LPC

Statutory requirements

The basic position is that the right of an employee to pursue a matter in an Employment Tribunal cannot be excluded under contract between (ex-) employer and employee.

However, there are 2 main exceptions to this rule:

1. Where there has been a formal settlement agreement fulfilling the condition set out in s.203 of the ERA 1996; or
2. Where the ACAS conciliation officer has taken action under s.18 of the Employment Tribunals Act 1996, normally involving a COT3 form of settlement.

To comply with s.203 ERA 1996 an agreement must:

• be in writing;
• relate to the particular proceedings or the specific claim being settled;
• identify a relevant independent adviser from whom the employee has received advice as to the terms and effect of the agreement. In particular the employee must have received advice as to the effect on his ability to pursue a claim in the Tribunal;
• ensure that the adviser is covered by professional indemnity insurance; and
• state that the conditions regulating settlement agreements are satisfied.

If the settlement agreement does not comply with the s.203 ERA 1996 conditions, it will be void against the employee’s statutory claims (i.e. the employee will be able to bring his/her statutory claims against their former employer). However, it will still be effective to bind the employee in respect of the waiver of any contractual claims.

The first £30,000 of a payment as genuine compensation for loss of employment can be paid tax-free. However, if the payment is contractual (e.g. a payment for unused holiday) the payment will be subject to tax.

Negotiation points

Solicitors must give careful thought to the contents of what the settlement agreement should cover. A solicitor acting for the employer in a dismissal claim, for example, will want to ensure that the payment settles all claims (whether or not they have been made) for wrongful and unfair dismissal, discrimination and claims outstanding when the employment is terminated.

In contrast, an employee’s solicitor will want to ensure that the wording of the settlement document is broad enough to allow his client flexibility to bring subsequent claims, e.g. in respect of future pension rights and personal injury. These two types of claim are often excluded by an employee’s solicitor on the basis that they are common examples of claims which an employee may need to bring after he has signed the agreement but which were not within his knowledge, nor in his reasonable contemplation, at the time. An employee’s claim in relation to his loss of pension rights, for example, may not arise until a considerable time after he has entered into a settlement agreement.

It is important to note that it is unlikely that the wording of an agreement would prevent an employee from bringing a claim which was not known about nor could have been known about at the time agreement was entered into.

References

The general rule is that an employer is not under a duty to provide a reference for an employee or ex-employee, but if the employer does provide a reference, the employer should take care to provide a reference which is true, accurate and fair otherwise the employer may be liable for deceit, defamation and/or negligent mis-statement. To avoid any future problems with trying to obtain a reference, an employee’s solicitor is likely to negotiate agreed wording for a reference as part of the settlement agreement, as the employee will usually need a reference to secure a job with another employer and the Employment Tribunal has no power to order an employer to provide a reference in respect of an ex-employee.

Once a contract of employment has ended, there are no implied restrictions on an employee, other than a prohibition on the employee disclosing confidential information. In order to protect its business, an employer may choose to put further restrictions on an employee, e.g. to prevent him from working for a competitor after his employment has ended, by including an express term in the contract of employment. Such an express term is known as a restrictive covenant.

The courts look unfavourably on any provision which restrains an employee from earning a living in the future (a so-called ‘restraint of trade’). Therefore, the basic premise is that all restraints are prima facie void and unenforceable unless they:

1. protect a legitimate interest of the business (e.g. customer connections, stable workforce, trade secrets); and
2. go no further than is reasonably necessary to protect that legitimate interest.

To ensure enforceability, the covenants must be tailored to suit the requirements of each individual employment situation and should be reviewed regularly.

Types of restrictive covenants

There are 3 common types of restrictive covenants:
1. Non-competition – these prevent the ex-employee from working for a competitor or setting up a competing company.
2. Non-dealing – these prevent any dealings between the ex-employee and customers (even if the customers approached him).
3. Non-solicitation/poaching – of customers (prevents the ex-employee soliciting business of customers) or of staff (prevents the ex-employee poaching members of the team to join a new business).

Blue pencil test

The court will not rewrite restrictive covenants to make them enforceable. However, it may strike out the unenforceable part of a restrictive covenant clause (e.g. an offending word) but will only enforce the remainder of the clause if it makes independent sense. Any enforcement of restrictive covenants by the court will be at the minimum level needed to protect the employer’s legitimate interests.

Reasonableness factors

These factors are used to assess the reasonableness of restrictive covenants:

• The duration of the restraint – should not be longer than is necessary
  to protect the interest (e.g. how long will the information remain
  confidential?)
• The geographical scope of the restraint – this may link into the needs of the business (e.g. where is its customer base?)
• The needs/interests of the business – is the nature of the business global or local? Is it very specialised?
• The duties of the employee – how senior is the employee? How much influence does he have over clients or staff? Does he in fact have any contact with clients at all? There is no real justification in having a nonsolicitation clause for someone who never had any client contact.
• The interest that the business is seeking to protect and whether a lesser restriction would suffice. For example, bearing in mind the other reasonableness factors, is the clause as drafted wider than is necessary to protect the employer’s business interest? Could customer connections be adequately protected by a non-solicitation clause rather than a more draconian non-competition clause?

The effect of wrongful dismissal

If the employer dismisses an employee in breach of contract or if the employee resigns as a result of a constructive dismissal then any restrictive covenants are unlikely to be enforceable. This is because the employer will have committed a repudiatory breach of the underlying employment contract entitling the employee to free themselves of their obligations under the contract.

Redundancy is one of the five potentially fair reasons for dismissal and is defined in the ERA 1996. To summarise, the definition envisages 3 possible circumstances in which a genuine redundancy situation can arise, as follows:

• the business is shut down altogether;
• the place of business where the employee works is shut down; or
• there is a reduction in the need for employees.

This last situation is perhaps the most common example of redundancy. If there is a genuine redundancy situation, employees will be entitled to a statutory redundancy payment (in addition to their proper notice entitlement) provided they have been continuously employed for at least two years. The redundancy payment is calculated in the same way as the basic award for an unfair dismissal claim.

If there was a genuine redundancy situation, then the employee will have no claim against the employer, provided:

1. the correct redundancy payment was made (including any notice payment); and
2. a proper procedure was followed and the employer acted reasonably in carrying it out.

In deciding on the second element (whether or not a proper procedure was followed and the employer acted reasonably in carrying it out), the Tribunal will consider a number of factors:

1. The employer’s reason for redundancy. However an employer’s reasons for wishing to reduce staff levels will generally not be closely scrutinised by the Tribunal unless it is claimed that the redundancy is a sham.
2. Consultation. The Tribunal will consider whether the employer consulted with the employees about the redundancy situation and how the selection process would work. Individual consultation is always required. There are additional requirements for collective consultation where 20 or more redundancies at one establishment are to be made within a 90 day period.
3. The selection process. The Tribunal will look closely at the selection process in deciding which individuals were to be made redundant. It will look at the pool (the precise area(s) of the business where the redundancies are likely to take place) used from which to select individuals for redundancy. It will also look at how the employer selected from that pool. An employer seeking to reduce the headcount must use objective criteria, e.g. qualifications, skills, attendance and experience in selecting employees for redundancy. The Tribunal will also consider whether employees were properly assessed in accordance with those criteria.
4. The employer must consider the possibility of offering the redundant employees suitable alternative employment if there are vacancies in other departments.
5. Whether the employer allowed employees to appeal the selection for redundancy decision.

The right to claim unfair dismissal is available to employees only. It is not available to workers or independent contractors.

The ERA 1996 states that an employee has a right not to be unfairly dismissed by his employer.

Where the claim will be heard

A claim of unfair dismissal must be made to an Employment Tribunal with appeal to the Employment Appeals Tribunal and then to the Court of Appeal and, very occasionally, the Supreme Court. Appeals are permitted on questions of law only.

Who can make a claim?

In order to bring a claim of unfair dismissal, the employee must show:

• that he was dismissed;
• that he was employed for the qualifying period of service; and
• that he was not in an excluded category (e.g. police, armed forces).

Once the employee has satisfied these criteria, the employer has the burden of showing:

• that it had a fair reason for the dismissal; and
• that the dismissal was fair in all the circumstances.

Was the employee dismissed?

This should be fairly easy to establish. An employee will have been dismissed if he was given notice of termination by the employer, simply told to leave, sacked or where the employer used language which would amount to dismissal.

Dismissal includes ‘constructive dismissal’. This occurs where it is the employee who leaves the job but he is compelled to do so by the conduct of the employer. The employer’s conduct must amount to a fundamental breach of the employment contract to which the employee must have resigned in response. The employee must not have waived the breach. If the employee can show these elements, he is then deemed to have been dismissed by the employer.

Does the employee have the required qualifying period of service?

In most cases, the employee must show that he has one or two years’ continuous employment with the employer in question. For employees whose employment began before 6 April 2012 the qualifying period of service is one year. For employees whose employment began on or after 6 April 2012 the qualifying period of service is two years.

However, in certain limited cases, the employee is not required to have the qualifying period of service, for example: dismissals connected with pregnancy, maternity or paternity leave; dismissals for health and safety reasons; dismissals relating to the enforcement of the Working Time Regulations and dismissals for having made a protected disclosure.

Did the employer have a fair reason for the dismissal?

There are five potentially fair reasons for dismissal:

1. Capability – an employee can be dismissed for incompetence or incapability if he or she is unable to do the job properly.
2. Conduct – includes disobedience to orders; abusive language; theft; drunkenness at work; persistent lateness.
3. Redundancy
4. Statutory illegality – on those rare occasions where it may become illegal to continue employing someone, for example, if their work permit expires.
5. Some other substantial reason – this is really a catch-all category – it is there to allow an employer to put forward another substantial reason for justifying the dismissal (e.g. where there is a clash of personalities or where there is an economic, technical or organisational reason (‘ETO reason’) for dismissal on a TUPE transfer).

The onus of showing that there was a fair reason lies with the employer. If the employer did not have a fair reason for the dismissal, or gave the employee the wrong reason, the dismissal will be unfair.

Was the dismissal fair in all the circumstances?

Proving that the reason for the dismissal was fair does not make the dismissal fair. In order for the dismissal not to be declared unfair, the procedures followed in carrying out the dismissal must also be fair in all the circumstances. This is where employers frequently get caught out. No matter how good the reason for the dismissal is, if the handling of the dismissal procedure is unfair, then the dismissal is more than likely also going to be held to be unfair.

The question of whether fair procedures were followed before dismissing an employee will very much depend on the facts and the reason for the dismissal. In cases where the fair reason relied upon is capability or conduct, the Tribunal will consider whether both the employer’s disciplinary procedure and the ACAS Code of Practice 1 – Disciplinary and Grievance Procedures (the ‘ACAS Code’) have been followed. If the Tribunal considers that there has been an unreasonable failure by the employer to comply with the ACAS Code, it may increase the compensatory award by up to 25%.

As a minimum, the ACAS Code requires employers to:

• establish the facts of the case (i.e. investigate);
• inform the employee of the problem;
• hold a meeting with the employee to discuss the problem, allowing the employee to be accompanied;
• decide on appropriate action; and
• provide an opportunity to appeal.

In addition, a Tribunal will look at a number of other factors to determine whether or not the dismissal was fair in all the circumstances, for example:

• Consistency – whether the employer’s actions were consistent with past practice.
• Equitability – whether equal treatment was given to employees in the same position.
• Warning procedures – whether the employer made proper use of warnings. Was the employee given an oral or written warning before the dismissal?
• Offers of training or re-training – whether the employer considered retraining the employee for another position if he is not capable of doing his own job.
• Fair hearings – in cases where an employee is dismissed for misconduct or incapability the employee should be given a fair hearing so he is given the chance to state his case by producing evidence or calling witnesses if necessary.
• Appeals procedures – the employee should also be given an opportunity to appeal against the employer’s decision and so the question of whether the employer had an appeals procedure in place is also important.

Limitation period

A claim for unfair dismissal must be presented to the Tribunal within 3 months of the effective date of termination, subject to the early conciliation procedure
as described.

Remedies for unfair dismissal

There are 3 remedies available to the unfairly dismissed employee, namely reinstatement, re-engagement and compensation.

Re-instatement involves returning the employee to the same job. Re-engagement involves placing the employee in a similar job with the same, or an associated, employer.

While re-instatement and re-engagement are obviously important remedies, they are granted in fewer than 2% of cases.

Compensation is by far the most common remedy. There are two elements to this remedy – the basic award and the compensatory award.

Basic award

The basic award is based solely on past service and the amount awarded will depend on the length of service of the dismissed employee, their age and weekly pay.

The basic award is calculated using the fixed statutory formula set out below: [AGE FACTOR] x [SERVICE] x [WEEK’S PAY]

The employee’s age factor is as follows:

For each complete year of employment below the age of 22	½ a week’s pay
For each complete year of employment between the ages of 22 – 41 (N.B. There will be a year during which the employee turns 41 which will count as 1 week’s pay as the year does not count as a complete year during which the employee was 41 or over.)	1 week’s pay
For each complete year of employment when the employee is 41 or over until retirement	1½ weeks’ pay

 

The number of years’ service is subject to a maximum of 20 years.

The employee’s weekly salary is subject to a statutory maximum, which is revised annually.

Compensatory award

The compensatory award is the second element to the remedy of compensation. It is intended to cover the employee for the actual loss suffered. The compensatory award is also subject to a statutory maximum which is revised annually.

The Tribunal will look at the immediate loss of wages between the date of termination and the date of the hearing. In addition to wages, the Tribunal will also take into account loss of other fringe benefits including bonus payments, company car, pension rights etc. The employee should always attempt to mitigate his loss during this period by looking for another job. Any wages and benefits received by an employee from his new job will be taken into account by the Tribunal when granting an award. If the employee makes no attempt to mitigate his loss by finding another job, the Tribunal can reduce the amount awarded.

If the employee has still not found work by the time of the hearing, the Tribunal may also award an amount for future loss of wages and benefits. This involves a degree of guesswork and the Tribunal will need to establish how long the claimant is likely to remain unemployed taking into account the employee’s skills and the current market for such skills.

Where the Tribunal finds that the employer has not complied with the ACAS Code, it can increase the compensatory award by up to 25%. Equally if it is the employee that has failed to follow the ACAS Code, the Tribunal can decrease the compensatory award by up to 25%.

What is wrongful dismissal?

A claim for wrongful dismissal arises where the employer has dismissed the employee in breach of the terms of the employment contract by, for example, failing to give the employee any or sufficient notice.

In actions for wrongful dismissal, the court/Employment Tribunal’s only concern is whether the correct contractual requirements have been complied with.

The amount of notice which is required to be given to an employee will be determined by the terms of the employee’s contract but this is subject to a statutory minimum. Under the ERA 1996, employees are essentially entitled to one week’s notice if employed for more than one month but less than two years. Employees employed for two years or more are entitled to one week’s notice for every completed year of service up to a maximum of 12 years (i.e. 12 weeks’ notice).

Therefore, if the contract of employment gives less than what is required by statute, the statutory notice entitlements apply.

The only situation in which an employer is not required to give notice is where the employee is in very serious breach of contract, e.g. the employee has been caught red-handed stealing from the employer or has assaulted another member of staff. Dismissals without notice are referred to as ‘summary dismissals’.

Where the claim will be heard

A claim of wrongful dismissal may be made in the County Court or the High Court, or in an Employment Tribunal. Damages awarded for wrongful dismissal claims taken to the Employment Tribunal are subject to a limit of £25,000.

Since claims for wrongful dismissal are claims for breach of contract, the normal limitation periods apply and claims in the ordinary courts must be brought within six years of the date of the dismissal. Claims made in the Employment Tribunal must be brought within three months of the dismissal, subject to a mandatory early conciliation procedure. This is a period of conciliation using the Advisory, Conciliation and Arbitration Service (‘ACAS’) of up to one month before the claim is presented at the Employment Tribunal with the aim of encouraging parties to settle the claim. The clock on the time limit is stopped during this period and starts again if conciliation is not successful.

Remedy for wrongful dismissal

The remedy for wrongful dismissal is damages for breach of contract. The exemployee is therefore under a duty to mitigate his or her loss by seeking new employment. If the ex-employee finds a new job, this must be taken into account and damages reduced accordingly. If the ex-employee makes no attempt to mitigate his or her loss by trying to find another job the amount of damages awarded can be reduced.

Relationship between damages for wrongful dismissal and compensation for unfair dismissal

It is possible for an employee to have a claim for wrongful dismissal and unfair dismissal at the same time if, for example, he or she has been unfairly dismissed and was also not given the proper notice before his or her contract was terminated. In such cases, the compensatory element of the unfair dismissal award will be reduced by the payment received for wrongful dismissal, so that the employee does not benefit from double recovery.

Payment in lieu of notice clauses

A payment in lieu of notice clause (‘PILON’) allows the employer to pay the employee rather than require the employee to work during their notice period.

An employment contract often allows the employer the discretion to give the employee a PILON. If the employment contract contains a PILON clause and the employer dismisses the employee and pays him/her in accordance with the PILON clause – instead of employing him/her until the end of his/her notice period – there will be no breach of contract and no claim for wrongful dismissal. The main reason for having a PILON clause is to preserve any restrictive covenants that would otherwise be unenforceable because the employment would have been terminated in breach of contract.

Payments made under PILON provisions are usually taxable as earnings for income tax purposes.

It is very important to determine whether someone is an employee, an independent contractor or a worker for employment law purposes. The answer will essentially determine who qualifies for certain employment rights and who does not.

On a very simple level, independent contractors are individuals who set up business on their own account and provide services to others under a contract for services. This could be, for example, an individual who has set up his own contract cleaning business. He will normally provide cleaning services to a number of different customers when needed and invoice the customer on a weekly or monthly basis. He will incur his own expenses in running the business and sort out his own tax affairs with HMRC directly. Independent contractors are therefore regarded as self-employed and have no employment relationship with those for whom they perform services.

Employees on the other hand are usually required to work regular hours, on tasks set by the employer, at a set location and for a fixed salary. They will generally receive the usual employee benefits including a fixed salary and paid holiday leave.

Who is an employee?

The definition of an employee

Section 230(1) ERA 1996 provides that an employee is an individual who has entered into, or works under (or where the employment has ceased, worked under) a contract of employment.

This definition is fairly unhelpful because (as with most contracts) the courts will look at the substance and not the form of the contract. The label the parties choose to put on a contract in terms of whether they call it a contract of employment (sometimes also called a contract of service) or label it a contract for services is of very little significance. This label will only be one of the many factors which the courts will look at before deciding whether an individual is an employee or falls into some other category.

The answer to the question of whether an individual is an employee rests instead on a number of common law tests. These are:

1. the personal service test;
2. the control test;
3. mutuality of obligation test; and
4. other factors – economic reality and integration tests.

The personal service test

This test considers whether the individual must perform work personally. If the
individual has a right to send a substitute to perform the work in his/her place
this may negate employment status. However the Tribunal will consider if the
right to substitute is fettered in any way (e.g. does the substitute have to be
selected from a list that the employer has pre-approved?). The Tribunal will
also look at whether the right to send a substitute has actually been exercised
in practice.

The control test

The control test explores the level of control an employer has over the individual’s work pattern. The control test involves applying a number of questions to the circumstances of the case to determine what level of control the employer has. For example:

• To what extent does the employer control who does the work?
• Does the employer control what work is done e.g. does he control the order in which jobs or tasks are undertaken?
• What control does the employer have over where the work is done?
• Does the employer have control over when the work is done and the number of hours worked?
• Can the employer control how the work is to be performed?

If, after asking these questions, you arrive at the conclusion that the employer has very little control, this will tend to point away from an employment relationship existing.

The mutuality of obligation test

Under this test the employer should be under a duty to provide work and the individual under a duty to accept and then perform the work when given it. The expression ‘employer’ is used in this context as meaning the person to whom the services are being provided and not the ‘employer’ in the legal sense of an employer/employee relationship.

Other factors – economic reality and integration tests

The courts recognise that the question of whether an individual is an employee comes down to a combination of features taking into account all aspects of a person’s work activities.

The tests mentioned above are relevant and examples of additional factors taken into account under this test include:

• whether the individual is integrated into the workforce;
• whether the individual bears a degree of financial risk;
• how the individual is paid (is it via a regular wage slip or does he/she submit an invoice for work done?);
• whether the individual is able to work for others;
• how have the parties described their relationship?
• is the individual subject to the company’s disciplinary or grievance procedure?
• is the individual paid holiday or sick pay?
• does the individual wear the uniform of the company and/or appear to the outside world to be an employee of the company? and
• how his/her earnings are taxed (is tax deducted at source via PAYE or does he/she account to HMRC for his/her own taxes?).

Once you have applied these tests, you should be able to paint an overall picture from which to decipher who is likely to be considered an employee and who is not. If the individual is not an employee then he will not be able to benefit from some of the very important and more traditional employment rights, including the right not to be unfairly dismissed and the right to receive a redundancy payment in the event of a redundancy situation arising.

Who is a worker?

Why do we need to know?

As the scope of employment protection broadens, workers have acquired new rights in the workplace. The following are some of the legislative measures that contain provisions covering workers and not just employees:

• Public Interest Disclosure Act 1998
• Working Time Regulations 1998
• National Minimum Wage Act 1998
• Equality Act 2010

The definition of a worker

All employees are also workers, but not all workers are employees. Therefore, the category of ‘worker’ is wider and extends certain employment law protection to others who are not employees.

Section 230(3) ERA 1996 defines a worker as an individual who has entered into or works under (or where the employment has ceased, worked under):

1. a contract of employment; or
2. any other contract, whether express or implied, and (if it is express) whether oral or in writing, whereby the individual undertakes to do or perform personally any work or services for another party to the contract whose status is not by virtue of the contract that of a client or customer of any profession or business undertaking carried on by the individual.

The requirement to perform the services personally and not to be doing so as part of a business venture or profession where there is a client/customer relationship is the key to whether or not the person will be regarded as a worker. Workers may fall into any of the following categories: temporary workers; casual workers; locums; sub-contractors; and consultants.

Who is an independent contractor?

An independent contractor is someone who works under a contract for services rather than a contract of service. They are sometimes referred to as freelance workers or self employed.

Independent contractors are commonly found in certain industries such as construction, catering, shipping and the IT industry. Very often the individual concerned will enter into a contract through which his services will be provided to the relevant business.

The contract between the individual and the business will be drafted to provide for maximum flexibility, to ensure that the individual is not required to perform the services personally, is not subject to overt control and can be seen to bear a degree of financial risk. Again the courts will look at the substance and not just the form of the contract. Provided the arrangement is genuine, the independent contractor should not be an employee or a worker.

Introduction to Employment Law

As a corporate lawyer you will not be expected to be an expert in employment law. However, you will need to be able to identify potential employment law issues, know when to consult an appropriate colleague and understand the solution being suggested to your client and how this will impact on the work that you are doing.

A good example of this is the impact of TUPE on corporate transactions. As a corporate lawyer you will need to be able to identify a potential TUPE transfer. You will also be expected to understand at a basic level what obligations arise for your client as a result of the deal constituting a TUPE transfer.

By illustration, the potential impact of TUPE was highlighted in a case in June 2005 when The Transport & General Workers Union alleged that William Hill had failed to consult with employees prior to its acquisition of Stanley Racing and brought a claim for compensation of up to £4,000,000. Thankfully for William Hill the claim was subsequently thrown out by the Employment Tribunal on the basis that there had only been a share sale and not a business sale, so TUPE did not apply. However, this demonstrates the potential costs of not complying with these regulations and the importance of being able to identify such employment issues in the context of a corporate deal.

The impact of European Law

EC legislation and case law has had a major influence on UK employment law. You may already be familiar with the Equal Treatment Directive, the Equal Pay Directive and the Acquired Rights Directive which gave rise respectively to the Sex Discrimination Act, the Equal Pay Act (both of which have now been replaced by the Equality Act 2010) and TUPE.

The role of EU law in domestic legislation is something that could undergo significant change following the UK’s decision to leave the EU as a result of the Brexit referendum in June 2016.

The law is moving towards the protection of workers generally, and not just employees.

General nature of Employment Law

Employment law is best described as a mixture of contractual and statutory rights.

In essence, the employment relationship is largely governed by the employment contract between the employer and the employee (whether it is an oral agreement or an agreement in writing). The employment contract will always be the starting point when advising an employer or employee of their respective rights and duties. Many issues relating to employment law therefore involve the application of the common law principles of contract law.

However, the reality of the employment relationship is such that the employer is typically in a much stronger negotiating position than the employee. To address this inequality and protect employees, a raft of statutory provisions has been introduced. The employment contract and the entire employment relationship is now very strictly controlled by statutes (many of which have derived from EC law). For example, we have statutory control over the two most basic elements of the contract of employment, namely the minimum amount which employees must be paid (this is controlled by the National Minimum Wage Act 1998) and how long they can be required to work (controlled by the Working Time Regulations 1998).

Employment law is driven by the economic and political climate making it an extremely fast-changing area. The economic downturn of 2007-09 led to a government drive to try and promote business recovery and remove excessive restrictions and regulations upon businesses. Much of the consequent employment law legislation was designed with this aim in mind and it produced a real reduction in employment rights. For example, an increase in the qualifying period needed to claim unfair dismissal has meant that fewer employees are eligible to bring claims for unfair dismissal and the introduction of fees for Employment Tribunal claims, designed to discourage unmeritorious claims, has resulted in a huge drop in proceedings being issued against employers.

Whether the Government will take this deregulation agenda further following the UK’s decision to leave the EU as a result of the Brexit referendum is something that remains to be seen.

Requirement for shareholder approval

In the situation where a director leaves or loses his position, the company may wish/agree to pay him compensation for loss of office due to the specific circumstances involved. As a check against less scrupulous directors awarding each other gratuitous payouts, s.217 CA 2006 requires that any such payments must be approved by the company’s shareholders by way of ordinary resolution unless:

1. the payment, together with any other relevant payments, does not exceed £200 (s.221 CA 2006) (a definition of “other relevant payments” is given in s.221 CA 2006); or
2. the payment is made in good faith: (i) in discharge of an existing legal obligation; (ii) by way of damages in respect of such an obligation (for example, damages for breach of contract as discussed at paragraph 2.4 above); (iii) in settlement or compromise of a claim in connection with termination of a person’s office or employment; or (iv) by way of pension in respect of past services (s.220 CA 2006).

Any such payment by a company to a director of its holding company must also be approved by that company – in this case, approval must be obtained from the shareholders of both companies. However, no approval is required under s.217 CA 2006 from the shareholders of a wholly-owned subsidiary (s.217(4) CA 2006).

Directors cannot avoid these provisions by the payment being made to a third party rather than directly to the director himself – under s.215(3) CA 2006 payments made to a person connected to a director, or made to any person at his direction, or for the benefit of, a director or a connected person, will be treated as a payment to the director and will also require shareholder approval.

A memorandum setting out particulars of the payment must be made available to shareholders for 15 days before the ordinary resolution is passed, ending with the date of the general meeting (s.217(3) CA 2006). The legislation also includes provisions requiring shareholder approval for:

• any payment for loss of office made by any person to a director in connection with the transfer of the whole or part of the undertaking or property of a company (for example, on a share or business sale of the company) (s.218 CA 2006); and
• any payment for loss of office made by any person to a director in connection with a transfer of shares in the company, or one of its subsidiaries, resulting from a takeover bid (s.219 CA 2006). Note that in such a vote neither the offeror nor their associates (defined in s.988 CA 2006) will be allowed to vote on the resolution (s.219(4) CA 2006).

As specific shareholder approval is required under the above sections (ss.217, 218 and 219 CA 2006) for such compensation payments, it is not also necessary to comply with the authorisation requirements set out in s.175 CA 2006 regarding the directors’ duties to avoid conflicts of interest (s.180(2) CA 2006).

Meaning of “payment for loss of office”

What exactly is a “payment for loss of office”? This is defined under s.215(1) CA 2006 as a payment made to a director or past director by way of:

1. compensation for loss of office as director of the company;
2. compensation for loss of any other office or employment in connection with the management of the affairs of the company or its subsidiary undertakings while director of the company or in connection with ceasing to become a director of the company; or
3. consideration for, or in connection with, retirement from the office of director, or from any other office or employment in connection with the management of the affairs of the company or its subsidiary undertakings while director of the company or in connection with ceasing to become a director of the company.

Section 215(2) CA 2006 makes it clear that “compensation” includes both cash and non-cash benefits.

Consequences of breach

These are found in s.222 CA 2006. Where a payment is made in contravention of s.217 the recipient will hold the payment on trust for the company (s.222(1)(a) CA 2006). In addition, any directors who authorise the payment are jointly and severally liable to indemnify the company that made the payment from any resulting loss (s.222(1)(b) CA 2006).

A payment in contravention of s.218 (payment in connection with transfer of undertaking or property) will result in the recipient holding the payment on trust for the company whose undertaking or property is or is proposed to be transferred (s.222(2) CA 2006).

Where s.219 CA 2006 (payment in connection with share sale) is contravened the recipient will hold the payment on trust for those who have sold their shares as result of the offer. Moreover, any expenses in distributing the sum to those persons will be borne by the recipient and cannot be deducted from the sum received (s.222(3) CA 2006).

Corporate Governance Code requirements (listed companies only)

Corporate Governance Code (‘CGC’)

For listed companies whose shares are listed on the Main Market on the London Stock Exchange only, the CGC sets out requirements in respect of service contracts and compensation. You will study the CGC in further detail if you take the Equity Finance or Corporate Finance elective modules. Companies should carefully consider what compensation commitments the director’s terms of appointment would entail in the event of early termination. Unless certain limited exemptions apply (in relation to the recruitment of new directors) notice or contract periods should be for a period of one year or less.

In addition, the CGC contains specific provisions relating to directors’ remuneration. In particular:

• The remuneration should be designed to support strategy and promote the long-term sustainable success of the company.
• Remuneration arrangements should ensure reputational and other risks from excessive rewards, and behavioural risks that can arise from target based incentive plans are identified and mitigated.
• The link between individual awards, the delivery or strategy and the long-term performance of the company should be clear. Outcomes should not reward poor performance.

As compensation for loss of office is likely to be linked to remuneration, the above provisions should also serve to reduce the scope of any compensation payable to a director.

Directors’ Remuneration Report

The Large and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013 as amended by The Companies (Directors’ Remuneration Policy and Directors’ Remuneration Report) Regulations 2019 set out the requirements for preparation of the directors’ remuneration report (which forms part of the company’s Annual Report and Accounts) by UK incorporated quoted companies and, as from 10 June 2019, unquoted trading companies (of which there are only a very small number in the UK) . The directors’ remuneration report must include:

1. an annual statement by the chair of the remuneration committee which summarises the major decisions the committee has made on directors’ remuneration that year and any exercise of discretion in the award of directors’ remuneration;
2. an annual report on remuneration disclosing how the existing remuneration policy is intended to be implemented in the current financial year; and
3. the directors’ remuneration policy.

Shareholders of UK incorporated quoted companies and unquoted trading companies will need to approve the director’s remuneration policy at least once every three years by way of ordinary resolution (s.439A(1) CA 2006). This resolution will be binding so that once the remuneration policy has been approved, the company must only make payments in accordance with the policy or else seek shareholder approval to amend the policy to authoirse the Company to make the payment (s.226B(1) and s.226C(1) CA 2006). Any obligation, however arising, to make a payment of remuneration or loss-ofoffice payment which would be in contravention of the policy will have no effect (s.226E(1) CA 2006).

From 10 June 2019 references to “directors” in s226A – 226F CA 2006 dealing with remuneration payments and loss of office payments include somone who isn’t a director but is a company’s chief executive office or deputy chief executive officer. Although it would be unusual for someone with this job title not to be a director.

Waiver of directors’ personal liability

It may be that, even though a director has not acted in compliance with his duties to the company, the shareholders are willing to forgive him for the breach. This often occurs when the breach was inadvertent or minor. As you are aware already, if a director acts negligently or in breach of duty or trust in relation to the company he will incur personal liability. However, the shareholders of a company have the option to forgive conduct by a director amounting to negligence, default, or breach of duty or trust with the
consequence that the director’s personal liability in respect of that conduct will be waived.

This ratification of a director’s conduct was dealt with under the common law, until the introduction of s.239 CA 2006 which put ratification on a statutory footing. Section 239 CA 2006 sets out the minimum requirements which must be met for a ratification to be effective. It applies to former directors and shadow directors, as well as to current directors. Although s.239 CA 2006 is very much based on the common law requirements, it also introduces more restrictive elements.

Shareholder approval required

Unless the company’s articles require a higher majority (or unanimity), an ordinary resolution must be passed in order to ratify conduct by a director amounting to negligence, default, or breach of duty or trust (s.239(2) CA 2006). However, it is important to note that in obtaining the required level of approval, any votes which the director and any person connected to him may have as shareholders of the company cannot be taken into consideration. This introduces a significant restriction on ratification which did not exist under common law. The intention behind it is to prevent those who may gain a personal advantage from the ratification from voting – it is not appropriate for those that have done wrong, or those connected to them, to be able to vote to waive their own liability.

“Connected persons” is defined in s.252 CA 2006 and includes, amongst others, the spouse, children and parents of a director (s.253 CA 2006) as well as companies with which the director is connected. Notably “connected persons” for these purposes may also include a director’s fellow directors if they satisfy one of the other requirements in the connected person definition (s.239(5)(d) CA 2006).

As a result of this new restriction:

1. if the ratification is proposed as a written resolution, as the director and any shareholders connected to him are not eligible to take part (s.239(3) CA 2006), the resolution need not be sent to them and they are not taken into account in determining whether the requisite majority has been achieved to pass the resolution; and
2. if the resolution to ratify is proposed at a meeting, the necessary majority must be achieved disregarding any votes in favour made by the director and any members connected to him (s.239(4) CA 2006). The director and connected member can, however, still attend, count in the quorum and take part in the proceedings at a meeting where such a resolution is proposed.

Section 239(6) CA 2006, however, does clarify that nothing in s.239 CA 2006 affects the validity of a decision taken by unanimous consent of the shareholders. Therefore, when such consent has been obtained, the restrictions on who can vote will not apply.

Overall, these statutory provisions will make it harder for companies to ratify a director’s conduct, particularly in small family companies where the directors often hold the majority of the shares and are related.

Other requirements for valid ratification

Section 239(7) CA 2006 makes it clear that the requirements set out in s.239 CA 2006 are in addition to, rather than an alternative to, any other requirements that statute or common law may impose for ratification to be valid. It states that s.239 CA 2006 does not affect:

1. any statute or rule of law imposing additional requirements to those set out in s.239 CA 2006; and
2. any rule of law as to acts that are incapable of being ratified by the company.

So, for example, it is still not possible for illegal acts or acts which defraud creditors to be ratified.

Removal by shareholders is obviously not the only way in which a director may leave his position. The other ways in which he may cease to be a director are set out below.

Resignation by notice

A director could be put under pressure to resign either by the shareholders or by fellow board members and may simply take the decision to resign from the board by tendering a letter of resignation. This procedure is provided for in MA 18(f). A director may also decide to resign for personal reasons. It is usual, although not obligatory, in these circumstances for the board to pass a board resolution accepting the letter of resignation. If the resigning director is also a shareholder, consideration must be given as to what will happen to his shares i.e. will the other shareholders be able/willing to buy them?

Automatic termination

Under MA 18 a person ceases to be a director as soon as:

1. the director becomes disqualified from being a director;
2. the director becomes bankrupt;
3. the director becomes the subject of an individual voluntary arrangement or enters into some other similar arrangement with his creditors; or
4. a registered medical practitioner who is treating the director states in writing to the company that the director has become physically or mentally incapable of acting as a director and will remain so for more than three months.

Retirement by rotation

Public companies

The model articles for public companies require retirement and reappointment of directors by the members every three years.

Listed companies

In addition, listed companies are required under the Listing Rules to comply with the UK Corporate Governance Code (‘CGC’), or at least to explain in their annual accounts where and why they have not done so. One of the requirements of the CGC is that all directors should be subject to annual re-election.

Disqualification – Company Directors Disqualification Act 1986 (‘CDDA’)

The CDDA is the key piece of legislation regarding disqualification of directors. Under this Act, the court may make a disqualification order against a person preventing them, unless they obtain leave of the court, to be a director, liquidator, receiver or in any other way directly or indirectly involved in the promotion, formation or management of a company. The purpose of such an order is to protect the public against the activities of such a director. The period of disqualification is for a maximum of 15 years.

Grounds for disqualification

These include:

• conviction for indictable offences connected with the company’s promotion, formation, management, liquidation or striking off (s.2 CDDA);
• persistent breaches of company legislation (s.3 CDDA);
• fraud in a winding up (s.4 CDDA);
• unfit conduct of directors of insolvent companies (s.6 CDDA);
• fraudulent and wrongful trading;
• breach of competition law (s.9A CDDA); and
• conviction of certain offences overseas (s.5A CDDA – introduced by SBEEA 2015).

The most common reason for disqualification is the conduct of directors of insolvent companies which makes them unfit to be concerned in the management of a company (s.6 CDDA).

Unfit conduct of directors of insolvent companies

When a company goes into insolvency, the appointed insolvency practitioner (i.e. liquidator, administrator or administrative receiver) is required to submit a confidential report to the relevant Government department, dealing with the conduct of directors (and shadow directors) holding positions in the three years prior to the insolvency practitioner’s appointment. Save for competition infringements, only the Secretary of State or, in certain cases if the Secretary of State so directs, the Official Receiver, can make an application to court where the report indicates that a disqualification order should be sought. The application must be made within three years of the company becoming insolvent (this period was increased from two to three years by SBEEA 2015). The relevant Government department is currently the Department for Business, Energy and Industrial Strategy.

Where an application satisfies the court under s.6 CDDA that the conduct of a director of an insolvent company (which has gone into liquidation, administration or administrative receivership) makes him unfit to be concerned in the management of a company, the court is required to make a disqualification order against him. Matters to be considered by the court when determining the question of unfitness to be concerned in the management of a company are referred to in s.12C CDDA and Schedule 1 (they are nonexhaustive and are intended to be guidelines only).

Relevant matters include:

• misfeasance or breach of any fiduciary or other duty to the company;
• responsibility for the causes of the company becoming insolvent; and
• responsibility for any material breaches of legislation or other obligations by the company.

Undischarged bankrupts

It is a criminal offence for an undischarged bankrupt to take part directly or indirectly in the management of a company without leave of the court (ss.11 and 13 CDDA).

Consequences of failing to comply with a disqualification order

It is a criminal offence to act as a director or to participate directly or indirectly in corporate management without leave of the court (s.13 CDDA). The director is also personally liable for the company’s debts incurred while involved in the management of a company, in breach of a disqualification order (s.15 CDDA).

Disqualification undertakings

The Insolvency Act 2000 (‘IA 2000’) introduced s.1A to the CDDA with a view to improving the speed and efficiency of the disqualification process. Directors who are considered to be ‘unfit’ may consent to an appropriate period of disqualification from being a director or involved in the management of a company or acting as an insolvency practitioner, without the need for court proceedings. Disqualification can therefore occur administratively, where agreed, by such a director giving a ‘disqualification undertaking’ to the Secretary of State. The maximum and minimum periods are the same as under a disqualification order.

Human rights

The IA 2000 s.11 also amended s.219 of the IA 1986, whereby answers obtained from an individual under powers of compulsion in a company investigation (given in s.218(5) IA 1986) cannot generally be used against that person in subsequent criminal proceedings. This amendment resulted from the ECHR decision in the case of Saunders v UK 1996 23 EHRR 313, that such use of those answers infringed Article 6 of the First Protocol to the European Convention on Human Rights.

Disqualification for competition infringements – CDDA ss.9A-9E

The Enterprise Act 2002 amended the CDDA by allowing the Competition and Markets Authority (‘CMA) (which took over the functions of the Office of Fair Trading under this provision from 1 April 2014) to apply to the court for a competition disqualification order against any director of a company which has infringed either UK or EC competition law. The court will need to be satisfied that the director’s conduct in relation to that infringement, makes the director unfit to be concerned in the management of a company (s.9A CDDA). A maximum of fifteen years’ disqualification as well as possible disqualification undertakings apply.

Foreign disqualification

Under CA 2006 the Secretary of State is given power to make regulations to disqualify a director who has been disqualified under foreign laws. This power is intended to close a gap in the current law through which people who had been disqualified in other countries could still set up, and be directors of, UK companies.

The CDDA has also been amended by SBEEA 2015 to provide that in considering an application for disqualification of a director of an insolvent company, the court must have regard to conduct of that director in relation to overseas companies.