EAT explains when company owners are employees

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:

1. 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.
2. 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).
3. 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).
4. 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.
5. 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.
6. 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.
7. 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.
8. 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."