Insolvent Company Directors Can Receive Redundancy Pay in Certain Circumstances

The director or an insolvent business could be able to receive redundancy payment as an “employee” in certain circumstances, depending on the nature of the case, the British Employment Appeal Tribunal (EAT) has ruled.

May 21

The EAT decided to uphold a previous ruling of an employment tribunal that a Mrs Knight, the only stakeholder and managing director of Receptors Security Systems (UK) Ltd, was legally entitled to receive redundancy payment. In its previous two years of trading, Mrs Knight had forfeited the income that she was legally entitled to receive under a contract of employment between herself and her business. However, the judge ruled that this did not concretely constitute that she had “entered into an agreed variation of the contract or a discharge of that contract”.

“Whether the regularity of payment in this case negated the continuing existence of a contract was a matter of fact for the employment judge; he had to decide whether the evidence showed that the contract of employment had been varied or discharged or whether there had only been a choice by Mrs Knight not to take her salary when the company was in difficulties: and the judge found on the facts in favour of the latter alternative,” the EAT judge said.

The EAT judge also rejection the criticism levelled by the Insolvency Service that there was no “mutuality” in the agreement between Mrs Knight and her business during the previous two years, or that the agreement was not a legitimate contract because there was no ‘consideration’ moving from the employer to the employee.

The Judge reinforced his ruling by highlighting that he had upheld the previous ruling because of a genuine belief that there was no “perversity in the sense that an employment judge has reached a decision which no reasonable judge could have reached”.

Mrs Knight started up her business in February 1991. It stopped trading due to insolvency problems on the 18th of October 2011. When it first begun trading, a contract of employment, thought to have been written on the 13th June 1991, was created between Knight and her business, though its contents were never officially executed or applied to the company. The contract contained Mrs Knight’s employment description, her working hours and salary, bonus clauses and termination provisions.

This means that theoretically, Knight was functioning in a director and employee role right from the initial point of trading, which would suggest that she was legally entitled to receive the £7,296 redundancy payment that she was given by the Insolvency Service.

The Insolvency Service didn’t take issue with the fact that she received the payment as an employee, highlighting that she was entitled to do so through the 1996 Employment Rights Act. They also accepted that the company’s insolvency was legitimate, and as such she was fully applicable for redundancy payment. However, they argued that when she intentionally decided to waive her contractual salary during her businesses’ final two years of trading, that she ceased to be an employee of the company, and thus she was not eligible to receive the redundancy payment of £7,286.

In Mrs Knight’s witness statement, she outlined that she had done this because she was aware that her business was struggling financially, and thus she “forfeited” her legitimate, contractual salary so that she could make sure that all of her trading partners, suppliers and employees were paid in full and on time. When her company then passed into insolvency, she then compensated for this by applying for and receiving a redundancy payment of £7,296, given to her by the Insolvency Service.

And EAT judge chose to rule in Mrs Knight’s favour, arguing that the initial employment tribunal had “specifically considered” whether the contract in question was legitimate in the final two years of the company’s life. He concluded that Knight had “chosen not to ask the company to honour her contractual entitlement to pay in order to keep the company afloat”.

“That finding is inconsistent with her having agreed with the company that no salary would be payable – thereby agreeing that she would be unpaid even if, hypothetically, the company had suddenly landed a highly profitable new contract and found itself in a position in which it could pay what otherwise would have been her contractual salary,” the EAT judge said.

“When the concise judgment is read as a whole, it is clear that the employment judge found Mrs Knight to have been an employee during those two years in which she drew no salary and that she was an employee at the relevant date, the date at which the claimed obligation arose. No other date was relevant,” he said.

As with all legal matters, lawyers and insolvency practitioners will undoubtedly highlight this case in the future when representing directors in court with similar situations. Whether a precedent has been established for cases such as this may becontentious, though what is certain is that it is now possible for a director to receive redundancy payments as an ‘employee’ of their own business. It can be argued that the ruling represents a landmark moment in insolvency law, and could potentially serve as ammunition for company directors in the future, who find themselves in a similar situation to Mrs Knight.

Moreover, it is a sign that the legal sector will support company director’s who make genuine personal financial sacrifices when supporting and running an insolvent business.

Image courtesy of franky242 / FreeDigitalPhotos.net

Written by: Mike Smith

Recent News
Schedule a callback
Unfortunately, we are unavailable at the moment, but we can schedule a callback