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Commercial Question

Employee status and its implications for employers

updated on 22 July 2014

Question

'Employee', 'worker', or 'self-employed consultant/contractor': why should an employer care as long as they get the job done?

Answer

Employers should care about the contractual statuses of their employees, because what may seem like semantics can have huge organisational, administrative and financial consequences.

Employees are awarded far more rights than workers or self-employed individuals, at the expense of flexibility. This makes employees more "expensive" than their two counterparts, which is why some employers put misleading clauses in contracts representing employees as being self-employed (whether deliberately or otherwise). However, the law is wise to this and will look behind the contract to see what goes on in practice.

The three 'classes'

The terms 'employee', 'worker', and to a lesser extent 'self-employed consultant/contractor', are often used interchangeably. Despite this, there are fundamental differences between these classes, of which employers should be aware.

According to the Employment Rights Act 1996 (ERA), an employee is "an individual who has entered into works under (or, where the employment has ceased, worked under) a contract of employment". Employees enjoy the most rights out of the three classes, but the trade-off is that they have less autonomy than the other classes (eg, having their places of work and working days/hours dictated by their employers, being subject to the day-to-day direction of their employers, and being expected to carry out their work personally, with little or no scope for 'substitution').

The concept of a 'worker' is relatively recent. This class was borne out of the ERA and is defined as "an individual who has entered into works under… a contract of employment, or any other contract… whereby the individual undertakes to do or perform personally any work or services for another party to the contract whose status is not… that of a client or customer". That workers can be engaged under a contract of employment means that all employees are workers, but not all workers are employees. Generally speaking, the distinction between the two is that an employer has far less control over a worker, and the levels of mutuality of obligation (see below) are significantly lower.

Self-employed people, also referred to as 'consultants', work under a contract for services. They are often used to allow a company access to that consultant's expertise for a limited period of time or for a particular project. A consultant who is self-employed is neither an employee nor a worker. Often, consultants will perform the work through a 'vehicle' company and, therefore, will not be a party to the contract for services. Consultants have the fewest rights of the three classes, but by far the most flexibility as to the manner of the work carried out. Factors pointing toward self-employed status include: irregular payment, little or no provision of equipment by the employer, no workplace benefits (eg, paid holiday or medical expenses) and/or no access to workplace training.

No value in face value

Courts and tribunals are vigilant regarding 'sham' contracts - these being contracts wherein individuals will be defined as being a certain class, but they are in practice a different class altogether. For example, if a contract says an individual is self-employed, she or he may actually perform the duties of an employee in practice and will be found as such by a tribunal (as was the case in Protectacoat Firthglow Limited v Szilagyi).

As another example, in Autoclenz Ltd v Belcher and others, car valeters were held to be employees despite their written agreements stating that there was no mutuality of obligation (that the employer may provide work and the employee shall make themselves available for work - a key feature of an employer-employee relationship (see Nethermere (St Neots) v Taverna and Gardiner)) and that the individuals may substitute themselves for another to perform the work in their stead (not to be expected in a contract of employment). The tribunal was more concerned with how things were in practice. There was in fact a high level of mutuality of obligation and the tribunal found that the valeters were not aware of their right to substitute. The day-to-day exercise of their work pointed to them being employees, which the tribunal prioritised over the constitution of their contracts.

Not just semantics

This is not just a matter of minor legal distinctions with few practical consequences; unfortunately for employers, it can be a costly mistake to make if the status of an individual's employment is challenged.

If a 'worker' or a 'consultant' is in fact an employee, she or he will be entitled to such rights as statutory sick pay, maternity or paternity pay, and time off for things such as trade union activity or seeking work in the event of redundancy (both of which are paid). Depending on the length of these absences from work, employers can end up paying quite large and unforeseen (if they intended the individual to be self-employed) sums of money. Furthermore, employers may need to find temporary cover for these absences, which would be of further expense.

Employees also have the right not to be unfairly dismissed and the right to a statutory redundancy payment (after two years of continuous service). Failing to recognise that your 'consultant' is actually an employee could result in an unfair dismissal claim in the event of dismissal (which, when all awards are combined, could amount to just under £100,000) or a claim for a redundancy payment (which, at the time of writing, can be up to £13,920). Neither workers nor self-employed individuals are entitled to these protections.

Another possible liability is from a tax perspective. Employers are responsible for the payment of PAYE for their employees, but no responsibility exists for self-employed consultants. For this reason, HMRC takes a keen interest in the definition of 'employees' (including, for example, Talbot v HMRC, which was an exploration of the definition from a VAT perspective). Employers falling foul of sham - or simply inaccurate - contracts may find themselves liable for significant backdated tax liabilities.

Lastly, employers are vicariously liable for the tortious acts of their employees while they are "on the job". This is not the case with workers or self-employed individuals. Depending on the nature of any offending act, this could have disastrous consequences for the employer.

Conclusion

It is clear, therefore, that employee status goes beyond a mere labelling exercise. Getting your nomenclature wrong could result in costly claims and/or back-payments from the employee, HMRC or third parties. Therefore, employers should (i) ensure that what is portrayed in the contract actually happens in practice - relying on a clause that says "you are self-employed" is not enough, and (ii) monitor the activities of non-employee workers and/or self-employed consultants/contractors, ensuring that their activities do not "evolve" into that of an employee.

Iain Naylor is a trainee solicitor at Addleshaw Goddard’s Manchester office.