Employment status of directors and shareholders

Nesbitt and Nesbitt v Secretary of State for Trade and Industry (2007)
Employment Appeal Tribunal

Background
Company directors owe statutory and common law duties to their company. In addition, they may
hold shares and be employed by this company. Despite this, if a director seeks to exercise rights
granted to employees, disputes often then arise as to their employment status.
An employee, according to s230(1) of the Employment Rights Act 1996, is an individual who has
entered into or works under (or where employment has ceased, has worked under) a contract of
employment. Courts have previously considered whether a director who holds shares in a
company can also be considered to be an employee within this definition. Courts have ruled in the
past that even if a director is a controlling shareholder, this does not in itself preclude the director
from also being an employee. The notable factual situation should be considered in reaching the
determination.
In this particular case of Nesbitt and Nesbitt v Secretary of State for Trade and Industry, the EAT
considered what additional facts would be relevant to determine whether the director and
controlling shareholder was an employee.

Facts
The EAT considered the status of the directors of an insolvent company who were also
shareholders but had been made redundant by the companys liquidator. These directors now
wished to claim payments from the insolvency fund.
The company in question provided IT training to businesses and public authorities. Three
members of the Nesbitt family had written contracts with this company and were paid salaries.
However, they did not receive directors fees or dividends. In 2006 the company became insolvent
and the Nesbitts, along with all remaining employees, were made redundant.
The Nesbitts then applied for redundancy payments and other monies under the insolvency
provisions of the Employment Rights Act 1996, for which only an employee would be eligible.
The tribunal dismissed their claims on the basis that they were not employees and so it was then
referred to the EAT.

Decision
The EAT decided that the Nesbitts were entitled to the insolvency payments and remitted the case
to the tribunal to decide on quantum.
In reaching this conclusion the EAT stated that the Nesbitts appeared to be employees of the
company owing to the nature of the relationship between the company and the individuals and
because of the contracts of employment that were in existence. However, the EAT also noted that
some cases in the past had held that directors who had contracts of employment were not
necessarily employees simply for that reason. Factors other than the simple existence of a
contract need to be considered. Key among these factors was the question of control over the
director.

A08345775/1.0/21 Sep 2007

The EAT stated that, when considering control, tribunals should examine the distinction between
theoretical control that a majority shareholder has over whether they are dismissed and the reality
of the situation, having regard to the make-up of the board and terms of the memorandum and
articles. The EAT felt that real as well as theoretical control over whether they can be dismissed is
a strong pointer against a shareholder also being an employee. Furthermore, it was held that a
contract of employment should be regarded as such unless either the individual concerned did not
behave as an employee or the company was a mere simulacrum of the employee.
In applying this approach to the current set of facts, the EAT concluded that the company was not
a mere simulacrum. Therefore, despite the fact that two of the Nesbitts were a married couple
and between them had 99.9% shareholding, the Nesbitts were held to have proper employment
contracts, received remuneration by way of salary and no other factors pointed away from their
employee status.
They were therefore held to be employed and would be entitled to some of the insolvency fund.

Comment
Tribunals should now consider all the factors and the reality of their situation before deciding
whether a controlling shareholder is an employee. The fact that the individual is a controlling
shareholder will only deny him employee status if the company is held to be a mere simulacrum,
controlled completely by the individual and the employment is therefore a sham.

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A08345775/1.0/21 Sep 2007