Until recently, there was confusion over whether a controlling shareholder of a company could also be an employee. In some recent cases, the tribunal held that a shareholder was not an employee. However, the position has recently been clarified, says Richard White.

The questions over whether a shareholder can also be an employee was recently addressed and made clear in the case of Secretary of State for Business Enterprise and Regulatory Reform v Neufeld and Howe.

Mr Neufeld’s case

Mr Neufeld was employed as a salesman by Neufeld Press Limited in 1982. He became a director and shareholder in 1988. In 2001 Neufeld Press transferred to A & N Communications In Print Limited (A & N). Mr Neufeld held 90% of the shares and he agreed with his two fellow directors, who each held 5%, that he would be the managing director of the company and would also be employed as part of its sales team.

To fulfil his duties as managing director and salesman, Mr Neufeld worked an average of 60 hours per week. He took his full holiday entitlement for the time when he was employed as part of the sales team, but did not take his full entitlement for the time when he was a director.

He made a personal loan to A & N of £20,000 and made personal guarantees on machine and sales financing to the value of £10,000 and £20,000 – £25,000. When A & N became insolvent in October 2005, Mr Neufeld claimed redundancy pay, notice pay and holiday pay.

Mr Howe’s case

Mr Howe started Track Records in 1979. He transferred the assets to Track Music Records Limited (TRM) when it was incorporated in 2004. Mr Howe was the sole director of TRM and held 100% of its shares. He was paid a salary, from which tax and national insurance was deducted.

In 2005, Mr Howe borrowed £50,000 to invest in TRM and gave a guarantee to the landlord of TRM’s premises. Mr Howe claimed a statutory redundancy payment when TRM became insolvent.

Decision: Mr Neufeld

The employment tribunal took into account several considerations including that Mr Neufeld had made loans to the company and provided personal guarantees, as well as the fact that he was a controlling shareholder. It was held that he was not an employee. Mr Neufeld appealed to the Employment Appeal Tribunal (EAT). The EAT overturned this decision and established that Mr Neufeld was an employee.

Decision: Mr Howe

The tribunal judge held that Mr Howe was an employee which was confirmed by the EAT. The Secretary of State for Trade and Industry appealed against the decisions in both cases.

The Court of Appeal acknowledged the difficulties that had arisen from the guidance provided by the earlier cases of Fleming v Secretary of State for Trade and Industry [1997] and Secretary of State for Trade and Industry v Bottrill [1999] and held that, in principle, there is no reason why a shareholder cannot also be considered an employee of the company.

The fact that the individuals had made personal guarantees and loans to the company was irrelevant. It set out two issues which the tribunal should address when considering this issue.

First, whether the contract between the individual and the company was genuine or a sham and second, whether it was a contract of employment. To determine whether the contract is a sham, the tribunal should consider the circumstances in which the contract was formed and the parties’ conduct. To establish whether the contract was a contract of employment, the tribunal needs to consider what had been done under the contract and the method of remuneration. Having considered these factors, the Court of Appeal held that Mr Neufeld and Mr Howe were both employees and dismissed the Secretary of State’s appeal.

Comment

This case has highlighted the importance of determining whether a true contract of employment exists between a company and its shareholders. In order for directors and shareholders to be employees, there must be a genuine contract of employment as this will have an effect on the process that must be followed when dealing with dismissals and redundancies.

The existence of an employment contract between a company and a director is a question of fact and depends on the individual circumstances of the case. As such, smaller businesses might still be left with some uncertainty as to whether their directors and shareholders are employees. This decision is particularly important at this time due to the number of insolvencies at present and the number of directors making claims.

For further advice, please contact Richard White, specialist employment solicitor at Withy King, on 01865 268636 or email richard.white@withyking.co.uk