Over Taylor Biggs

Small companies are often run akin to partnerships.  Directors' remuneration is frequently a mixture of basic salary, a dividend and a bonus in order to make it as tax efficient as possible.  In some cases controlling shareholders who are also directors are lent money by the company each month against declaration of an interim dividend to repay that loan each month.  Unless this practice has been approved by the shareholders of the company it could be in breach of the Companies Act 2006.

If a small company that remunerates its directors in this way gets into financial difficulties and goes into liquidation, the Liquidator must ascertain who are employees of the company.  Employees have certain protection on a company's liquidation. Where sole employees are also the sole shareholders and also sole directors, the lines can become blurred.  It is often difficult to establish the various relationships and ascertain the relevant roles of those concerned. 

If a company has gone into liquidation, certain debts (such as notice pay, holiday pay and statutory redundancy payments) can be claimed from the National Insurance Fund in relation to employees.  Only employees of the relevant company may claim against the Fund.  Any Director who is not an employee cannot make a claim.

In the first case, Mr Neufeld was the Managing Director of A & N Communications In Print Limited.  He owned 90% of its issued share capital.  He also worked as part of the sales force of the company.  He worked in excess of 60 hours a week on his various sales and managerial roles.  He had not taken his full holiday entitlement.  He had also made personal loans to the company and provided personal guarantees in relation to some sales financing.  

The company went into liquidation.  Mr Neufeld claimed redundancy pay, notice pay and holiday pay from the National Insurance Fund.  This was disputed and it was claimed that Mr Neufeld was not an employee. 

The Court of Appeal upheld that Mr Neufeld was in fact an employee, even though that he was also a director and a controlling shareholder.

In a second case also in the Court of Appeal the same point arose.  Mr Howe claimed statutory redundancy payments from the National Insurance Fund when his company, Track Music Records Limited, went into liquidation.  Mr Howe was the sole director and held all the shares in the company.  He was paid a salary, from which tax and national insurance contributions were deducted.  Mr Howe borrowed to invest in his company and provided a guarantee to the landlord of the company's premises. 

The Court of Appeal held that Mr Howe was an employee of his company and, therefore, was entitled to claim against the National Insurance Fund.

In each case the Court of Appeal rejected the argument that an individual could not be an employee if he was a controlling shareholder of a company. 

This area of the law has attracted considerable interest in light of the increasing frequency of liquidations of companies and the implications for claims against the National Insurance Fund.  Buyers of businesses as going concerns may end up under the Transfer of Undertaking (Protection of Employment) Regulations 2006 (TUPE) becoming liable for directors' unwritten employment contracts. 

Care must, therefore, be taken to ensure that investigations are made into all employees and directors (whether or not they have formal written employment contracts) to determine how they have been treated for the purposes of their remuneration.  Specific warranties in asset purchase agreements should be included confirming the status of the various employees. 

Particular attention should be paid to the financial records to see how any controlling shareholders who are also directors (or any other person for that matter) have been treated for the purposes of their remuneration, including checking Schedule E Returns and National Insurance records to see whether contributions have been made on behalf of employees.

In addition, holiday and any other entitlements that might imply that the person is an employee rather than some form of self-employed consultant should be carefully scrutinised.  It may be appropriate to prepare a compromise agreement in relation to any former directors of the company for whom the buyer is not expecting to take over any remuneration liabilities following the acquisition of the relevant business.