United Kingdom Employment Appeal Tribunal

Appeal No. UKEAT/0445/10/ZT

EMPLOYMENT APPEAL TRIBUNAL

58 VICTORIA EMBANKMENT, LONDON EC4Y 0DS

At the Tribunal

On 24 June 2011

Before

HIS HONOUR JUDGE RICHARDSON

(SITTING ALONE)

MR S CONNOLLY APPELLANT

WHITESTONE SOLICITORS RESPONDENT

Transcript of Proceedings

JUDGMENT

APPEARANCES

SUMMARY

JURISDICTIONAL POINTS – Fraud and illegality

Contract of employment – illegality in performance.

An employee who knows that his assertion to be self employed is unsustainable and yet claims to the Revenue to be self employed misrepresents his own understanding of the position and acts in bad faith; it is contrary to public policy to lend support to him in an unfair dismissal claim.  Enfield Technical Services v Payne [2007] IRLR 840 (EAT), [2008] IRLR 500 (CA) considered and applied.

In this case, however, the Employment Judge having correctly raised the issue of illegality, did not apply the law correctly and did not deal adequately in her reasons with the Claimant’s case.  Moreover she should have ensured that the question whether he knew his assertion to be self employed was unsustainable was put to him for him to deal with.

HIS HONOUR JUDGE RICHARDSON

1.            This is an appeal by Mr Stephen Connolly (“the Claimant”) against part of a judgment of the Employment Tribunal (Employment Judge Slater sitting alone) dated 3 June 2010.

2.            The Claimant worked for the Respondents between 28 September 2006 and 9 July 2009 as a solicitor. In circumstances which I shall set out in greater detail in a moment, it was agreed that he would be treated as self employed and paid gross.  He presented himself to Her Majesty’s Revenue and Customs as self employed. 

3.            Following the termination of his engagement (to use a neutral phrase) with the Respondents the Claimant brought proceedings for unfair dismissal, breach of contract and holiday pay.  He asserted that he was an employee.  The Respondents denied that he was an employee, contending that he was self-employed.  The Employment Judge decided that the Claimant was indeed an employee; and there is no cross-appeal from that finding. 

4.            Neither party contended that the contract between them was tainted by illegality.  The Employment Judge, however, raised this issue herself.  She decided that the contract was illegal in its performance, from which it followed that the Claimant was unable to pursue his claims upon it, which were dismissed.  The Claimant appeals against this finding.

5.            The Respondents, a firm of solicitors, ran a personal injury department.  In September 2006 they desired to replace an employed solicitor who was leaving.  They advertised for an assistant solicitor to be employed by them.  The Claimant attended an interview with two partners, one of whom was Mr Sadiq, the Respondent’s senior partner. By letter dated 13 September 2006 Mr Sadiq offered him employment as an assistant solicitor at a salary of £32,000 per annum.

6.            As the Employment Judge found, there was a discussion between the Claimant and the Respondent, instigated by the Claimant, as a result of which the parties agreed that he would be treated for tax purposes as self-employed.  It was agreed that his remuneration (initially £32,000, later increased to £36,000) would be paid gross.  Thereafter he was paid against invoices without deduction of tax and national insurance.  He submitted self-assessment forms to Her Majesty’s Inland Revenue & Customs, presenting himself as self-employed, not employed, and claiming expenses to set off against tax on the basis that he was self-employed.  As the Employment Judge correctly said, the ability to claim expenses on a self-employed basis together with deferment of the date at which tax would be payable provided the Claimant with a financial advantage compared to his position if he had been employed.

7.            The Employment Judge, who had to find whether the Claimant was an employee or not, made other findings as to the relationship between the Claimant and the Respondents.  The Claimant worked full-time, although he started and finished later than the usual time.  He was under an obligation personally to perform the work, there being no question of any right to provide a substitute.  The work was under the control of the Respondents to the normal extent for a professional employee of considerable experience; for example at one point Mr Sadiq instructed him to use house standard letters rather than his own precedents.  The Respondents paid for his practising certificate and organised and paid for his CPD training.  Although to begin with the Claimant did not invoice for days when he was absent, after a while the amounts always added up to £9,000 per quarter, £36,000 per annum.

8.            As I have said, the issue which the parties prepared for hearing was whether the Claimant was, or was not, an employee.  As to the circumstances of his appointment the Claimant said:

9.            The Claimant went on to describe how, as time went by, there were changes.  He was in particular given the title of head of the personal injury department.  He said:

10.         At the conclusion of his statement, which was mainly dedicated to demonstrating that he was an employee, he said:

11.         I have the Employment Judge’s notes of the Claimant’s evidence.  He said, as I understand it, that he had not been intending that the initial arrangement would go on for 3 years, but in the absence of a review had no option but to continue submitting invoices.  It was not put to him at any stage that he always knew he was employed and that he falsely claimed from the outset to the Revenue that he was an employee.

12.         At the Tribunal hearing the Claimant was represented by Mr Martin Budworth, counsel, and the Respondents by Miss Skye Bibi, a consultant.  They also appear before me today.

13.         It was during the course of the Claimant’s evidence in chief that the Employment Judge appreciated that there might be an issue of illegality.  She raised it with the parties before cross-examination of the Claimant began.  She said that she would deal with the issue of whether the Claimant was barred from bringing his claims due to illegality at the same time as she decided on employment/worker status.

14.         The Employment Judge’s reasoning contains a fact-finding section.  In that section she said:

15.         Later the Employment Judge set out the principal submissions of the parties.  The Respondents’ primary case was that the Claimant was self-employed.  As a secondary case, the Respondents submitted that “the contract was void for illegality as HMRC would be defrauded”.  The Claimant’s case was summarised as follows.

“15. The claimant submitted on the illegality issue, that this was a categorisation case.  The claimant submitted that refusal to enforce due to illegality should be reserved for cases where the parties play fast and loose with the arrangement.  Mr Budwar referred to Enfield Technical Services Limited v Payne [2008] IRLR 500 CA.  Mr Budwar submitted that there was no positive misrepresentation; the relationship was categorised in good faith at the beginning.”

16.         The Employment Judge summarised the law as follows:

“19. A contract may become illegal if it is performed in an illegal way e.g. some form of tax evasion in the way the employee is paid.  If a contract is performed illegally, an employee will be barred, on public policy grounds, from bringing any claim founded upon the contract.  In Hall v Woolston Hall Leisure Limited [2001] ICR 99, the Court of Appeal held that an employee may be prevented from enforcing a contract if he or she knowingly participates in the illegal performance; the employee must know of the facts which make the performance illegal and actively participate in the illegal performance.

20. An employee will not be prevented from relying on the contract if the categorisation of the claimant as self employed is due to an error of categorisation unaccompanied by false representations, express or implied, as to the facts: Enfield Technical Services Limited v Payne [2008] IRLR 500 CA.”

17.         The Employment Judge’s conclusions on the question of illegality are set out in paragraph 24 of her reasons.

18.         On behalf of the Claimant Mr Budworth submits that the Tribunal erred in law in its approach to the question of illegality.  He submits that something additional to the mere claiming of self employed status is required: some additional misrepresentation to the tax authorities above and beyond the use of self-assessment.  In this case there was no additional feature. He rests his argument principally upon the decision in Enfield Technical Services v Payne [2007] IRLR 840 (EAT), [2008] IRLR 500 (CA).

19.         If that submission is wrong, he nevertheless submits that the Employment Judge’s reasoning cannot stand.  He submits that if the Employment Judge’s conclusion is that the Claimant acted in bad faith from the start, her reasoning is inadequate, failing to deal with the Claimant’s case as it was put in his witness statement (viz, that he realised his true status as an employee only gradually and with hindsight) and resting upon an assumption that the job could only be done as an employee, whereas looking after a caseload of personal injury files could equally be done lawfully under a contract of service or a contract for services. Simply saying that the Claimant chose self-employment because he would be better off is different to saying that he decided to defraud the Revenue from the outset.

20.         Further Mr Budworth submits that if the Employment Judge concluded that the Claimant acted in bad faith from the start, the procedure adopted was unfair.  The Claimant was not cross-examined to suggest this; his explanation as to why the label was chosen was not challenged or tested.  Mr Sadiq’s suggestion that the Claimant chose self employment because he would be better off (which was made to the Employment Judge) was not put to the Claimant. 

21.         On behalf of the Respondents Miss Bibi submits that Enfield is distinguishable because in that case both parties intended the categorisation of self employment; here the Claimant invited and miscategorised the relationship.  She submits that there were express and implied misrepresentations of employment status to the Revenue sufficient to engage the doctrine of illegality by performance.  She submits that there was ample opportunity to cross examine Mr Sadiq and to recall the Claimant.  She accepts that neither she nor the Employment Judge put it specifically to the Claimant that he knew from the beginning that he was employed and that his stance with the Revenue could not be sustained.  She submits that the Employment Judge’s reasons were sufficient and to the point.

22.         It is convenient to begin with Enfield.  In that case the employee Mr Payne was offered employment as a catering equipment manager.  He expressed an interest in working as a sub-contractor.  The employer agreed, on the employee undertaking to work exclusively for it.  The arrangement was disclosed to the Revenue, which was prepared to accept it although it did not consider the matter clear-cut.  At first instance and on appeal it was held that performance of the contract was not vitiated by illegality.

23.         At the same time the Appeal Tribunal and the Court of Appeal considered the case of Grace v BF Components Ltd.  From the beginning of his employment Mr Grace submitted invoices for gross pay and paid his own tax and national insurance.  His employers suggested that he should invoice them in that way. Some ten weeks later they asked him to go onto a salaried basis but he rejected that because he did not think he could earn enough to live on. Then in August 2003 the employers told him that he would be regarded as an employee by the Revenue and that they were going to put him "on the books".  He sent an email reply in which he complained that the pay was too little to support him and his family; and that whilst he wanted to remain in employment he would prefer to remain self employed. However, the company insisted on his accepting a contract of employment and he reluctantly did so.  The Tribunal found that he became “fully aware” by August 2003 that his employers were liable to deduct tax and national insurance.  The Tribunal held that the contract was illegal after the first ten weeks, alternatively from the date in August 2003 when he was “fully aware”.  The Appeal Tribunal, although saying that this case was “not as clear cut as Payne”, reversed that conclusion, and the Court of Appeal agreed.

24.         There is a valuable review of the basic principles in this field in the judgment of the Appeal Tribunal at paragraph 26.  The whole passage repays study.  It is sufficient, by way of background, to refer to certain of the principles which Elias P set out.

“(3) There are three categories of case where a contract may be tainted with illegality. These were identified by Lord Justice Peter Gibson in his seminal judgment in Hall v Woolston Leisure Services Ltd [2000] IRLR 578 (paras 30-31). The first is where the contract is entered into with the intention of committing an illegal act. The second is where the contract is expressly or impliedly prohibited by statute. The third- and the category relevant to these two appeals - is where the contract was lawful when made but has been illegally performed, and the party seeking the assistance of the court knowingly participated in the illegal performance.

(4) In order to fall within this third category, it is traditionally said that there are two requirements. There must be knowledge of the illegal performance and participation: see the observations of Gibson LJ in the Hall case, para 31, referring to passages from the judgments of Lord Denning MR and Scarman LJ, as he then was, in Ashmore Benson Ltd v Dawson Ltd. [1973] 1 WLR 828.

(5) Implicit in the analysis of Gibson LJ is of course a third requirement, namely that the performance must be illegal. It must be a form of illegality which properly attracts the operation of the doctrine.

(6) The concept of knowledge requires that the employee must have knowledge of the facts which renders the performance illegal: Gibson LJ in Hall para 38. However, it is irrelevant whether the party appreciates that what he is doing is illegal. Ignorance of the law is no excuse. This has been reiterated on many occasions: see e.g. Miller v Karlinski (1945) 62 TLR 85(CA); Salvesen v Simons [1994] IRLR 52.

(7) The concept of participation on requires some active participation. There are cases in which the courts have held that mere knowledge of the illegality coupled with a failure to do anything about it can constitute participation: see e.g. Newland v Willer (Hairdressers) Ltd. [1981] IRLR 359 where an employee who became aware that her employers were deceiving the Revenue was held to be a participant in the scheme and therefore unable to claim unfair dismissal. However, in the Hall case the facts were similar. Mrs Hall asked to receive her pay gross but it came to her attention that her employers were deceiving the Revenue and not paying the appropriate tax. The Court of Appeal held that the Employment Tribunal was wrong to find that this was sufficient to render the contract an illegal one. There was no illegality by Mrs Hall. Peter Gibson LJ said this (para 47):

‘Her acquiescence in the employer's conduct, which is the highest her involvement in the illegality can be put, no doubt reflects the reality that she could not compel her employer to change its conduct.’

Lord Justice Mance, as he was, similarly held that there was no participation arising from the fact that she had turned a blind eye to the fraud on the Revenue, from which she did not benefit. He referred expressly to the Newland decision and said that he had doubts "about both the reasoning and the outcome of it". (para 80).

25.         After discussing the authorities, Elias P said (paragraph 43, 46):

“In our judgment the essential feature of all the cases where there has been found to be illegality is that the parties have knowingly entered into arrangements which have to their knowledge represented the facts of the employment relationship to be other than that they really were.

In none of these cases has the contract been held to be illegal merely as a consequence of the fact that the parties in good faith and without misrepresentation wrongly characterised their relationship with the result that the wrong tax regime was adopted. That is a relatively common occurrence. Tribunals frequently have to determine whether someone ostensibly employed under a contract for services has in fact been subject to a contract of service. Such cases typically involve the employee resiling from the arrangement he originally made.”

26.         Applying these principles, both appeals were allowed.  In neither case was any misrepresentation made to the Revenue.  In neither case did the employee know that the characterisation of the relationship as self employed was wrong, although for a short period Mr Grace knew his employers were saying that (see paragraph 50).

27.         The reference to “characterisation” found in the Employment Judge’s reasons in this case, echoes paragraph 52 of the judgment of Elias P:

“As the Tribunal here noted, there is often a fine dividing line between those properly described as employees and those who are self employed. In many cases lawyers may reach different conclusions on the same facts. It would be extraordinary if adopting the wrong characterisation – wrong in the sense that it was not the view of the court subsequently charged with determining the matter - could place the parties outside the law's protection. It would be even more offensive in circumstances, as here, where the Revenue is informed of the nature of the relationship and accepts the legal characterisation adopted by the parties.”

28.         It is important, in the context of this appeal, to note what Elias P said in paragraph 56:

“We accept that on occasions where the parties have sought to claim self employed status knowing that this was not sustainable then it might be legitimate to infer that they are seeking to misrepresent the true nature of their relationship. It is not, however, the mischaracterisation of the legal status which is the relevant misrepresentation; it is the implicit representation about the underlying facts of the relationship.”

29.         The decision of the Appeal Tribunal was upheld by the Court of Appeal.  Pill LJ said (paragraphs 26-28):

“26. A decision as to whether a relationship is one of employment or whether the person performing the services is self-employed will often be very difficult. Circumstances are infinitely variable. The issue is, as Elias J with his extensive experience of employment work put it at paragraph 46, one which is "relatively common". A number of factors will be involved and the relationship between them and the weight to be given to each of them in the particular case will need to be assessed. Predictions as to the side of the line on which a particular relationship will be held to fall are notoriously difficult to make.

27. For present purposes, I am prepared to assume that there could be tax advantage for the respondents in claiming to have self-employed status. I do not accept that, of itself, such advantage renders a contract subsequently found to have been a contract of employment unlawfully performed. I do not accept that a characterisation of the relationship held to be erroneous necessarily prevents an employee subsequently claiming the advantages of being, or having been, an employee.

28. A contract of employment may, as the cases show, be unlawfully performed if there are misrepresentations, express or implied, as to the facts. An obvious example occurs when what is in fact taxable salary is claimed to be non-taxable expenses. That is, however, distinguishable from an error of categorisation (as in the present cases) unaccompanied by such false representations, even if the employee had claimed the advantages of self-employment before the dispute arose. I accept that there are limits to that principle and that the circumstances in which a miscategorisation is made may amount to misrepresentation and bad faith which would deprive the employee of the right subsequently to claim the benefits of employment.”

30.         Lloyd LJ said (paragraph 37):

“I agree with Pill LJ that the EAT, chaired by Elias J, President, was correct to hold that it is not sufficient, in a case of this kind, to show that the employer's fiscal obligations were not complied with, and that the employee knew of the facts which led to this, namely the mischaracterisation of the relationship as being not one of employment, and participated knowingly and actively in that mischaracterisation. In a case of this kind there must in addition be a misrepresentation, express or implied, to the Revenue as to the facts if the contract is to be tainted by illegality of performance. That was the case in Miller v Karlinski (1945) 62 LT 85 and in Salvesen v Simons [1994] IRLR 52, as well as in other cases cited to us.”

31.         In this case the Employment Judge regarded herself as dealing with a third category case of illegality – by which I mean a contract where the party seeking the assistance of the court has knowingly participated in the illegal performance of the contract (see principle (3) in the judgment of Elias P, quoted already).  It is plain from the judgments in Enfield that a case will not come within this category merely because a claimant wrongly informs the Revenue that he is self employed when the Tribunal subsequently finds that he was not; nor will it come within this category merely because the claimant mistakenly chose to have or retain self employed status by reason of its financial benefits.  It is plain from the judgments that some form of misrepresentation, express or implied is required: see Elias P at paragraph 56, Pill LJ at paragraph 28 and Lloyd LJ at paragraph 37.

32.         Equally, however, it is plain that there are limits beyond which an employee or employer cannot go, explored to some extent in paragraphs 56 of the judgment of Elias P and paragraph 28 of the judgment of Pill LJ.

33.         In my judgment the true position is as follows.  When a taxpayer claims self-employed status with the Revenue he represents that he honestly believes he is entitled to such a status.  If he knows that he is not entitled to claim self-employed status, but goes ahead and claims it, he implicitly misrepresents his own belief.  This is why Elias P referred, in paragraph 56, to parties who have sought to claim self-employed status “knowing it is unsustainable” and Pill LJ referred, in paragraph 28, to bad faith.  An employee who knows that his assertion to be self employed is unsustainable and yet claims to the Revenue to be self employed misrepresents his own understanding of the position and acts in bad faith; it is contrary to public policy to lend support to him.

34.         Cases of this kind will no doubt be relatively rare, for the reasons given in Enfield.  It is often not straightforward to decide whether a person is (or is to be recruited as) an employee or self-employed.  There is no “bright line”. In many walks of life people are taken on to do similar work as employees or as self employed persons. It is not readily to be supposed that they will always or even usually know that it is unsustainable to claim a particular status.

35.         I turn, against that background, to the reasoning of the Employment Judge in this case.

36.         In my judgment the Employment Judge was quite right to raise the question of illegality.  The parties on each side were solicitors.  The offer to the Claimant was an offer of employment.  There were strong grounds for saying that the Claimant was – as he belatedly asserted when it suited him – an employee.  It is not surprising that the Employment Judge was concerned lest performance of the contract be tainted by illegality.

37.         The Employment Judge did not, however, find in terms that there was any express or implied misrepresentation (beyond the character of the relationship itself) to the Revenue or to any other person or authority.  Enfield requires such a finding.

38.         The Employment Judge said that the agreement to treat the Claimant as self employed was “not because of any genuine belief that the arrangements were such that the claimant was genuinely self employed for tax purposes”.  She found that the Claimant wished to be engaged on a self-employed basis because it was more beneficial to him financially.  Later she said that the nature of the relationship was “deliberately miscategorised at the instigation of the claimant”. 

39.         In my judgment the Employment Judge ought to have found performance of the contract to be illegal (in the absence of any misrepresentation as to specific facts) if and only if she positively found that the Claimant claimed self-employed status to the Revenue knowing that it was unsustainable to do so. 

40.         This is a very serious finding to make against any party, but particularly so against a solicitor. It is a finding that should only be made fairly and squarely, and then with reasons which clearly address what is said by way of answer, and after the matter has been put to the party.

41.         I am not satisfied that the Employment Judge made this finding; to say that the agreement was “not because of any genuine belief” but rather for financial advantage does not directly address the key question whether the Claimant knew that it was unsustainable to claim self-employed status.  I think if she did make that finding one part of her reasoning (which appears to be a significant element both in paragraph 6 and in paragraph 24) cannot stand.  The fact that a person wishes to be engaged on a self employed basis because it is more beneficial financially is not of any real significance in deciding the question whether he believes he is or may be entitled to that status.  Many people who choose to be self employed do so for the financial advantages it brings: it does not follow that they know their choice to be unsustainable.

42.         Further, before such an important finding was made the Employment Judge ought to have specifically addressed in her reasons the case which was put forward on behalf of the Claimant: namely, that he believed he could claim self-employed status as a locum, and then sought to regularise the position with the Respondents as time went on.  There are no reasons relating to the Claimant’s evidence.  If the Employment Judge rejected it, she should have made findings as to the facts and explained why she rejected it.

43.         Further, it is common ground that it was never put to the Claimant squarely that he did not believe his claim to self-employed status was sustainable.  This, I suspect, was because at the hearing there was no articulation of precisely what had to be established in order for the contract to be illegal in its performance.  If it was Ms Bibi’s case – even in the alternative – that the Claimant was not genuine in his claim to self-employed status, she should have put it to him. In one way or another, the Employment Judge should have ensured that it was put.

44.         For these reasons the appeal will be allowed.  The Employment Judge’s conclusion cannot stand.  Nevertheless her concerns were proper and legitimate concerns.  She was right to question whether the circumstances were such that the Tribunal should lend itself to hearing the Claimant’s case.  The matter will be remitted for rehearing according to the principles which I have identified.  The hearing should be afresh, now that both parties plainly know and understand the issues.  For that reason it is convenient for it to be before a freshly constituted Tribunal.