When do Founders become Employees?

A start up  tech Company instructed Gannons when one of its founding directors attempted to bring a claim for constructive unfair dismissal. This claim couldn’t succeed unless the Outgoing Director had been an employee for more than two years. The Company asserted its directors had only recently become employees following the execution of directors’ service agreements. The Outgoing Director claimed he had been an employee ever since he had begun receiving remuneration from the Company, a much earlier date which would bring him over the crucial two year threshold needed to claim unfair dismissal and resultant compensation.

The Employment Tribunal had to determine whether the founding directors had become employees of the Company before entering into their directors service agreements. In this instance, the Tribunal decided that the directors had not.

Employee or not?

An employee is someone who works under a contract of employment. While this contract is usually written, it is possible for a contract of employment to be  verbal and  inferred from the conduct of the parties. When a matter comes before the Employment Tribunal the employee must prove that he/she was in reality an employee. In deciding whether an employment relationship exists the Employment Tribunal will consider:

• Written evidence - The most obvious example being a contract of employment. However, evidence of an employment relationship could also come from board minutes or a memorandum of understanding which defines the relationship.
• How is payment made? - in our case the founding directors were paid a comparatively small sum through the company payroll and received the rest of their remuneration in the form of shareholder dividends. This is a common arrangement in newer companies, as it allows directors to take full advantage of their personal allowances, but it is not a typical feature of an employment contract. Where a director receives no wage, or a comparatively small wage compared to the value of their work, it suggests that they are not an employee.
• Have the parties behaved like an employer and employee? - If a director is required to work regular hours, needs to work in a specified place, is allocated specific holidays or is subject to restrictive covenants it is likely that they are an employee. Conversely, where a director sets their own hours and working arrangements, and is entitled to take unlimited holidays while still receiving their remuneration (as is the case with shareholder dividends) it is likely that they are not an employee.

Conclusions

In the case of our client, the result was the former director employee did not have the requisite period of employment to claim unfair dismissal or constructive dismissal.  If the claim had been successful the award could have been in excess of £80,000.

The Employment Tribunal refused to deal with the position on whether he was a bad leaver for the purposes of the prevailing shareholders agreement.   The judge took the usual approach of deeming the shares to be separate from the employment contract and determine the Employment Tribunal does not have jurisdiction to look into matters relating to shareholdings.

Even if the employee had been successful it is a moot point as to whether any claim for unfair/constructive dismissal would take into account dividends as they are not “earnings”.