Company Directors: The Problems caused by Informality and Lack of Records

A recent case in the Employment Appeal Tribunal illustrates the type of dispute that is so often seen within small companies, frequently but not always family-owned ones. Such disputes occur where there is a complete lack of documentation recording the nature of the relationship between the directors and the company.

The Company in the recent case was owned by two brothers. They were the only two directors of the Company. Their shareholdings were split 60/40. Neither had a contract of employment with the Company. There was no document recording the nature of their rights and obligations vis-à-vis the Company.

The two brothers each received what was described as a “salary” payment of £1,500 per month on the advice of the Company’s accountants. During or at the end of each year the brothers decided between themselves how much the Company could afford to pay to each of them by way of dividends on their shareholdings.

The brothers decided on the split of work between themselves. Neither brother was under the control of the other. Both were free to carry out work outside the Company, if they wished. Both were free to take holidays when they wished, though in practice they notified each other and co-ordinated their holiday plans.

The brothers fell out. One brother (X) informed the other by letter that he had “decided to take a step away” from the Company. For about 4 months after his letter X devoted his time exclusively to one particular landscaping project which for some time had been his principal piece of work for the Company. He invoiced the client for this work via another business which he owned, rather than via the Company. The other brother (Y) stopped paying the monthly “salary” to X.

X claimed that he had been dismissed and that various sums were owed to him. He brought claims in the Employment Tribunal for unfair dismissal, pay for his notice period, unlawful deduction of wages and holiday pay. Only an employee could bring all of these claims. A “worker” could bring claims for unlawful deduction from pay and holiday pay, but not the other two claims. X therefore had to establish that he had the status of being an employee or at least a worker before the Tribunal could consider any of his claims.  

At the Tribunal hearing neither X nor Y suggested that there was any oral agreement between X and the Company which might have shed light on X’s contractual relationship, if any, with the Company. The Employment Tribunal ruled that X was neither an employee nor a worker. He was simply a director. He was therefore not entitled to bring any of the claims which he had made. X appealed to the Employment Appeal Tribunal.

Dismissing the appeal, the Appeal Tribunal accepted that a shareholder/director could in principle be an employee of a company. They said that in the absence of any written contract or any evidence of a verbal agreement, it was necessary to look at how the parties had conducted themselves in practice and how payments had been made for work done for the purpose of ascertaining X’s status.  A person who is a statutory director of a company is not automatically assumed to be an employee. The Appeal Tribunal agreed that the Employment Tribunal was justified in concluding that X was neither an employee nor a worker of the Company. X therefore recovered no compensation of any kind.

The dispute was one which would not have arisen at all if the parties had taken the trouble to put in place a short simple contract stating what the position of X was in relation to the Company and his rights and responsibilities, dealing with basic matters such as pay, duties, holidays and notice periods. As well as being avoidable, the dispute was costly for all parties. It is worth noting that if the brothers had wished to sell the Company, the absence of records showing the terms of the relationship between the directors and the Company would have been a potentially serious obstacle to a sale agreement.

For further help and advice, contact the employment team at Downs Solicitors to see how we can help.


Keith Potter

Keith Potter

Consultant Solicitor

Tel: +44 (0)1306 502329

Office: Dorking

Email: k.potter@downslaw.co.uk