United Kingdom Employment Appeal Tribunal

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Cite as: [2008] ICR 635, [2008] UKEAT 0225_07_2902, [2008] UKEAT 225_7_2902, [2008] IRLR 364

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		BAILII case number: [2008] UKEAT 0225_07_2902
		Appeal No. UKEAT/0225/07

EMPLOYMENT APPEAL TRIBUNAL
58 VICTORIA EMBANKMENT, LONDON EC4Y 0DS

	At the Tribunal
	On 5 February 2008
	Judgment delivered on 29 February 2008

Before

THE HONOURABLE MR JUSTICE ELIAS (PRESIDENT)
MR D BLEIMAN
MR P GAMMON MBE

MR J E CLARK APPELLANT

CLARK CONSTRUCTION INITIATIVES LTD
UTILITY CONSULTANCY SERVICES LTD RESPONDENT

Transcript of Proceedings

JUDGMENT

APPEARANCES

For the Appellant	MR JAMES LADDIE (of Counsel) Instructed by: Messrs Chattertons Solicitors 30 Avenue Road GRANTHAM Lincs NG31 6TH
For the First and Second Respondents	MR NEIL HAMILTON (of Counsel) Instructed by: Messrs Bird & Co LLP Solicitors 15 Castlegate GRANTHAM Lincs NG31 6SE

SUMMARY

JURISDICTIONAL POINTS: Worker, employee or neither

PRACTICE AND DPROCEDURE: Bias, misconduct and procedural irregularity

Employee was for a time also controlling shareholder; was he an employee during that period so as to be able to count the period in assessing continuity of employment? ET said no, and the EAT held that they had properly applied the relevant legal principles and were entitled to reach that decision.

Was the Tribunal entitled to find that the reasonable notice period, absent an express term, was one month only? In principle, yes. However, there was strong evidence that both parties had considered three months to be the appropriate notice period, and the Tribunal should have dealt with that evidence in its judgment.

EAT rejected certain allegations of misconduct by the Tribunal on the grounds that the Tribunal had failed to draw the parties' attention to certain cases not referred to by the parties but cited in the judgment. There was no unfairness in the circumstances.

EAT accepted, however, that the Tribunal had failed to consider or make findings upon whether the claimant had been dismissed or suffered a detriment for making certain protected disclosures, and certain other matters. Case remitted to a fresh tribunal to determine these outstanding issues. This was linked to the Tribunal's award of costs, which also will need reconsideration.

Observations on the relevant criteria to consider when seeking to determine whether a controlling shareholder is also an employee.

THE HONOURABLE MR JUSTICE ELIAS (PRESIDENT)

The Claimant brought proceedings before the Employment Tribunal at Nottingham alleging that he had been unfairly dismissed; that he had suffered a detriment and had been dismissed contrary to section 103A of the Employment Rights Act 1996 by reason of having made various public interest disclosures; that his employers had failed to pay him the full wages to which he was due; that he had not been provided with statutory statement of written particulars as required by section 1 of the 1996 Act and should be awarded compensation for that; and that he was entitled to at least three months' notice under his contract of employment but had been compensated for only three weeks.

Apart from finding that he was entitled to a week's pay (that having been conceded by the employers) the Tribunal dismissed all his claims. They held that they had no jurisdiction to hear his unfair dismissal claim. This was because although he was an employee at the date of dismissal, they concluded that he did not have twelve months' continuous employment. For a period within twelve months of his dismissal he had been a majority shareholder in the company and the Tribunal concluded that he had not at that time been an employee. It is only periods of employment during which relations are regulated by a contract of employment that can count for the purposes of determining continuous employment: see section 212 of the 1996 Act.

The rejection of the claim for public interest disclosure was on two grounds. First, the Tribunal found that the relevant disclosure on which the claimant principally relied, namely that management had forged his signature to effect a sale of a flat, was not a protected disclosure within the meaning of the 1996 Act because it was not made in good faith as that term was construed in Street v Derbyshire Unemployed Workers Centre [2005] ICR 97. It had been used as a way of putting pressure on his employers so that they may make certain concessions to him with regard to disputes between them. Second, the Tribunal held that in any event even if there were a protected disclosure, the reason for dismissal was not the alleged disclosure. Nor was any detriment suffered since no adverse consequences had flowed from it.

The Tribunal assessed the reasonable period of notice in the circumstances as being one month and on that basis they concluded that there was no further liability for the company with respect to the notice period.

Finally, they stated in their judgment (but this was not dealt with in the reasons) that no award would be made for the failure to provide written statement of particulars.

The Claimant initially challenged each and every adverse conclusion, and has made a broader challenge of misconduct. We return to consider the grounds of appeal after we have set out the material factual background.

The background.

The Claimant was a building contractor. In the 1990s he ran a small contractor's business on his own account. At that stage the business was unincorporated, but he converted it into a corporation in October 2002. This was the first Respondent, Clark Construction Initiatives Ltd. (CCI). At that stage he owned all the shares in the company and was formally declared an employee. He was the managing director of the new company. No formal written contract was ever produced, nor was any written statement of particulars provided to him.

The Tribunal found that Mr Clark was paid by the company "a very small salary" which elsewhere they said was the minimum which he could receive before – as they put it – "any serious tax band bit". We were told by Mr Hamilton, who appeared for the Respondents below, that it was such a small payment that it fell below any tax band, but we had no direct evidence of that. Thereafter his living expenses, which were not inconsiderable, were covered by loans that he drew from the company. The way this was achieved was that he used company credit cards to pay his own personal expenses. For example, he used the cards as a matter of course to pay his mortgage, utility bills, shopping bills, insurance payments and to draw cash.

It is plain that the loans were very substantially more than the salary. The Tribunal found that the intention was that the loans would be repaid by the dividends that he would earn if and when the company became profitable. To that extent, the Tribunal concluded that Mr Clark remained in a position where he was taking the risks of the business succeeding, much as he had done prior to incorporation.

At about the same time as the company was incorporated, the claimant became friendly with Mr and Mrs Grew and they developed a business relationship. The Grews controlled a company which was developing a large block of flats and CCI became the company responsible for building it. Mr Grew took a 24% share in CCI.

By the summer of 2005, the majority of flats had been completed. Mr Clark then transferred all the remaining shares in CCI to Mr Grew. Mr Clark's version of events was that this was necessary for CCI to survive.

The Tribunal did not accept that this was the reason. They formed the view that Mr Clark had deliberately transferred the shares for the entirely different reason that he was in the throws of a divorce and wished to minimise the capital in his hands in any investigation as to his finances. In reaching that conclusion they were influenced by Mr Tutin, the senior partner in a national firm of chartered accountants, who had seen Mr Clark on a regular basis. He described Mr Clark as manipulative and "a person who knew exactly what was going on".

At about the same time as these shares were sold, there was the transfer of some property from Mr Clark to Mr Grew. The details were not clear to the Tribunal but one of the allegations made by Mr Clark, which was relied upon also as one of the alleged protected disclosures, was that Mr Grew had forged his signature when effecting that sale.

Following the transfer of shares, Mr Clark remained the managing director and he was put on an income that reflected his function and status. However, the company was only small, with limited business opportunities, and there was a relatively little amount of work to support the substantial income that Mr Clark still required. The Tribunal took the view that the Grews were in part financing Mr Clark because of their personal friendship.

By the winter of 2005 a dispute arose over the pre-sale cleaning of the flats. Some of Mr Clark's relatives were involved in providing the cleaning and the Grews thought that they had overcharged. There was litigation and the Claimant was a key witness for the Grews, and even prepared a witness statement in support of their case. However, at the last minute he resiled from that and refused to attend the trial thereby causing substantial embarrassment to the Grews. He subsequently alleged that the Grews had sought to persuade him to lie to the court.

This led to a breakdown in the relationship between Mr Clark and the Grews. There was an attempt to discipline Mr Clark, which the Tribunal referred to as "petty". This led to a disciplinary hearing which Mr Clark secretly taped, culminating in a verbal warning. The Tribunal concluded that at about this time the Grews had in fact resolved to dismiss Mr Clark. There was an appeal against the warning which was heard by Mr Grew on the 3 February, again secretly taped. We assume that it was unsuccessful although that is not stated in terms. The Tribunal saw the transcripts of the meeting and concluded that Mr Grew's aim was to get rid of the Claimant as cheaply as possible.

The Claimant was summarily dismissed on the 6 February. The Grews did this ostensibly by making Mr Clark "redundant", shutting down CCI and re-employing the rest of the workforce in the second respondent, Utility Consultancy Services Ltd. He was paid three weeks pay and his statutory redundancy payment. Mr Clark appealed, but no appeal ever took place. The Tribunal accepted that this was because Mr Clark would not attend an appeal.

The Tribunal had no doubt that but for the question of jurisdiction, which we consider below, they would have found that the dismissal was unfair.

The Tribunal's decision.

The Tribunal then considered the various claims. Of their own motion they took the point that they may not have jurisdiction to hear the claim for unfair dismissal. They did so on the basis that they were not satisfied that Mr Clark was necessarily employed by CCI in the period where he owned a majority of the shares. They accepted that he was so employed from the summer of 2005 when his shares were transferred to the Grews, but there was not twelve months' continuous employment between that date and the date of his dismissal.

The Tribunal noted that in the period when he controlled the company, he was paid a very small salary and took substantial loans. They then had regard to a number of considerations which they felt pointed either for or against there being a contract of employment but concluded that there was not. They summarised the principal factors and their evaluation of them as follows (paras 5.7-5.9):

"…We took into account all those matters that would indicate a contract of employment including the label conferred upon him by his financial advisers. He had regularity of work which he appeared to have an obligation to complete. He had the protection of sick pay and regular paid holiday. He had regular income albeit artificially low. Whilst he was the controlling shareholder in reality, he would say, the controller of the company was the company's customer the second respondent.

Against that we have the fact that the majority of the claimant's income came from his borrowings from the company. 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.

We have regard in our consideration those cases regularly referred to us by the Secretary of State in cases involving this point. We considered the case of Eaton vs. Robert Eaton Ltd. Wilson vs. Trenton Service Station Ltd and McLean vs. Secretary of State. We note the age of those cases and we recognise that employment law may well have progressed. But the later cases for instance Fairly vs. Secretary of State, Gladwell v Secretary of State and the guideline case of Secretary of State v Bottrill would seem to establish the principle that what we have to do is to look at the whole picture – which we have done. We should balance out all of the factors and make a reasoned conclusion. We do that balancing exercise. It seemed to us that during the first and middle phases the claimant was in business on his own account and not employed."

They then turned to the issue of public interest disclosure. As we have said, they rejected that part of the case. However, in so doing the Tribunal analysed this aspect of the case purely on the assumption that there was only one protected act relied upon, namely an allegation by the Claimant that the Grews had transferred the flat in circumstances where his signature had been forged. Although this aspect of the decision was originally appealed, in the event it was not - in our view sensibly - pursued before us.

The Tribunal then considered the alleged breach of contract claim on the grounds that insufficient notice money had been paid upon dismissal. The Claimant had received three weeks' money. The Tribunal recognised that normally a director would be entitled to a longer period of notice than an ordinary worker, but they considered that the proper period of notice would depend on the salary and the nature of the company. Their conclusion was expressed as follows:

"The Lay Members, using their experience of commerce and industry, take the view that one month's notice is the appropriate length. The Chairman concurs."

The Tribunal thought that the Claimant had received the appropriate pay, although there is a dispute about that, and we return to that below.

The Tribunal then considered an application for costs. They concluded that the claim relating to public interest disclosure was misconceived and that this should have been plain from the beginning. Given that the allegation was made in bad faith, in the sense that it was advanced as a negotiating tactic, this was not a claim that could properly be advanced in law, and it should not have been. The Tribunal fixed the compensation by reference to the additional time which they felt had been spent dealing with this part of the claim. They assessed that at ten hours and awarded £175.00 for each hour, giving £1,750.00 in all. This is to be contrasted with the costs which the Respondents claimed they had incurred, namely in excess of £30,000.00.

Finally, in its judgment the Tribunal stated that they were awarding no compensation for the failure to provide statutory particulars. It was accepted that no statement of particulars had been provided. The normal rule is that compensation of at least two, and in some circumstances up to four, weeks' pay is to be made: see section 38 of the Employment Act 2002. However, the tribunal need not award this where there are exceptional circumstances such that it would not be just and equitable to do so: section 38(5). Presumably the Tribunal thought that there were exceptional circumstances, but when the full reasons were given, no explanation was given for this conclusion. Subsequently, the Tribunal were given the opportunity of explaining their reasons but could not recall what they were.

The grounds of appeal.

They can be summarised as follows:

(1) The Tribunal erred in law in concluding that it had no jurisdiction to hear the unfair dismissal claim.

(2) They erred in failing to determine certain issues before them, namely the argument that dismissal was by reason of certain other protective disclosures and not merely the particular one identified by the Tribunal in their judgment, and the reasons why no compensation was awarded pursuant to section 38 of the Employment Act 2002. In connection with that latter claim, the Tribunal reached a perverse decision in any event. Mr Laddie, counsel for the Claimant, contended that the only proper conclusion, given the admitted breach, was that compensation ought to have been awarded.

(3) They wrongly found that the Claimant was entitled only to one month's notice; and erred in concluding that wages for the notice period had been paid.

(4) They ought not to have awarded any costs at all. Moreover, the calculation was premised on the assumption that the costs with respect to protected disclosure were all directed at the one act of disclosure which the Tribunal considered whereas there were in fact other acts which ought to have been considered and would have involved preparation time.

(5) There is a broader challenge directed to the whole decision. This is in part relying on the failures to determine certain matters but also on other alleged acts of misconduct which we consider below.

Ground 2, and to some extent grounds (3) and (4), are conceded.

First, Mr Hamilton accepts that the Tribunal did not address the other alleged protected disclosures. He submits that some of the matters raised are not protected disclosures at all, but recognises that that is an argument he can address when the issue is reconsidered. He also made the point that to some extent this aspect of the claim was a moving feast. The original claim identified three such alleged disclosures but others were added in the course of the hearing. Indeed, that was true of the particular disclosure actually addressed by the Tribunal.

Second, Mr Hamilton recognises that the Tribunal's failure to deal with these matters potentially has a knock on effect on costs. The calculation was on the basis that ten hours was spent on the protected disclosure argument; but this would appear to have been all the protected disclosure grounds raised, and some of the other grounds may well be either correct or at least reasonably advanced, in which case no costs could properly be awarded with respect to them. Accordingly, he accepts that there is an issue as to the amount that should have been awarded and this should be referred to the Tribunal.

There is a further issue with respect to costs, which Mr Hamilton does not concede, as to whether the liability itself for costs should now be revisited. We consider that issue below.

Third, he also accepts that since the Tribunal cannot now remember its reasons for rejecting the claim for compensation for failure to provide written particulars, the whole issue - including the question whether there should be any compensation made at all - will have to be reconsidered.

In that connection however, we reject the submission of Mr Laddie that the Tribunal could not properly have concluded that there were exceptional circumstances which could have rendered it just and equitable not to award any compensation. It seems to us that if, as appears to have been the case, the Claimant ought to have issued the particulars to himself, that may well be capable of amounting to circumstances where it would be inequitable to award any, or at least the full amount, of compensation.

We recognise that this was not a matter relied on by the employers in their response, but it is a factor which in principle a tribunal could consider. The award of compensation is not, in our view, inevitable such as to make a reconsideration pointless.

Finally, Mr Hamilton accepts that the Tribunal were wrong in finding, alternatively failed adequately to explain, how they had concluded that the employee had been paid for the month's notice. It is common ground that only three weeks' notice pay was received. Mr Hamilton submits that the Tribunal had probably had regard to the fact that any additional moneys due had been met by the statutory redundancy payment to which, on the Tribunal's analysis, the Claimant was not entitled since he was not redundant. However, Mr Hamilton accepts that this was not explained by the Tribunal and that the matter should be revisited.

The remaining grounds.

We turn to consider the remaining grounds. We consider first the misconduct challenge, on the basis that it was common ground that if this argument were to succeed, it would mean that the decision could not stand, there would have to be a complete rehearing, and the other grounds would be superfluous.

Misconduct.

First, Mr Laddie alleged that the Tribunal misconducted themselves by having regard to authorities and other material (see the passage reproduced in para.20 above) which had not been put before the Tribunal by the parties, and which the Tribunal had not drawn to the attention of the parties for their observations.

Furthermore, it was contended that the Tribunal were falsely representing that they had had regard to these decisions when reaching their conclusion whereas that was not the case, and indeed with respect to one authority, namely the Gladwell case, could not have been.

This particular ground was linked with two others. The first was the admitted failure by the Tribunal to make findings with respect to all the matters before them. As we have said, that point is conceded by the Respondents. The second was that the Tribunal had made findings to the effect that Mr Clark had acted to conceal his true wealth in the context of a divorce settlement when there was no evidence to support that.

We reject this last aspect of the argument on the simple ground that we have no information about what evidence was before the Tribunal about that, and we cannot possibly assume, in the absence of such information, that there was no factual substratum for their decision. We should add that there were also some criticisms of the grammar and spelling of the Tribunal decision which, whilst they display a certain sloppiness, do not in our view take matters further.

In dealing with this part of the appeal, it is necessary to give a little background to the procedures leading to the giving of the written judgment. The Tribunal met in chambers to consider its decision on 19 October 2006. It then handed down its judgment, including making the award for costs, and giving oral reasons for its decision, on 7 November 2006.

An appeal was lodged and the Employment Appeal Tribunal sought written reasons for the decision. Due to the illness of the employment judge these were not provided until 17 January 2007.

The original oral reasons were expanded upon in the written judgment. The Tribunal were requested to give some explanation about paragraph 5.9 (set out in para.20 above) by an Order of His Honour Judge Clark. The judge approved a list of questions which had been drafted by the Claimant. In particular, the Tribunal were asked to state whether in the course of the Tribunal's deliberations they had considered the various cases referred to in that paragraph and also whether they could provide copies of those authorities.

They were also asked to explain how they had come to make reference to the Wilson, McLean and Gladwell decisions in particular.

It is right to say that in his response the employment judge does not specifically answer all the questions. He appears to have treated the request as an indication that the real concern of the Claimant was that the decision handed down in January did not fairly reflect what all three members of the Tribunal had originally agreed. That was indeed part of the original grounds of appeal.

The employment judge accepted that the written reasons were fuller than the ex-tempore reasons which had been handed down orally, and in particular it contained references to authorities not mentioned in the oral reasons, but he confirmed, as did the lay members, that the written decision fairly reflected their views. He commented that the question of whether a majority shareholder can be an employee is one that arises from time to time. He described it as a "bread and butter" issue for tribunals. One of the lay members had been a tax inspector for thirty years and the employment judge said that he was entirely familiar with the relevant jurisprudence.

He then observed that the sources for the cases referred to paragraph 5.9 were passages in the text of Harvey on Industrial Relations and Employment Law and some written submissions which the Secretary of State had provided in another case which had been heard during the week of the Tribunal's retirement. The employment judge said he had in the course of his career regularly read these cases, although the actual reports were not before the Tribunal and the lay members did not see them. There were also observations from the lay members, each of whom confirmed that the written decision fairly reflected what had been agreed in their deliberations.

There was also the suggestion from Mr Laddie that the Tribunal may have modified its original reasons to try to bolster its decision because it already knew, when it gave full reasons for its decision, that an appeal had been lodged against its conclusions. (Full reasons had been given following a direction from the EAT, after the appeal had been lodged.)

More specifically, it is pointed out that the case of Gladwell v Secretary of State to which the Tribunal referred, could not have been in the mind of the Tribunal when it reached its decision. This is because the Tribunal deliberated on 19 October 2006 and the decision in Gladwell was not delivered until six days later. Of course, it would have been known to the Tribunal when it subsequently gave its full reasons, which were dated 17 January 2007.

Perhaps more seriously, it is suggested the employment judge was admitting that in reaching its decision the Tribunal had had regard to certain submissions from the Secretary of State in another decision which was not shown to the parties at all.

Insofar as it is still being maintained, we reject the notion that the full reasons given did not fairly reflect the Tribunal's reasoning at the time. In our view the responses of the Tribunal members have laid that charge to rest.

Ought the Tribunal then to have drawn attention to the authorities which they cite in para 5.9? The Claimant relies upon the decision of this Tribunal (His Honour Judge Serota QC presiding) in Albion Hotel (Freshwater) Ltd v Maia E Silva [2002] IRLR 200 where it had to consider a case where the appellant contended that the Tribunal had acted unfairly in considering three unreported decisions which had not been drawn to the attention of the parties. The EAT upheld this ground of appeal and said this (para 35):

"In our opinion, where an employment tribunal considers that an authority is relevant, significant and material to its decision but has not been referred to by the parties, it should refer that authority to the parties and invite their submissions before concluding its decision. This is more than mere good practice. Failure to do so may amount to a breach of natural justice and of the right to a fair hearing. The failure of the tribunal to invite submissions from the parties on the three authorities was doubtless inadvertent. The employment tribunal may not have recognised the particular significance it attached to the authorities, and the balancing exercise it undertook in relation to the relevant facts. However, the consideration of the authorities played a significant and material part in the decision. It seems to us, accordingly, that there has been significant procedural unfairness and this ground of appeal succeeds."

We respectfully endorse that proposition. However, that Tribunal had earlier said this (para 29):

"Nothing that we say hereafter should be thought to have any bearing on the case where a court or tribunal refers to an authority not cited by the parties which is necessary to explain the background or some point of law that is uncontroversial."

We have no doubt at all that that is the position with regard to the cases cited here. They were referred to in order to demonstrate there is a long line of authority emphasising that in determining whether there is a contract of service in place or not with regard to controlling shareholders, the Tribunal has to look at all the circumstances.

The employment judge stated in his observations that he was very well acquainted with three of the cases, namely Eaton, Wilson and McLain. It is true that he did not specifically mention the Fairly case in his response, and no case of that name has been identified by anyone. We strongly suspect that it was intended to be a reference to another well known case, namely the decision of the Inner House of the Court of Session in Fleming v Secretary of State [1997] IRLR 682 (in which the Eaton case is in fact cited).

We think that the only fair inference is that the Tribunal, in wrongly citing the name Fairly, had some other case in mind and could not remember which it was. We are not prepared to infer that they simply made a case up out of nowhere. Moreover, we note that in the judgment, they do not say that they had read each of these cases, merely that they had taken them into account.

We accept that insofar as the Tribunal was seeking to suggest that it took account of the Gladwell case when reaching its decision that would have been wrong. They could not have done so. Plainly the employment judge by January 2007 was conscious of the Gladwell decision and knew that it was in line with the earlier authorities. We do not accept that the reference to Gladwell made this decision in any way unsatisfactory or misleading.

If the Tribunal had said in terms 'We note that the case of Gladwell, reported subsequently to our deliberations, confirms this line of approach', or words to that effect, there could be no criticism at all of the observations. Had Gladwell contained some new point of principle which was material to the case then, of course, the observations of His Honour Judge Serota QC in the Albion Hotel case would become highly relevant. But it did not. We think there is nothing therefore in this criticism of the Tribunal.

Finally, we think that there is nothing either in the submission that the Tribunal formed their view on the basis of an argument advanced in a different case. We do not think that the employment judge is saying anything more than that the Secretary of State's submissions in the other case was in part the source from which the Tribunal were reminded of the material authorities to which they made reference. In truth, the only inference from these authorities was that all relevant circumstances must be taken into account. Bottrill alone could have been cited for that proposition. It is difficult to think what detailed argument or submission could have been advanced on this particular point.

Mr Laddie suggested that the employment judge's response indicated that this was not a truthful decision and therefore cast doubt upon the integrity of all of the whole decision. We think that it was unfortunate that he pressed the point in that way. We accept that there was some sloppiness in the decision, compounded by the Tribunal's failure, as is conceded by Mr Hamilton, to consider certain matters. It is also unfortunate that the employment judge did not specifically deal with each question posed by the EAT rather than responding in a broad brush way. However, we entirely reject the submission that these defects are so fundamental as to invalidate the whole decision.

The specific substantive issues.

We turn then to the specific substantive issues.

Jurisdiction.

We turn first to consider the case law relating to this question. Two principles seem to be firmly established. The first, enunciated in a stream of cases, is that whether the contract of employment exists is for the tribunal to determine as an industrial jury, and any appellate body can interfere only if the decision involved a misdirection in law or was perverse. The second is that in determining this question, all relevant information must be considered: see for a recent statement of both these principles the decision of the Court of Appeal in Bottrill v Secretary of State for Trade and Industry [1999] ICR 592 and in Scotland, the decision of the Inner House of the Court of Session in Fleming v Secretary of State for Trade & Industry [1997] IRLR 682.

But what material is relevant? That depends upon what the Tribunal is seeking to determine. Of course, at one level it is simply asking whether an employment contract exists. But that simply raises a further question. In practice, the claimant will be alleging that there is such a contract- and will generally point to a formal written document- and the respondent will be contending that the courts should for some reason refuse to recognise it. So the issue becomes this: on what grounds can the court refuse to give effect to the contract entered into between the company and the majority shareholder? Until that question is answered, it is impossible to state what material is relevant and what is not.

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. The test of control always plays a significant part in the analysis but there are a whole range of factors potentially relevant to that question. The starting point remains the three fold test identified by Mackenna J in Ready Mixed Concrete (South East) Limited v Minister of Pensions and National Insurance [1968] 2 QB 97.

When the question is whether a controlling shareholder is also an employee, the task is generally a very different one. 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.

The unease sometimes felt about recognising that controlling shareholders can be employees derives from the feeling that there is an air of unreality in describing the controlling shareholder as under the control of the company when he can, by the exercise of his votes as majority shareholder, ultimately control what the company does. Is the controlling shareholder really in a subordinate economic and social position when he can control the very body that ostensibly has control over him?

This was the issue before the Judicial Committee of the Privy Council in Lee v Lee's Air Farming [1961] AC 12. It was an appeal from the High Court of New Zealand. The appellant's husband had formed a company for the purposes of carrying on the business of aerial top dressing. He was the pilot and the controlling shareholder of the company. He was also the governing director. He entered into a contract with the company and was paid a salary as its chief pilot. He exercised full and unrestricted control over all the operations of the company. There was a statutory obligation to insure employees against liability to pay compensation in the case of an accident. He was killed after an aircraft accident, and the question was whether his widow was entitled to compensation. This depended on whether he was a worker within the meaning of the New Zealand Workers' Compensation Act.

The Judicial Committee held that the fact that he was in control of the company was no bar to his being employed as an employee pursuant to a contract of service. Lord Morris, delivering the judgment of the Committee, said this:

"Ex facie there was a contract of service. Their Lordships conclude, therefore, that the real issue in the case is whether the position of the deceased as sole governing director made it impossible for him to be the servant of the company in the capacity of chief pilot of the company. In their Lordships' view, for the reasons which have been indicated, there was no such impossibility. There appears to be no greater difficulty in holding that a man acting in one capacity can give orders to himself in another capacity than there is in holding that a man acting in one capacity can make a contract with himself in another capacity. The company and the deceased were separate legal entities. The company had the right to decide what contracts for aerial top-dressing it would enter into. The deceased was the agent of the company in making the necessary decisions. Any profits earned would belong to the company and not to the deceased. If the company entered into a contract with a farmer, then it lay within its right and power to direct its chief pilot to perform certain operations. The right to control existed even though it would be for the deceased in his capacity as agent for the company to decide what orders to give. The right to control existed in the company, and an application of the principles of Salomon's case demonstrates that the company was distinct from the deceased. As pointed out above, there might have come a time when the deceased would remain bound contractually to serve the company as chief pilot though he had retired from the office of sole governing director. Their Lordships consider, therefore, that the deceased was a worker and that the question posed in the case stated should be answered in the affirmative. "

That case demonstrates that even someone who has total control over the operation of the company - because in that case he was governing director, as well as being effectively the sole shareholder - can enter into a binding and effective contract of employment with the company.

An issue for the courts following that case was to what extend the result in Lee should be seen to have depended upon the statutory context in which the question of status arose. The view of the EAT (Mummery P presiding) in Buchan and Ivey v Secretary of State for Employment [1997] IRLR 80 was that context was decisive. Lee was a case that had to be considered in its context. The purpose of the insurance arrangements was to provide compensation for dependants, such as the widow, and that would have been defeated if her husband had not been an employee within the meaning of the relevant legislation.

By contrast, the EAT was faced with a claim by a controlling shareholder who sought to recover redundancy and other payments from the Secretary of State when the company which he controlled was insolvent, under rights now conferred by part XII of the Employment Rights Act. Mummery P considered that in the context of employment protection it was contrary to both common sense and industrial or commercial realities to treat a controlling shareholder as somebody who is also capable of being an employee. The Tribunal noted that a controlling shareholder can prevent the company from dismissing him by the exercise of his voting rights. Mummery P added (para 36):

"The context in which the issue of employee or non-employee arises under [1996 Act] is protection of employment. More particularly the purpose of [part XII of the Act] is to provide for State-funded compensation to be available for employees employed by those whose businesses have failed financially. It is not the purpose of those provisions to provide compensation to an individual businessman or entrepreneur whose own incorporated business ventures have been unsuccessful."

In formal terms the EAT merely decided that each of the employment tribunals in the two cases it was considering was entitled to find on the facts that there was no contract of employment in place. But the logic of the reasoning was that at least in the context of employment protection, no other finding could sensibly be reached. In essence, if a man is running his own business then he cannot at the same time be an employee of the business. For employment purposes, he cannot both control the company and be subject to its control.

That approach was rejected by a different division of the EAT (Morison P presiding) in Secretary of State for Trade & Industry v Bottrill [1998] ICR 564. In that case the claimant was the managing director and sole shareholder of the company which had been set up on the understanding that that 80 per cent of the shares would subsequently be acquired by an American company. A draft agreement to that effect had been prepared, but not executed. The claimant was paid a salary under the contract which was fixed for three years. His salary was reviewable on an annual basis to be set at a level to be agreed mutually with fellow directors. He worked set hours. He was not paid any director's fees. Subsequently, a receiver was appointed and the company went into liquidation. He claimed a redundancy payment from the Secretary of State, pursuant to section 182 of the Employment Rights Act. The Employment Tribunal found that he was an employee and the appeal by the Secretary of State failed.

The court expressly rejected the view that the mere fact that somebody is a controlling shareholder of itself prevents that person being employed pursuant to a contract of employment. The EAT recited extensively from the judgment in the Lee case and did not accept the premise in Buchan that Lee should be distinguished because of the different statutory provisions in play.

They were fortified in that conclusion by the fact that the Inner House of the Court of Session also rejected the approach in Buchan in the Fleming case, to which we have made reference. The EAT did not, however, suggest that the existence of a majority shareholding was necessarily immaterial. They accepted that it was a factor to be taken into account "because it might tend to establish how the company was a mere simulacrum or that the contract under scrutiny was a sham." The assumption appears to have been that outside those two categories – the company being a simulacrum or the contract a sham- the court must give effect to a contract entered into between a company and its controlling shareholder.

In the Fleming case the employee was a majority shareholder who entered into a contract the terms of which were never identified or recorded. He had personally guaranteed the obligations of the company. The Tribunal held that in those circumstances he was not an employee, and the EAT held that this was a sustainable conclusion.

The Inner House dismissed a further appeal, holding that there was plenty of evidence before the Tribunal to justify their conclusion that there was no valid contract in place, and therefore the appeal failed. These factors included the lack of any specifically recorded contractual terms, the guarantees, and the majority holding. Lord Coulsfield, giving the judgment of the court, observed that Buchan came very near to establishing a rule of law to the effect that if an individual was a majority shareholder, that would inevitably preclude a contract arising, and that the court was reluctant to accept any such rule. However, his Lordship did observe that such a shareholding was always a relevant factor, normally an important one, and sometimes a decisive one when seeking to determine whether a contract of employment exists.

When the Bottrill case went to the Court of Appeal (Lord Woolf MR, Peter Gibson and Mantell LJJ), the Court expressly approved both the judgment of the EAT in that case, and also the approach in Fleming, stating in terms that it had "no hesitation" that they were to be preferred to the approach of the court in Buchan. Lord Woolf, giving the judgment of the Court, observed, in line with the observations in the Fleming case, that the fact that an individual has a controlling shareholder is likely to be significant in all situations and in some may prove to be decisive, but it was only one factor to consider along with all the relevant circumstances.

He confirmed that as Morison P had said in the Bottrill case, there were methods whereby the courts could refuse to give effect to an arrangement if it were a sham designed purely to render the Secretary of State liable for certain payments. However, he also observed that:

"In a case such as this where national insurance contributions have been paid to deprive an individual of his claims under the 1996 Act could be to deprive unjustly that individual of the benefits to which he could properly expect to be entitled after he and his "employer" had made the appropriate contributions."

Later in the judgment Lord Woolf made certain comments (not, he emphasised, to be treated as rigid guidelines) which the Court suggested may be of assistance to parties in future cases (p.604A-E):

"The first question which the tribunal is likely to wish to consider is whether there is or has been a genuine contract between the company and the shareholder. In this context, how and for what reasons the contract came into existence (for example whether the contract was made at a time when insolvency loomed) and what each party actually did pursuant to the contract are likely to be relevant considerations.

If the tribunal concludes that the contract is not a sham, it is likely to wish to consider next whether the contract, which may well have been labelled a contract of employment, actually gave rise to an employer/employee relationship. In this context, of the various factors usually regarded as relevant (see, for example, Chitty on Contracts 27th edn (1994) para. 37-008), the degree of control exercised by the company over the shareholder employee is always important. This is not the same question as that relating to whether there is a controlling shareholding. The tribunal may think it appropriate to consider whether there are directors other than or in addition to the shareholder employee and whether the constitution of the company gives that shareholder rights such that he is in reality answerable only to himself and incapable of being dismissed. If he is a director, it may be relevant to consider whether he is able under the Articles of Association to vote on matters in which he is personally interested, such as the termination of his contract of employment. Again, the actual conduct of the parties pursuant to the terms of the contract is likely to be relevant. It is for the tribunal as an industrial jury to take all relevant factors into account in reaching its conclusion, giving such weight to them as it considers appropriate."

It is pertinent to note that this guidance appears to envisage that even where the contract is genuine and not a sham, there will still be circumstances where a tribunal could properly find that no contract of service exists.

In Sellars Arenascene Ltd v Connolly [2001] IRLR 222, the claimant had made an agreement drafted by a solicitor which he had signed on his own behalf and on behalf of the company. He owned the majority of the shares. The Employment Tribunal held that he was not an employee because at the time he became a shareholder he sought to gain if the company profited and he was what the Employment Tribunal described as an "accomplished and expert entrepreneur". In addition, the company's bank required him to remain controlling shareholder as a condition of continuing financial support.

The EAT (Morison P presiding) reversed the decision of the Employment Tribunal and the Court of Appeal upheld its ruling. Lord Justice Pill, giving the leading judgment of the court, held that on the facts the only proper conclusion was that the claimant was an employee.

Neither the fact that the claimant was an entrepreneur who had built up the business, nor the fact that he could profit from the company's success, nor that he sought to retain absolute overall control, could properly be relied upon as evidence that he was not an employee. Many employees would equally obtain a profit if the business succeeded, as the existence of share option schemes demonstrates. The Employment Tribunal had held that the contract was not a sham and that the claimant had "behaved as an employee". In those circumstances the Court held the only proper inference that he was an employee. There was no evidence at all that the contract was not what it appeared to be and the Tribunal had to give effect to it. In practice, the Tribunal had been unduly swayed by the single feature of the controlling shareholding.

In Gladwell v Secretary of State for Trade and Industry [2007] ICR 264 the Connolly case was followed and applied in circumstances where the Tribunal appeared in practice to have treated control as a decisive factor negating a contract of employment.

All these authorities, and some others, were very carefully analysed by the EAT (Underhill J presiding) in Nesbitt v Secretary of State for Trade and Industry [2007] IRLR 847. The EAT sought to divine from the authorities in what circumstances the court could refuse to give effect to an ostensible contract. They found it difficult to do so, and we respectfully agree.

In part the problem is that the Court of Appeal in Bottrill supported both the EAT decision in that case and the Court of Session decision in Fleming. Whilst both those courts were agreed in their opposition to the approach in Buchan, thereafter they appear to have diverged as to the proper test to be applied. As we have seen, Morison J thought that the only issue is whether the contract was a sham or the company a simulacrum, but the court in Fleming seems to have envisaged a more open-ended inquiry (but without specifying what are its parameters).

In Nesbitt, Underhill J summarised his reading of the cases as follows:

"I do not find it easy to reach a firm conclusion as to the approach to be derived from these authorities. Read in isolation, the final paragraph of the judgment of the Court of Appeal in Bottrill strongly suggests that the most important, if not the decisive, factor is whether the putative employee has "real" control of the company. That reflects how the test appears to have been applied in Hauxwell. It also seems to me more consistent with Fleming: although the Inner House expressed doubts about Buchan and Ivey, those doubts only extended to whether there should be any rule of law in this area, and it upheld the decision of the industrial tribunal on the basis that it was a legitimate factual assessment. But I find that approach hard to reconcile with the reasoning of the Appeal Tribunal in Bottrill (based on Lee's case), which the Court of Appeal elsewhere in its judgment appeared to approve, and with the subsequent decisions of the Court of Appeal in Connolly and of this Tribunal in Gladwell.

For reasons which will appear, I do not ultimately need to decide which approach is correct. I should however say that I believe that the law is that the fact that a claimant under the employment protection legislation is a majority shareholder and a director of the company which employs him does not affect his status as employee unless the tribunal finds that the company is a "mere simulacrum" in the sense discussed at para. 12 above (and thus, by the same token, that the contract between it and the putative employee is a sham). That seems to me the right approach in principle. It reflects the reality that in the event of an insolvency (or indeed a share sale) control of the company would pass out of his hands and leave him to be treated like all other employees. It is also in my view likely to be more workable in practice. It should not in most cases be difficult to decide whether the business in which the claimant is apparently employed is genuinely being run through the company. The same cannot be said of the alternative approach, where it is far from clear what the indicia of "real" control are and tribunals will have to make subjective judgments of a kind which will only conduce to uncertainty and dissatisfaction. "

The concept of simulacrum was then expressed in the following way:

" "Simulacrum" is defined in the Oxford English Dictionary as "something having merely the form or appearance of a certain thing, without possessing its substance or proper qualities".

Given that the Privy Council in Lee's case recognised that a one-man company could nevertheless be treated as having real substance, presumably "simulacrum" cases should be confined to those where it appears that there is no real intention to vest the business in the company in question or, therefore, to distinguish between the two roles of director and employee – in which case, as Morison P's formulation acknowledges, the contract of employment would necessarily also be a sham. But, at the risk of repetition, Lee's case establishes that no such conclusion can be drawn simply from the fact that director and employee are the same person so that "really" the employee is his own boss. No doubt the distinction between the claimant qua employee and the claimant qua director may appear artificial, but companies are artificial things. A "simulacrum" case must therefore, on Morison P's approach, be one where there were grounds for believing not simply that the distinction was (in that sense) artificial but that it was not intended to be observed at all. "

Underhill J, therefore, appears to treat the concepts of sham and simulacrum as essentially the same, and to limit the circumstances where the courts can refuse to give effect to a contract of employment to cases where there is no real independent company at all. The contract must be recognised unless the company itself is the alter ego of the individual. It would have to be a case where it would be appropriate to pierce the corporate veil. That, however, would only be in the most exceptional circumstances.

As Lord Keith of Kinkel observed in Woolfson v Strathclyde Regional Council [1978] SLT 159 it is appropriate to pierce the corporate veil only where "special circumstances exist indicating that it is a mere façade concealing the true facts." The discussion of the topic in Gower and Davies' Principles of Modern Company Law (7^th edition, 2003) pp.181-190 is to the same effect.

We do not, with respect to the learned judge, think that the cases would support a principle which permits the judges to treat the contract as invalid only in such very exceptional circumstances. In particular the Fleming case itself was one where the Tribunal was held entitled to conclude that a contract did not exist but the circumstances were surely not such as to have justified the lifting of the corporate veil.

We would suggest that there may be three sets of circumstances where it may be legitimate not to give effect to what is alleged to be a binding contract of employment. The first is in the circumstances envisaged by Underhill J, namely where the company itself is a sham.

The second is where the contract is entered into for some ulterior purpose, such as to secure some statutory payment from the Secretary of State. Hence the reason why in both Fleming and Bottrill the courts recognised that one potentially relevant factor would be the circumstances in which the contract was created.

The third is where the parties do not in fact conduct their relationship in accordance with the contract. This may be either because they never really intended that it should be so conducted, or because the relationship has ceased to reflect the contractual terms. The former- where the parties never intended the contract to have any significance- is what would classically be described as a "sham". In Snook v London & West Riding Investments [1967] 2 QB 786

at 801 Diplock LJ said this:

"It is, I think, necessary to consider what, if any, legal concept is involved in the use of this popular and pejorative word. I apprehend that, if it has any meaning in law, it means acts done or documents executed by parties to the "sham" which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create."

His Lordship added that:

"…..For acts or documents to be a "sham" with whatever legal consequences follow from this, all the parties thereto must have a common intention that the acts or documents are not to create legal rights and obligations which they give the appearance of creating."

But the contract may cease to reflect the true nature of the parties' relationship even where no sham was originally intended.

The second and third categories will overlap. If, for example, the contract is entered into in anticipation of an insolvency solely to land debts on the Secretary of State, that will be for an improper purpose and the contract will also be a sham in the sense identified by Diplock LJ.

Support for the notion that the Tribunals are entitled to refuse to recognise the contract as a contract of employment if it fails to reflect the true nature of the relationship is supported by the fact that the guidance in Bottrill twice emphasises the potential relevance of whether the conduct of the parties is consistent with the contract. That is not to say that any minor breach of the terms will invalidate the contract. However, if the controlling shareholder acts in a manner which suggests that the contract is being set at nought, or is treated as no more than an irrelevant piece of paper, then the Tribunal will be entitled to refuse to give effect to it.

We agree with Underhill J that there are passages in the Bottrill judgment which might suggest that a potentially decisive factor is whether the individual in fact exercises real control over the company. But we do not think that the Court of Appeal can have intended to adopt such a principle. First, it is not far removed from the approach in Buchan, which the Court unambiguously rejected. Moreover, it does not sit happily with the Lee decision for the pilot in that case exercised entire control in law and in fact over the company.

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 (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) 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.

Applying the principles to the facts.