Before : LORD JUSTICE RIX LORD JUSTICE TOULSON and LORD JUSTICE RIMER Between :

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1 Neutral Citation Number: [2009] EWCA Civ 280 Case Nos: 2008/1008; 2008/2756 IN THE SUPREME COURT OF JUDICATURE COURT OF APPEAL (CIVIL DIVISION) ON APPEAL FROM THE EMPLOYMENT APPEAL TRIBUNAL His Honour Judge McMullen QC Mr Justice Bean UKEAT/0177/07/JOJ; UKEATPTA/0042/08/LA Royal Courts of Justice Strand, London, WC2A 2LL Before : Date: 02/04/2009 LORD JUSTICE RIX LORD JUSTICE TOULSON and LORD JUSTICE RIMER Between : SECRETARY OF STATE FOR BUSINESS, Appellant ENTERPRISE AND REGULATORY REFORM - and - (1) RICHARD NEUFELD Respondents (2) KEITH HOWE (Transcript of the Handed Down Judgment of WordWave International Limited A Merrill Communications Company 190 Fleet Street, London EC4A 2AG Tel No: , Fax No: Official Shorthand Writers to the Court) Mr Adam Tolley (instructed by Simon Barnett, for the Treasury Solicitor) for the Appellant Mr Clive H. Jones (instructed on a pro bono basis by Verisona) for the First Respondent, Richard Neufeld The Second Respondent, Keith Howe, did not appear and was not represented Hearing date: 3 December Judgment

2 Lord Justice Rimer : Introduction 1. This is the judgment of the court to which all members have contributed. Two appeals are before us. Both are from the Employment Appeal Tribunal and both raise similar questions. The appellant in both is the Secretary of State for Business, Enterprise and Regulatory Reform, who was represented by Mr Adam Tolley. 2. The respondent to the first appeal is Mr Richard Neufeld, who was represented by Mr Clive Jones. Permission for that appeal was given by Maurice Kay LJ, whose view was that there was an element of uncertainty bordering on disarray in the recent EAT decisions and in their relationship with [the decision of the Court of Appeal in Secretary of State for Trade and Industry v. Bottrill [1999] ICR 592]. The issue clearly requires clarification by the Court of Appeal. The judgment of the Employment Appeal Tribunal under appeal in Mr Neufeld s case was given by His Honour Judge McMullen QC, sitting alone. He reversed the decision of an employment judge who had found in favour of the Secretary of State. 3. The respondent to the second appeal is Mr Keith Howe, who has not been represented before us. In his case there was no substantive hearing before the Employment Appeal Tribunal. What happened there was that, at the Secretary of State s request, Bean J simply dismissed the Secretary of State s appeal against the decision of the employment judge in favour of Mr Howe and gave permission to appeal to this court. That was done so that the appeal could catch up with the appeal in Mr Neufeld s case and be heard at the same time. 4. Both cases arose out of the insolvency of companies in whose businesses Mr Neufeld and Mr Howe were respectively engaged. The only issue in the cases was whether each had been an employee of the failed company. If they had, they enjoyed the protection given by section 182 of the Employment Rights Act 1996 ( the ERA ) to employees whose employer has become insolvent. Section 182, in Part XII ( Insolvency of Employers ), provides: 182. Employee s rights on insolvency of employer If, on an application made to him in writing by an employee, the Secretary of State is satisfied that (a) the employee s employer has become insolvent, (b) the employee s employment has terminated, and (c) on the appropriate date the employee was entitled to be paid the whole or part of any debt to which this Part applies, the Secretary of State shall, subject to section 186, pay the employee out of the National Insurance Fund the amount to which, in the opinion of the Secretary of State, the employee is entitled in respect of the debt. 5. It is unnecessary to cite the other provisions of Part XII. Section 183 describes when an employer has become relevantly insolvent. Section 184 describes the debts to

3 which Part XII applies: they include arrears of pay for up to eight weeks, notice pay to which the employee was entitled, unpaid holiday pay for up to six weeks during a defined 12-month period and any basic award for compensation for unfair dismissal. Section 186 imposes a limit on the total amount per week payable to an employee. Section 188 entitles a claimant who has applied for a payment from the Secretary of State, and who is not paid what he claims he should have been, to make a complaint to an employment tribunal. That is what happened in both cases. 6. The Part XII rights apply only to someone who was an employee of the insolvent employer; and the question whether he was has to be answered as at the date when the company became insolvent (see the decision of the Employment Appeal Tribunal in Rajah v. Secretary of State for Employment, unreported, 7 July 1995, EAT/125/95, Mummery J, the President, presiding). Section 230 of the ERA contains the relevant definitions: 230. Employees, workers etc (1) In this Act employee means an individual who has entered into or works under (or, where the employment has ceased, worked under) a contract of employment. (2) In this Act contract of employment means a contract of service or apprenticeship, whether express or implied, and (if it is express) whether oral or in writing. (4) In this Act employer, in relation to an employee or worker, means the person by whom the employee or worker is (or, where the employment has ceased, was) employed. (5) In this Act employment (a) in relation to an employee, means (except for the purposes of section 171) employment under a contract of employment, and (b) in relation to a worker, means employment under his contract; and employment shall be construed accordingly. 7. The special feature of each case under appeal is that the claimant was the controlling shareholder and a director of the company. The narrow questions raised by the appeals are whether the decisions of the employment judges were correct. More broadly, the Secretary of State asks the court to clarify the approach to be adopted by employment tribunals when faced with cases involving such a feature: indeed, Mr Tolley made it clear at the outset of his argument that that is the real purpose of these appeals. Consistently with that stance, the Secretary of State has in both cases undertaken not to seek costs from either respondent should he succeed in either appeal. The matter is of considerable importance to him. We were told that in 2008 there were some 12,000 claims by directors on the National Insurance Fund, of which some 600 had gone or were expected to go to employment tribunals. We were not told, because the information was not readily available, how many of these were by directors who were also controlling shareholders, but no doubt the number is

4 considerable. The Secretary of State s position is that, such is the conflicting guidance in the authorities as to how to resolve the type of question that has arisen in the cases under appeal, it is essential that this court should now give clear guidance on the subject. 8. In this judgment we will: (i) explain the facts found by, and conclusion of, the employment judge in Mr Neufeld s case and then summarise the decision of the appeal tribunal; (ii) explain the facts found by, and conclusion of, the employment judge in Mr Howe s case (there is no judgment of the appeal tribunal in his case); (iii) review the authorities; (iv) summarise what we regard as the principles applicable to cases such as these; and (v) give our decision on each appeal. Mr Neufeld s case A. The decision of the employment judge 9. Mr Neufeld s claim under section 188 of the ERA was decided by an employment judge (Mr J.R. Hardwick, sitting alone) by a judgment promulgated on 1 February The respondents were: (i) A & N Communications in Print Ltd ( A & N ), the putative employer, which was in insolvent liquidation; and (ii) the Secretary of State for Trade and Industry. Only the Secretary of State actively opposed the claim, which was for a redundancy payment, notice pay and holiday pay amounting to about 10,000. The single issue before the judge was whether Mr Neufeld was an employee of A & N in October 2005 when it became insolvent. His conclusion was that Mr Neufeld was not such an employee and so the claim was dismissed. 10. The judge found the following facts. Mr Neufeld commenced employment with Newfeld Press Limited ( NPL ) in He was a member of its sales team. It was common ground by the time the case came before the appeal tribunal that Mr Neufeld was an employee of NPL under a service contract, although the employment judge did not say so expressly. In 1988 Mr Neufeld became a shareholder in and director of NPL. In July 2001 NPL s undertaking was transferred to A & N. The consequence of that was that the employment contracts of NPL s employees became treated as if made with A & N. If Mr Neufeld was still an employee of NPL, he too became an employee of A & N. 11. The judge found that Mr Neufeld held 90% of A & N s issued shares and was a director. He had two co-directors, Mr Munns and Mr Faulkner, who each had 5% shareholdings. On an unspecified date, which we infer to have been in about July 2001, the three directors agreed that Mr Neufeld would be A & N s managing director and would also be employed as part of the sales team managed by Mr Faulkner, the sales director. Mr Neufeld s evidence was that he worked an average of 60 hours a week carrying out sales, management duties and helping with production and that he was a successful sales person who achieved the highest volume of business. 12. The judge said in paragraph 3.3: There were about 18 employees in the business of [A & N] and all the manual employees had written contracts of employment. The three directors did not have contracts of employment.

5 We read that as saying that there were 18 employees in addition to the three directors. The second sentence was unfortunately expressed. The sole question before the judge was whether Mr Neufeld was an employee of A & N; and, if he was, he did have a contract of employment. The judge was at this point setting out the facts, not making his decision. We interpret him as saying merely that the three directors did not have written contracts of employment: he has not yet decided whether or not they were employees. In paragraph 3.4 he explained that they had worked together for over 20 years (they had all been engaged in NPL s business). He also found that Mr Neufeld had given personal guarantees in respect of A & N s business. 13. In paragraph 4 the judge summarised the opposing submissions. The case for the Secretary of State was that whilst Mr Neufeld paid tax and National Insurance, he was a 90% shareholder of A & N and had given personal guarantees in respect of its liabilities. It was said that he did not take all his holiday entitlement and that, as he owned 90% of A & N, it was not possible for him to have been dismissed by it. We infer that the point there being made was that it followed that he could not have been an employee. That was a bad point that should not have been made (we make clear that Mr Tolley did not appear before the employment judge). Mr Neufeld s case was that his status as controlling shareholder did not rule out such a contract and he was paid a weekly wage subject to PAYE and National Insurance. His employment contract could not be described as a sham nor was that alleged. 14. The judge expressed his conclusions in paragraph 5. He started, in paragraph 5.1, by saying that Mr Neufeld certainly had a contract of employment albeit oral and noted that it had not been suggested that it was a sham or was otherwise unusual save that it was not in writing. The judge was plainly there referring to the contract that Mr Neufeld was asserting to have existed as at the relevant date and so one might think that that finding marked the point of victory for Mr Neufeld. But no, the judge, having there apparently decided the only point he was required to decide, went on to make a finding to the reverse effect. He referred first to the tests developed by the courts for the purpose of distinguishing between contracts of service and for services, referring to the economic reality and multiple tests. He said the case law required him: to look at the overall characteristics of the relationship and generally speaking no single factor on its own is generally conclusive. The Tribunal must weigh up each factor against the overall background picture and come to a conclusion. He said the one essential ingredient in an employment contract was an obligation upon the employer to provide work and a corresponding obligation upon the employee to accept and perform it. Such mutuality of obligation was not in issue in Mr Neufeld s case. 15. The judge accepted that Mr Neufeld was a working director, was on the payroll and paid his tax and National Insurance. He accepted that a large shareholding in itself does not debar that person from being an employee it is just one of the factors to be taken into account in the overall picture. He did not, however, explain how it was or might be relevant in such a picture. He rejected the absence of a written contract as counting against Mr Neufeld s claim. He then considered the question of the extent of A & N s effective control over Mr Neufeld. Whilst the evidence was that all three directors had worked together over 20 years in a collegiate atmosphere and had

6 together resolved to put A & N into liquidation, nevertheless as a 90% shareholder Mr Neufeld held the ultimate control and, in the face of disagreement with his codirectors, could have removed them and obstructed any efforts by them to remove or discipline him. He said that Mr Neufeld had said that three quarters of the time when he was a director he did not take his full holiday entitlement although we were told that his evidence was that he only failed to take one quarter of his holiday entitlement. The judge noted that employees generally take their full holiday allowance and said this was a consideration pointing against employee status and more to one of operating one s own business. 16. In paragraph 5.7 the judge said that what pointed particularly against Mr Neufeld s claimed employee status was the giving by him of the guarantees: one for 10,000 in relation to a machine and another for up to some 25,000 in relation to sales financing. A & N s bank manager had asked him to give them. He had also made a personal loan of 20,000 to A & N. The judge regarded these as significant factors to put into the balance. He expressed his conclusions as follows: 5.8 In my view [Mr Neufeld] has endeavoured to put a gloss on these issues. If a factoring company has advanced money and the sales do not materialise because of insolvency, it can have recourse to any guarantee. [A & N] itself may not be worth pursuing. There is no doubt in the Tribunal s mind that in arriving at these arrangements [Mr Neufeld] was seeking to give an advantage to [A & N]. However at the same time in the Tribunal s view he was involving himself in potential losses and liability. Very few employees would enter into such an arrangement where their own capital is at risk. In my view it points to [Mr Neufeld] running his own business as a manager and major shareholder of that business seeking commendably to secure ongoing finances through its bankers. 5.9 I have also taken into account against the overall background the very significant shareholding of [Mr Neufeld]. I am clear that the preponderance of characteristics of the relationship between [A & N] and [Mr Neufeld] point very much away from one of employer/employee particularly against the dimension of the personal guarantees It follows that as [Mr Neufeld] has been adjudged not to be an employee of [A & N] his claim against the Secretary of State must fail. 17. The judge s judgment shows his approach to have been as follows. The question required a consideration of the overall characteristics of the working relationship between Mr Neufeld and A & N. No single factor on its own was likely to be conclusive either way. Ignoring the guarantees, loan and Mr Neufeld s control of A & N, there was apparently no doubt (apart only from the point about the amount of holiday he took) that he worked under what appeared to be a genuine employment contract with A & N. But the fact that he gave personal guarantees on A & N s behalf, lent money to it and controlled it showed that in reality he was not an employee. They showed he was running his own business as a manager and major shareholder. The preponderance of the characteristics in the relationship showed that he was not an employee. B. The decision of the Employment Appeal Tribunal

7 18. As a preliminary to the disposal of the appeal, Judge McMullen clarified the facts found by the employment judge. In paragraphs 16 and 17 Judge McMullen held that he had found Mr Neufeld to have been employed by NPL as a salesman from 1982 and that the same employment contract continued in and following July 2001, when the three directors agreed that Mr Neufeld who held 90% of A & N s shares -- was to be the managing director. There was, Judge McMullen rightly said, no reason why a director and shareholder of a company cannot also be an employee of the company. He also said that if, as the judge appeared to have found, Mr Neufeld s 1982 employment contract (whether in its original form or as varied) continued after 2001, a simple solution to the case was that it would still have been in place in October There is, if we may say so, much to be said for that: the employment judge made no express finding to the effect that the original employment contract was ever discharged, although it is implicit in his conclusion that at some unidentified point in A & N s history it was. 19. In paragraph 20 of his judgment, Judge McMullen indicated that the real focus of the appeal was on a consideration of what each party had done under the contract, which we read as meaning under the purported contract. In a case such as Mr Neufeld s, where there was no written contract, that was obviously the correct approach: it was not enough for Mr Neufeld merely to assert that he had an employment contract, it was necessary for him to prove that what he actually did showed that he had such a contract. The employment judge had found that, on the face of it, Mr Neufeld did have such a contract, but had ultimately held that he did not. Judge McMullen s view was that, in arriving at that conclusion, the employment judge had taken account of irrelevant matters. He summarised as follows why in his view the judge had erred in law: That the parties had other relationships such as shareholder, managing director, creditor or guarantor is relevant only to the extent that it reflects upon the conduct of the parties in carrying out the contract of employment. To adopt an approach which involves consideration of matters outside the conduct of the parties in performing the contract of employment casts the net too wide and is wrong in law. With respect, the Employment Judge in our case who considered the preponderance of factors was wrong to include factors which did not reflect upon the conduct of the parties in the performance of the contract of employment. 20. That conclusion meant that Mr Neufeld s appeal had to be allowed. The ordinary consequence would be a remission of the case to the employment tribunal for its reconsideration on the correct basis but the parties agreed that Judge McMullen should make the decision himself rather than remit it. Judge McMullen did so by reference to the most recent decision on the type of issue that was before the employment judge, that of the Employment Appeal Tribunal in Clark v. Clark Construction Initiative Ltd [2008] IRLR 364 (Elias J, the President, presiding), a decision post-dating that of the employment judge. Elias J had there reviewed the authorities and outlined eight non-exhaustive factors for a tribunal s consideration. Judge McMullen applied the factors, concluded that Mr Neufeld was an employee of A & N within the meaning of section 230 of the ERA and reversed the decision of the employment judge. There is no need to refer to the factors at this stage. We will come to them in the course of our review of the authorities. Mr Howe s case

8 A. The decision of the employment judge 21. Mr Howe s claim under section 188 came before Employment Judge Burton on 26 November 2007, his reasons being promulgated on 18 January Mr Howe s claim against the Secretary of State, the only respondent, was for a statutory redundancy payment of 765 following the insolvency of Track Records Music Limited ( TRM ). The issue was whether Mr Howe was an employee of TRM. 22. The judge s findings were these. In 1979 Mr Howe started the business of Track Records, which was at that stage no more than his trading name. He was originally the sole proprietor of the business although between 1990 and 1995 he traded in partnership with his father. In December 2004 Mr Howe incorporated TRM. Track Record s assets were transferred to it and it began to trade. Mr Howe held 100% of its shares and was the sole director. He arranged to pay himself a weekly salary of 255 and paid tax and National Insurance as an employed person. TRM s profits were invested in its business. It had several employees, none of whom had written contracts of employment and nor did Mr Howe. He gave guarantees for TRM s liabilities to suppliers. In August 2005 TRM needed a cash injection and Mr Howe arranged for it to borrow 50,000 from the bank, for which he gave a guarantee secured on his house. He also gave a guarantee to the landlords of TRM s shop. By Christmas 2006 TRM was in financial difficulty. Mr Howe sought advice from insolvency practitioners, he ran the business down and by 4 August 2007 had disposed of TRM s stock and the fixtures and fittings in its shop. He put TRM into voluntary liquidation and his claimed employment was brought to an end. 23. The judge said that had the relevant guidance to his decision been that of this court in Bottrill (see paragraph [2] above), he would have held that Mr Howe s status as the owner of all TRM s shares prevented him from being an employee of TRM. But he regarded the then recent decision of the Employment Appeal Tribunal in Nesbitt v. Secretary of State for Trade and Industry [2007] IRLR 853 (Underhill J presiding) as requiring him to find, as he did, that Mr Howe was an employee of TRM. He read Nesbitt as directing him that, even though TRM was wholly owned by Mr Howe, it was for him to find that Mr Howe was such an employee unless only he was satisfied that the purported contract of employment between TRM and Mr Howe was a sham. There was no evidence that it was a sham. The judge found that it was clear that there was a contract of employment between TRM and Mr Howe. He held that the Secretary of State was bound to pay Mr Howe the claimed redundancy payment of 765. B. The decision of the Employment Appeal Tribunal 24. As we have said, Bean J simply dismissed the Secretary of State s appeal and gave permission to appeal. The modest size of Mr Howe s award probably explains why he was neither present nor represented before us. He was not disadvantaged by that because we had the benefit of a full argument on the issues from Mr Jones, for Mr Neufeld. The appeals to this court 25. The general questions raised by both appeals are: (i) can a controlling shareholder and director of a trading company become an employee of that company under a contract

9 of employment; (ii) if yes, are there any guidelines which may assist tribunals in deciding whether in any particular case such a shareholder/director has become an employee? The first question is not a novel one and has been considered in many authorities. It comes before us afresh because of what is regarded as confusion as to the principles which are applicable in answering it. What is a contract of employment? 26. The logical starting point is a reminder of the essentials of a contract of employment. MacKenna J provided a well-known summary in Ready Mixed Concrete (South East) Ltd. v. Minister of Pensions and National Insurance [1968] 2 QB 497, at 515: A contract of service exists if these three conditions are fulfilled. (i) The servant agrees that, in consideration of a wage or other remuneration, he will provide his own work and skill in the performance of some service for his master. (ii) He agrees, expressly or impliedly, that in the performance of that service he will be subject to the other s control in a sufficient degree to make that other master. (iii) The other provisions of the contract are consistent with its being a contract of service. MacKenna J s judgment continued with an elaboration of each condition. It is unnecessary to refer to all of what he said, or to the more recent authorities which have considered the essentials of a service agreement: the appeals do not require it. We do, however, at least refer to MacKenna J s elaboration of the control condition, which is of present relevance. He referred to control as including: the power of deciding the thing to be done, the way in which it shall be done, the means to be employed in doing it, the time when and the place where it shall be done. The one man company 27. The question of principle raised by the appeals is tested best by the consideration of the extreme position arising in the case of a so-called one man company. By that we mean a company in which one individual owns all its issued shares and is its sole director and thus has total dominion over its affairs. If in principle such an individual can have a contract of employment with his company, so in principle can an individual whose control is less than total but which is nevertheless still sufficient to give him control of the company in general meeting and of the constitution of its board of directors. 28. Approaching the matter apart from authority, it might be thought that the main conceptual barrier in the way of such a company granting a valid employment contract to its one man would be that there could in practice be no relevant control of the putative employee so as to meet that particular condition of an employment contract. In theory, the control would be exercisable by the company, a legal person separate from the individual. In practice, it would be exercisable by the putative employee himself since he controls the company. It is easy to conclude that that cannot be real control, with the consequence that a central condition of a contract of employment is missing.

10 29. It is, however, too late in the development of our jurisprudence, at any rate at the level of this court, to regard that particular control issue as providing a threshold obstacle to the creation of a valid contract of employment between a company and the one man who wholly controls it. The decision in Lee v. Lee s Air Farming Ltd [1961] AC 12 shows that it is not. Whilst, as a decision of the Privy Council, it is not strictly binding on us, its correctness as an authority has not, so far as we are aware, been challenged, nor did Mr Tolley challenge it. He recognised that this court regarded it as sound law in Bottrill. 30. Mr Lee formed Lee s Air Farming Limited for the purpose of conducting an aerial top-dressing business. He held 2,999 of its 3,000 issued shares, the other share being held by a solicitor. Article 32 of the articles of association appointed him governing director and conferred upon him the full government and control of the company. Article 33, as amended, provided that the company was to employ him as its chief pilot at an annual salary to be arranged by him and that in respect of such employment the rules of law applicable to the relationship of master and servant shall apply as between the company and [Mr Lee]. Mr Lee, as governing director and controlling shareholder, exercised unrestricted control over the company s affairs and made all decisions relating to contracts for aerial top-dressing, contract prices, the manner in which the company s aircraft was to be employed and the methods employed in carrying out the company s work. He exercised unfettered control over the company s operations at all times. 31. Mr Lee was killed in a crash whilst piloting the company s aircraft on an aerial topdressing operation. His widow sued the company on the basis that he had been employed under a contract of service with the company and that, under the Workers Compensation Act 1922 of New Zealand, his death in service as a result of an accident in the course of his employment entitled her to compensation. The contest was, in reality, between the widow and the company s insurers. The only issue was whether or not Mr Lee was an employee of the company. The Court of Appeal of New Zealand held that, as the governing director of the company, he could not be its employee. Its view was that the duty both of giving orders and obeying them lay upon Mr Lee in his dual capacity as (in effect) employer and worker and the two offices were incompatible. It followed that there could exist no power of control and therefore the relationship of master-servant was not created. On the widow s appeal to the Privy Council, her argument was that it was the company, not Mr Lee, that was the employer and it was the company that: was entitled under the contract to control both what Lee did and how he did it, and this control remained the control of the company whoever might be the agent empowered by the company to exercise it. ([1961] AC 12, at 21) The argument for the company was that [c]ontrol means a real living person to control another real living person ([1961] AC 12, at 22); and that where one gets the controller and the controlled person residing in the same person there is no control it is wholly illusory. ([1961] AC 12, at 23). 32. The Privy Council allowed the appeal and held that Mr Lee was an employee under a contract of service with the company. The judgment of Lord Morris of Borth-y-Guest is instructive for the purposes of the present appeals and plays an important role in the

11 later authorities. Despite their length, we will therefore cite two passages ([1961] AC 12, at 24 to 27): The Court of Appeal thought that [Mr Lee s] special position as governing director precluded him from being a servant of the company. On this view it is difficult to know what his status and position was when he was performing the arduous and skilful duties of piloting an aeroplane which belonged to the company and when he was carrying out the operation of top-dressing farm lands from the air. He was paid wages for so doing. The company kept a wages book in which these were recorded. The work that was being done was being done at the request of farmers whose contractual rights and obligations were with the company alone. It cannot be suggested that when engaged in the activities above referred to the deceased was discharging his duties as governing director. Their Lordships find it impossible to resist the conclusion that the active aerial operations were performed because the deceased was in some contractual relationship with the company. That relationship came about because the deceased as one legal person was willing to work for and to make a contract with the company which was another legal entity. A contractual relationship could only exist on the basis that there was consensus between two contracting parties. It was never suggested (nor in their Lordships view could it reasonably have been suggested) that the company was a sham or a mere simulacrum. It is well established that the mere fact that someone is a director of a company is no impediment to his entering into a contract to serve the company. If, then, it be accepted that the respondent company was a legal entity their Lordships see no reason to challenge the validity of any contractual obligations which were created between the company and the deceased. Nor in their Lordships view were any contractual obligations invalidated by the circumstance that the deceased was sole governing director in whom was vested the full government and control of the company. Always assuming that the company was not a sham then the capacity of the company to make a contract with the deceased could not be impugned merely because the deceased was the agent of the company in its negotiation. The deceased might have made a firm contract to serve the company for a fixed period of years. If within such period he had retired from the office of governing director and other directors had been appointed his contract would not have been affected. The circumstance that in his capacity as a shareholder he could control the course of events would not in itself affect the validity of his contractual relationship with the company. When, therefore, it is said that one of his first acts was to appoint himself the only pilot of the company, it must be recognised that the appointment was made by the company, and that it was none the less a valid appointment because it was the deceased himself who acted as the agent of the company in arranging it. In their Lordships view it is a logical consequence of the decision in [Salomon v. Salomon & Co [1897] AC 22] that one person may function in dual capacities. There is no reason, therefore, to deny the possibility of a contractual relationship being created as between the deceased and the company. If this stage is reached then their lordships see no reason why the range of possible contractual relationships should not include a contract for services, and if the deceased as agent for the company could negotiate a contract for services as between the company and himself there is no reason why a contract of service could not be

12 negotiated. It is said that therein lies the difficulty, because it is said that the deceased could not both be under the duty of giving orders and also be under the duty of obeying them. But this approach does not give effect to the circumstance that it would be the company and not the deceased that would be giving the orders. Control would remain with the company whoever might be the agent of the company to exercise it. The fact that so long as the deceased continued to be governing director, with amplitude of powers, it would be for him to act as the agent of the company to give the orders does not alter the fact that the company and the deceased were two separate and distinct legal persons. If the deceased had a contract of service with the company then the company had a right of control. The manner of its exercise would not affect or diminish the right to its exercise. But the existence of a right to control cannot be denied if once the reality of the legal existence of the company is recognised. Just as the company and the deceased were separate legal entities so as to permit of contractual relations being established between them, so also were they separate legal entities so as to enable the company to give an order to the deceased. (Emphasis added) In a later passage of his judgment, at [1961] AC 12, at 29, Lord Morris explained why, on the facts, the relevant contract was a contract of service, and not a contract for services. 33. Lee s case therefore establishes two propositions of direct present relevance. First, that an individual who owns all the shares in, and is the sole director of, a company and so has total dominion over it can also be employed by that company under a contract of service. Secondly, that it is no answer to the claimed creation of such a contract that the control condition that is essential to it is not satisfied. The answer to that point, even in relation to a one man company case, is that the company and the one man are not the same person; and it is the company that exercises the relevant control. In Lee s case the employer was the company and the employee was Mr Lee. The control necessary for the purposes of the claimed contract of service was exercisable by the company and it made no difference that in practice, so long as Mr Lee remained the sole governing director, that control would be and was exercised by him as the company s agent. The close identity that in reality existed between the company and Mr Lee did not prevent a contract for service being created. 34. We cannot leave Lee s case without a comment on Lord Morris s observation that it had not been, nor could be, suggested that the company was a sham or a mere simulacrum (our emphasis), an observation that has been discussed in the later authorities to which we shall come. It is a difficult expression because a registered company has legal personality. However, we consider that Lord Morris was probably there using the words sham and mere simulacrum as synonyms for essentially the same idea and had in mind the limited types of case in which an individual (as in Lee s case) owns all the shares in a company and the courts have considered it right for policy reasons to pierce the veil of incorporation and treat the company as the alter ego of the controlling shareholder, that is to treat them as one. In such a case, any suggestion that the individual had a service contract with the company would not succeed. 35. It appears to us that such circumstances, at least in a case in which the company is a genuine trading company, would be exceptional. No such question arises in these appeals, nor did it arise in the authorities to which we were referred. We propose

13 therefore to say no more about it. On the other hand, as Bottrill in this court makes clear, a preliminary question which may more commonly arise in a case in which a controlling shareholder claims to have a service contract with his own company will be whether the putative contract (rather than the company) is genuine or a sham. That is because the reality in such cases is that the controlling shareholder will have been the directing mind and will behind the purported creation of his own contract. That factor will be likely in many cases to require a careful scrutiny of the claim that a valid employment contract has been created. 36. As to the circumstances in which the contract might be regarded as a sham, the classic case will be that described by Diplock LJ in Snook v. London and West Riding Investments [1967] 2 QB 786, at 802: As regards the contention of the plaintiff that the transactions were a sham, it is, I think, necessary to consider what, if any, legal concept is involved in the use of the popular and pejorative word. I apprehend that if it has any meaning in law, it means acts done or documents executed by parties to the sham which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create. But one thing, I think, is clear in legal principle, morality and the authorities (see Yorkshire Railway Wagon Co. v. Maclure (1882) 21 Ch. D. 309 and Stoneleigh Finance Ltd v. Phillips [1965] 2 QB 537), that for acts or documents to be a sham with whatever legal consequences follow from this, all the parties thereto must have a common intention that the acts or documents are not to create legal rights and obligations which they give the appearance of creating. No unexpressed intentions of a shammer affect the rights of a party whom he deceived. 37. In most cases in which there arises a question as to whether the claimed employment contract is a sham, there will be what purports to be a formal written contract, or at least a board minute or memorandum purporting to evidence or record the contract: a shammer is hardly likely to rest his case on the claim that his contract was an oral one. An inquiry into whether any purported contract does amount to a sham does not limit the court or tribunal to a consideration of the evidence as at the time of its making. It will usually also be highly material to see what the company on the one hand and the shareholder/director on the other have actually done under the purported contract: that will be likely to shed light on its genuineness or otherwise. In principle, however, a similar problem could arise where the alleged employment contract is an oral one, for it might be said in response that the basis on which such a contract is alleged is a mere pretence and is false. This court has recently considered the concept of a sham in an employment law context: Protectacoat Firthglow Ltd v. Miklos Szilagyi [2009] EWCA Civ Having made those comments about the possibility of a purported service agreement in favour of a controlling shareholder being a sham, we emphasise that these appeals are not about allegedly sham contracts either. In the cases under appeal there was no question of either contract being a sham. The question in each is whether, accepting that the evidence supported the conclusion that the shareholder/director had worked under what was ostensibly a genuine service agreement, the fact that it was made in favour of an individual who was also the company s controlling shareholder who had personally invested in the business and assumed personal liabilities for it --

14 prevented the contract from amounting to a service agreement which could be recognised as such. The real question, therefore, is whether the putative employee s control of the company is fatal to the creation of a service agreement in his favour. A different view on the question of control 39. Lee s case might be thought to have provided a resounding No in answer to that question. But it did not. Mummery J, when President of the Employment Appeal Tribunal, made clear his own views on the topic, which can be said to have sidestepped the effect of Lee s case. The first of his decisions was McQuisten v. Secretary of State for Employment, unreported, 11 June 1996, EAT/1298/95. Following the company s entry into liquidation, Mrs McQuisten made a claim to a redundancy payment from the Secretary of State under the statutory predecessor of Part XII of the ERA. She was an 85% shareholder and (with her son) one of the company s two directors. She worked full time for it, her work including two hours a day on the books and seven hours a day labouring in the company s sawmill under the direction of her son and daughter, the other shareholders. She paid Schedule E tax and National Insurance contributions. She had guaranteed a company loan. The industrial tribunal found that she was not an employee. The Chairman was particularly influenced by the fact that she could secure to herself virtually complete control of the company. His conclusion was that she was, in effect, carrying on a business under the auspices of a limited company, a view reinforced by the fact that she was a guarantor of the company. 40. On Mrs McQuisten s appeal, the appeal tribunal directed themselves (correctly) that the question before the industrial tribunal was one of fact and that they could only interfere with the decision if it was flawed by an error of law. They rejected the argument that the Chairman s decision was perverse and upheld it as a decision to which he was entitled to come. He was, they said, entitled to place more weight on the control factor than on other factors and he made no error in that respect. The importance of their decision lies in Mummery J s postscript to his judgment, headed Majority Shareholding. Its essence was that an individual in control of a company could not normally be dismissed from any contract of employment save with his own concurrence; and, if he could not be dismissed, it was difficult to see how he could be regarded as an employee. There were, Mummery J said: real legal difficulties in regarding a majority shareholder as an employee when he is ultimately able to exercise his shareholder s powers to determine every question concerning his employment his rates of pay, his duties, his holidays, his pension arrangements and, most important, whether he continues to work for the company or not. It is unlikely that Parliament intended to include such persons within the scope of the protection of the 1978 Act [the Employment Protection (Consolidation) Act 1978]. 41. Given that view, it is no surprise that the appeal was dismissed. A question arises as to how such view was reconcilable with Lee s case, which does not appear to have been cited. Mummery J returned to this theme in the joined appeals of Buchan v. Secretary of State for Employment; and Ivey v. Secretary of State for Employment [1997] IRLR 80 ( Buchan ) and this time he had been referred to Lee s case. Buchan involved like claims by a majority shareholder and director to have been an employee of his insolvent company. Mr Buchan had a 50% shareholding in his company, worked for it

15 full time as a scanner operator and sales manager, received 35,000 a year subject to PAYE and National Insurance and was entitled to five weeks holiday a year. He did not have a written service contract. Mr Ivey had a 99% shareholding in his company and did have a written service contract, one entitling him to a salary of 28,500 and 22 days holiday a year. In both cases the industrial tribunal found that the claimants were not employees. The appeal tribunal dismissed both appeals. 42. In paragraph 8 of his judgment, Mummery J identified four principles which are supported by authority and correct: (1) a limited company is a distinct legal entity from its shareholders and directors; (2) a director, and managing director, of a limited company may have a contract of service with it; (3) a shareholder may likewise have a contract of service with it; and (4): a person will usually be regarded as having entered into and as working under a contract of service if he is bound by contract (whether express or implied, whether in writing or orally), (a) if he is bound to devote all his time to the affairs of the company and to do all in his power to develop and extend its business, and (b) if he is engaged on terms which provide for the payment of a regular fixed salary and for determination of that contract. The last point is important. If the putative contract was not a sham (in the Snook sense), there is a separate potential question whether it is properly to be characterised as a contract of employment rather than some other form of contract. That involves an analysis of the parties respective contractual rights and obligations. 43. In paragraph 9, Mummery J expressed his view that the application of his four legal principles either will or may not be capable of applying to an individual who, by reason of his controlling shareholding in the company, is able to prevent his dismissal from his position in it. His opinion was that the critical provisions of the Employment Protection (Consolidation) Act 1978 (his point would apply equally to the successor provisions of the ERA) gave legal protection to a person dismissed unfairly (including dismissal for redundancy on the insolvency of an employer) and provided guaranteed State payments for employees in that event. He said it would be inconsistent with the purposes of the 1978 Act to extend such protection to a person who cannot be dismissed without his consent. The argument that Lee s case showed that such persons can be employees of their company ignored the different context in which Lee s case was decided, that of a claim for compensation under the New Zealand Workers Compensation Act Mummery J said: 12. The issue in this case arises in the context of employment protection legislation. Taking the facts of Mr Lee s case it is difficult in an employment protection context to conceive of circumstances in which Mr Lee could have been regarded as an employee of the company for the purposes of making a claim against the company for a redundancy payment or for unfair or wrongful dismissal. None of those events could give rise to any remedy by him against the company, because the wrong of which he would complain could not occur without his concurrence. That feature would also affect the position of a guarantor of a liability of the company, such as the Secretary of State in relation to redundancy and other payments. The liability of the Secretary of State is to make a payment which the insolvent employer is liable to make, but cannot make because of lack of funds. If a person has no remedy against the company over

16 which he exercises control, he cannot have any claim against the guarantor of the company s liability. 44. Mr Buchan was in fact dismissed by the company s administrative receivers, but the appeal tribunal held that as his 50% shareholding had previously enabled him to block any decision to dismiss him, he was never an employee of the company and his purported dismissal did not make him one. Mr Ivey was, a fortiori, similarly not an employee: the label on his purported service contract was not conclusive as to its substantive effect. 45. As we shall explain, this court in Bottrill later disagreed with and rejected the basis on which Mummery J distinguished Lee s case. His point that a controlling shareholder of a company cannot also be its employee for the purposes of the employment protection legislation is no longer to be regarded as sound. The Secretary of State s attempted resurrection of the point before the employment judge in Mr Neufeld s case was mistaken. Guidance from the Court of Session and the Court of Appeal 46. Before the decision in Bottrill s case, Buchan was considered by the Court of Session in Fleming v. Secretary of State for Trade and Industry [1997] IRLR 682. We must refer to Fleming, since its approach was later endorsed by Bottrill. Mr Fleming held 65% of the shares in the company and worked alongside its employees, working the same 40 hours per week that they did. He had given guarantees to the company s main suppliers. He had no written contract of employment nor was there a board minute or memorandum recording an agreement to employ him. His remuneration was paid under the PAYE system although when the company ran into financial difficulty he suspended collection of his remuneration until sunnier days. They did not come, the company went into liquidation and he was dismissed by the liquidator. He claimed redundancy and statutory notice payments out of the National Insurance Fund but the Secretary of State refused to accept that he had been an employee. The industrial tribunal dismissed his application, holding that he was not an employee. It was clearly influenced by the fact that he was a majority shareholder, had guaranteed the company s obligations and was in control of the company: he was not under anyone else s control. The appeal tribunal dismissed his appeal and endorsed Mummery J s views in McQuisten that where the person involved is a majority shareholder in the company, his status as an employee must be seriously in doubt. 47. Mr Fleming appealed to the Court of Session. He challenged the proposition that a majority shareholder could not be an employee of the company. The counter argument was that (i) the question for the industrial tribunal was one of fact, (ii) the fact that his remuneration was taxed under Schedule E by the PAYE system was not significant since a director was an office-holder and taxable on the same basis, (iii) the giving of guarantees was a relevant consideration, and (iv) the shareholder control pointed away from an employment relationship. The court (The Lord President (Lord Rodger), Lord Kirkwood and Lord Coulsfield) dismissed the appeal. The judgment of the court was delivered by Lord Coulsfield, who accepted the arguments for the Secretary of State. He said: 9. In the present case, it seems to us that, taking all the factors together, there was ample material to entitle the industrial tribunal to reach the conclusion