This question has particular relevance for entrepreneurs who set up and run their own companies but for some time the answer has been unclear due to conflicting decisions by the courts. It has come to the fore in the current downturn due to the increasing numbers of claims being made on the National Insurance Fund (NIF). NIF provides individuals with compensation for arrears of pay, notice pay, unpaid holiday and statutory redundancy pay when their employers become insolvent – but compensation is only available to genuine employees. 
The rules and limits which apply to the payments mean that many individuals are entitled to relatively little. However, the total cost to the public purse of the 12,000 or so directors who made claims in 2008, many of whom will have been controlling shareholders, is not insignificant. This cost and the uncertainty over entitlement to payments has prompted the Secretary of State to seek clarity from the courts as to the approach Employment Tribunals should take when considering whether an individual qualifies for payments from NIF.
This has culminated in a key decision by the Court of Appeal (Secretary of State for Business, Enterprise and Regulatory Reform v Neufeld and another) which has provided much needed clarity and guidance. The Court explained that whether a shareholder or director is an employee is a question of fact for Employment Tribunals to determine by applying the guidance now provided in the Court of Appeal’s judgment. This guidance can be summarised as follows:
1.       If there is a dispute as to whether a putative contract between a company and a shareholder/director is a genuine contract or a sham then this issue needs to be determined first. The Court thought that cases where this point arises will probably be “relatively exceptional” but will involve the Tribunal considering both the circumstances in which the contract was created and also the conduct of the company and the individual under it. It might well not be a genuine contract if, for example, the contract was entered into for an ulterior motive (such as to obtain a payment from the NIF) or where the parties do not act in accordance with the contract.
2.       If a Tribunal concludes that there is a genuine contract (or if the point is not disputed) then the Tribunal should consider whether the contract is a contract of employment, meaning the individual is an employee, or some other type of contract (such as a contract for services / consultancy agreement).
3.       When considering whether it is contract of employment the Tribunal will also need to consider whether it was in force at the time of the insolvency. If not, the individual will not be eligible to claim under NIF.
4.       A director of a company will not, merely by virtue of being a director, be an employee. He will have to prove more than his appointment as a director. Has he been paid a salary or just fees for being a director? Has he acted as an employee, for example by working the hours required by his contract and not taking more than the holiday entitlement under it?
5.       The fact that an individual’s shareholding gives him control will form part of the “factual backdrop” but it “will not ordinarily be of any special relevance” and “nor will the fact that he has share capital invested in the company; or that he may have made loans to it; or that he has personally guaranteed its obligations…or that he has done any of the other things that the “owner” of the business will commonly do on its behalf”. The court commented that these are “usual features” of such companies and will “ordinarily be irrelevant to whether or not a valid contract of employment has been created and so they can and should be ignored”. It added that these actions showed an “owner” acting as an owner and that this is inevitable in companies where an individual has a controlling shareholding; it does not mean that the individual cannot also be an employee.
6.       If there is no written contract then this will be an important consideration and may suggest there is no employment relationship. Nonetheless, the conduct of the company and the individual may enable the Tribunal to conclude that there is such a relationship.
The guidance provides welcome clarity. It offers comfort to entrepreneurs whose business become insolvent as it makes clear that now (in contrast to some earlier decisions by the courts), being a controlling shareholder and director and acting as such does not ordinarily automatically rule out the possibility of being an employee too. However, it also creates scope in good times for other shareholders/directors to argue that they are employees and enjoy employment protection rights (such as the right not to be unfairly dismissed). What is clear that Tribunals will need to look at what the company and the individual have done in practice to ascertain whether there is a genuine employment relationship.
This article first appeared on The Telegraph Business Club’s website.
David Murphy is an employment and HR lawyer and a Senior Associate at Fox Williams LLP.  He can be contacted on 020 7614 2633 or dmurphy@foxwilliams.com

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