Company law – Determining employment status of shareholders and directors

Secretary of State for Business, Enterprise & Regulatory Reform v (1) Richard Neufeld (2) Keith Howe: CA (Civ Div) (Lords Justice Rix, Toulson, Rimer): 2 April 2009

The appellant secretary of state, in two joined cases, appealed against decisions of the Employment Appeal Tribunal that the respondents were employees under section 230 of the Employment Rights Act 1996 and were, therefore, entitled to payment under section 182 of the act on the insolvency of the companies that had respectively engaged them.

Each respondent had received a salary and had paid tax and national insurance as an employed person and purportedly had an oral contract of employment. Each had given personal guarantees in respect of his company’s business. The first respondent had also made a personal loan to his company. Each had also been the controlling shareholder and a director of his company.

The general issues were whether (i) a controlling shareholder and director of a trading company could become an employee of that company under a contract of employment; (ii) if yes, were there any guidelines which may assist tribunals in deciding whether in any particular case such a shareholder and director was also an employee.

Held: (1) There was no reason in principle why a shareholder, or controlling shareholder, and director of a company could not also be an employee of the company under a contract of employment. It would, in particular, be no answer to his claim to be such an employee to argue that the extent of his control of the company meant that the control condition of a contract of employment could not be satisfied. The relevant control was in the company, Lee v Lee’s Air Farming Ltd [1961] AC 12 PC (NZ) applied. Also it would be no answer to say that the practical control he had over his own destiny, including that he could not be dismissed from his employment except with his consent, had the effect in law that he could not be an employee, Secretary of State for Trade and Industry v Bottrill [2000] 1 All ER 915 CA (Civ Div) applied.

(2) The court gave fresh guidance in deciding whether in any particular case a shareholder and director was also an employee: (a) it was a question of fact requiring consideration of whether the putative contract of employment was a genuine or sham contract and whether, assuming it was a genuine contract, it amounted to a true contract of employment; (b) in cases involving an alleged sham, the court’s task was to decide whether a purported formal written employment contract or memorandum purporting to record or evidence the creation of such a contract amounted to a sham, particularly having regard to the circumstances of the creation of the document and the parties’ conduct under the purported contract of employment, Snook v London and West Riding Investments Ltd [1967] 2 QB 786 CA (Civ Div) applied, and Protectacoat Firthglow Ltd v Szilagyi [2009] EWCA Civ 98 considered. The fact that the putative employee had control over the company, and so was instrumental in the creation of the very contract that he was asserting, would be relevant to whether the contract was a sham; (c) in cases that raised no allegation of sham, it would or may be necessary to inquire into what had been done under the claimed contract, given that the critical question was whether the putative employee was an employee at the time of the company’s insolvency. For the employee to make good his case, it may well be insufficient merely to place reliance on a written contract made years earlier. The court would want to know that the claimed contract, perhaps as subsequently varied, was in place at the time of the insolvency; (d) in a case in which the alleged contract was not in writing, or was only in brief form, it would usually be necessary to inquire into how the parties had conducted themselves under it; (e) in deciding whether a valid contract of employment was in existence, consideration would have to be given to the requisite conditions for the creation of such a contract and the court would want to be satisfied that the contract met them; (f) the following features would not ordinarily be of any special relevance and should be ignored in deciding whether the putative employee had a valid contract of employment: his controlling shareholding in the company, share capital invested by him in the company, loans made by him to the company, his personal investment in the company and his other actions that a owner of business would commonly do on its behalf; (g) the court agreed with the essence of the factors set out in a case to determine whether a contract of employment should be given effect, Clark v Clark Construction Initiatives Ltd [2008] ICR 635 EAT applied. In cases where the putative employee was asserting the existence of an employment contract, it would be for him to prove it and the mere production of what purported to be a written service agreement may by itself be insufficient to prove the case sought to be made. If the putative employee’s assertion was challenged, the court would need to be satisfied that the document was a true reflection of the claimed employment relationship, for which purpose it would be relevant to know what the parties had done under it. If the parties’ conduct under the claimed contract pointed convincingly to the conclusion that there was a true contract of employment, the court would not wish employment tribunals to seize too readily on the absence of a written agreement as justifying the rejection of the claim.

(3) In the circumstances, each respondent had been an employee, Fleming v Xaniar Ltd (In Liquidation) [1998] SC 8 IH (1 Div) and Nesbitt v Secretary of State for Trade and Industry [2007] IRLR 847 EAT considered.

Appeals dismissed.

Adam Tolley (instructed by the Treasury Solicitor) for the appellant; Clive H Jones (pro bono) (instructed by Verisona) for the first respondent; no appearance or representation for the second respondent.