the court or tribunal to decide. In such a case, there will be two issues to decide:-

1)         whether the putative contract is a genuine one or a sham; and

2)         assuming that the contract is genuine, whether it amounts to a contract of employment, rather than, for example, a contract for services.

Comment

The case is useful as it provides clarification on the previous conflicting case law relating to whether shareholders and directors can also be employees. It was noted in the submissions in this case that in 2008 there were some 12,000 claims by directors on the National Insurance Fund. The Court of Appeal decision gives guidance to ETs dealing with such cases, which in the current economic climate will be welcomed as the numbers of such claims are expected to rise. While the case is good news for shareholder/director employees, who may be able to claim redundancy payments, it should act as a warning to prospective purchasers of companies who may obtain additional employment liabilities relating to shareholder or director employees.

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