When will a director and shareholder of a company also be considered an employee/worker?

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The Employment Appeal Tribunal (EAT) has again had to consider the issue of employment status – this time in the context of a director and shareholder arguing that they were also an employee or worker for the purposes of the Employment Rights Act 1996. The EAT's findings offer a further view on the ever-evolving question of employee classification.

Facts

In Rainford v. Dorset Aquatics Ltd (Rainford), the Claimant and his brother owned a small family company (the Respondent), of which they were both co-directors and shareholders. The Claimant owned 40% of the shares, whilst his brother owned 60%. There were no written contracts governing the brothers' involvement in the company but they agreed to split the work between them. The Claimant's predominant role was as a site manager for one of the company's longstanding landscaping projects. The brothers also agreed to pay themselves dividends based on their respective shares at the end of the year and, for tax reasons, both the Claimant and his brother were also paid a "salary" of £1,500 per month from which PAYE and National Insurance contributions were deducted.

In June 2018, the Claimant decided to step away from the Respondent company, stating that he felt "like an employee, with equal, if not less respect given to [him] as any other member of staff". However, he continued to work on the landscaping project until October 2018, invoicing the clients for that work through his partner's hair salon – a separate company. 

In due course, the Claimant brought claims against the Respondent for unfair dismissal, notice pay, unlawful deductions and holiday pay. A preliminary issue therefore arose as to the employment status of the Claimant. 

The Employment Tribunal (ET) decision

The Respondent argued that the Claimant had never been an employee or worker of the company and that therefore his claims could not be maintained. The ET analysed section 230 of the Employment Rights Act 1996 and the three-stage test for the existence of a contract of employment.

By way of background, the three-stage test was established in the case of Ready Mixed Concrete (South East) Ltd v. Ministry of Pensions and National Insurance in 1968 and provides that an employment relationship will exist where:

  • a person performs a service for a company in exchange for remuneration;
  • that person is subject to the control of the company to a sufficient degree to render the company their "master"; and
  • the contractual provisions in place are consistent with ordinary contracts of employment.

In the present case, there was no evidence of any relevant express contract, whether written or oral and the ET, therefore, had to decide whether one should be implied from the conduct of the parties and any other relevant circumstances. In making this decision, the ET relied on several findings of fact. These included: that there were four other employees in addition to the Claimant and his brother and that there was a clear difference in status between them; that the Claimant decided on his own hours of work and that there was no control over how he carried out that work; that he took holidays when he wished, subject only to co-ordinating with his brother; and that he was free to provide a substitute to carry out his work, as well as carrying out work outside the Respondent's business.

As a result of these findings, the ET held that there was no mutuality of obligation; that the Claimant was neither an employee nor a worker, despite the payment of a small "salary"; and therefore that his claims could not be upheld. 

The EAT decision

The Claimant appealed the ET's decision on four grounds. In summary, he argued that there were three categories of contract under section 230 of the Employment Rights Act 1996, as described in the case of Clyde and Co LLP v. Bates van Winkelhof in 2014. These were: an employee; a worker; and a self-employed contractor working for a client or customer. He submitted that, since the ET judge had found that he received a salary for his work and that the arrangement was not a sham, it followed that he must fall into one of these three categories. Further, he argued that, since the Respondent was not his client or customer, he must be an employee or a worker. 

The EAT, however, rejected the Claimant's argument. It held that first, although it is perfectly possible for a director or shareholder of a company to be an employee or worker, the fact that someone does work for a company and receives money does not necessarily mean they fall into one of the three categories identified in the 1996 Act. Second, the ET judge was entitled to find that there was a right of substitution (despite the fact that this had never been used in practice). Third, the ET had not erred by considering the Claimant's level of control/stake in the company as, although this was not directly relevant to the question of whether he was an employee or worker, it did not have any significant influence on the ET's decision. 

Ultimately, the EAT held that the ET's decision was one based on the relevant factors and was not perverse. The Claimant's appeal was dismissed.

Discussion

This case reiterates the approach to employee classification. It is the particular facts and circumstances of a case that are determinative when looking at employee status, rather than any "label" that is given. It is also a reminder that directors and shareholders can perform work for a company without necessarily being an employee or worker under the 1996 Act. The payment of a "salary" with payslips and PAYE/National Insurance deductions will be relevant for these purposes, but it is by no means decisive in itself. 

This case is very fact-specific. Where the relevant criteria are met, a director/shareholder will often also be deemed to be an employee or worker under the 1996 Act. Where this is the case, employers are at risk of breaching the National Minimum Wage Regulations if the relevant director/shareholder is not receiving sufficient remuneration. Buyers in particular should be aware of this possibility during a due diligence process and should insist on rectification and indemnities where necessary. 

Ultimately, although not determinative, working arrangements should always be clearly set out and documented in order to avoid conflicts arising. In the case where a director or shareholder also intends to be an employee of the company, a Director's Service Agreement or contract of employment should be entered into.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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