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The London Employment Appeal Tribunal (EAT), Judge McMullen QC sitting alone, has overturned the decision of an employment tribunal, also a chairman sitting alone, that a claim by two company directors of unfair and wrongful dismissal and unlawful deductions can proceed on the basis that their contracts were not illegal and could, therefore, be considered by a full tribunal. The employer of the directors had dismissed them for gross misconduct and fraud and had argued that their claims could not be heard because the contracts were operated illegally.
Judge McMullen's decision, considered in the case of Bakersfield Entertainment Ltd v Church and Stuart on 3/4 November 2005, clarifies the issues that must be considered when it is alleged that a contract is illegal and cannot, as a result, be enforced by a court or tribunal.
Mr. Church was the managing director of Bakersfield Entertainment, and Mr. Stuart was its operations director, each with a salary of £;60,000.
In 2003, Mr. Church and Mr. Stuart were approached by the managing director of the Group that was the principal shareholder in Bakersfield. He proposed that they take advantage of a scheme that was in place for directors and senior executives of the Group. The scheme, devised and operated by a tax consultant (apparently a former senior tax manager with the Inland Revenue), involved attributing half of the salaries of Church and Stuart to services provided to the employer by a "service company". Two separate service companies were set up and the scheme was run internally by Bakersfield's Finance Manager. The first £;30,000 of their salaries was treated as self-employed payments made to the service companies, and the other £;30,000 was paid through the company's payroll, subject to PAYE tax and NICs. In practice, however, all of the payments were made each month by BACS, direct into the accounts of Mr. Church and Mr. Stuart.
Judge McMullen points out in his ruling that, from advice given to him, there were only two situations where a person could properly be an employee of a company and provide self-employed services to that company at the same time, namely:
- An employee, in his spare time, conducts a business repairing computers. His employer has a problem with a computer and invites him to do the repairs. The employee submits an invoice, is paid separately and accounts separately for the payments made by the employer and the other businesses for which he repairs computers. In any given month, therefore, he could receive a net payment under PAYE for his duties as an employee and a separate gross payment from the employer for his services as an engineer.
- A director receives a salary for performing employment duties and, quite separately, provides company law duties as company secretary. Provided there is sufficient distinction between the duties, the payment for the employment duties is paid under PAYE and the separate payment in respect of the statutory office is paid gross.
It was quite clear, therefore, to Judge McMullen that the contractual arrangement between Bakersfield and Mr. Church and Mr. Stuart was illegal and would be followed up by the Inland Revenue. The tribunal chairman, however, had reasoned that the contract was not illegal and did not, therefore, prevent the claims of unfair dismissal being considered on their merits.
Judge McMullen had no difficulty in finding that the tribunal chairman had erred in deciding that the contracts were not illegal. They clearly were. However, much more was involved in deciding whether or not Mr. Church and Mr. Stuart could have their cases heard. Two Court of Appeal decisions are significant. The first, in the case Hall v Woolston Hall Leisure Limited, states:
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"In cases where the contract of employment is neither entered into for an illegal purpose nor prohibited by statute, the illegal performance of the contract will not render the contract unenforceable unless in addition to knowledge of the facts which make the performance illegal the employee actively participates in the illegal performance. It is a question of fact in each case whether there has been a sufficient degree of participation by the employee."
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The second, is a reference to the above text in the Court of Appeal decision in the case Vakante v Addey & Stanhope School, with the following further explanation:
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"Matters of fact and degree have to be considered: the circumstances surrounding the applicant's claim and the illegal conduct, the nature and seriousness of the illegal conduct, the extent of the applicant's involvement in it and the character of the applicant's claim are all matters relevant to determining whether the claim is so "inextricably bound up with" the applicant's illegal conduct that, by permitting the applicant to recover compensation, the tribunal might appear to condone the illegality."
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In the light of these principles, Judge McMullen dismissed the appeal and referred the case back to the same tribunal chairman for him to consider whether or not Mr. Church and Mr. Stuart knowingly participated substantially in the illegality. If they did, their tribunal claims cannot be pursued. If they did not, because they participated in the scheme in the belief that it was lawful, their cases can still be heard on their merits.
The question that the author - and likely the readers - of this article are left with, and that is unanswered in the EAT decision, is the role of the employer in this case. The employer dismissed Mr. Church and Mr. Stuart for gross misconduct and fraud. The appeal was undoubtedly a step taken to protect Bakersfield from an expensive unfavourable outcome, either from a tribunal ruling or an HMRC investigation. The company is endeavouring to distance itself from the activities of its former managing director and, by doing so, is suggesting that it was Mr. Church and Mr. Stuart who were responsible for the fraud, not the employer. Can it really do so if two of its principal directors gave directions for the accountants and payroll department to treat their payments illegally?
And, one final thought. If you had been the person responsible for Bakersfield's payroll, what position would you have taken when asked not to tax half of the directors' salaries?
...back to 15 December 2005
Sources:
Bakersfield Entertainment Ltd v P J Church and C L Stuart
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