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Employee Shareholders: Risks not rewards

01/02/2013

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United Kingdom

Unheralded, it was the most radical government proposal for employment law reform of the year.

Unheralded, it was the most radical government proposal for employment law reform of the year.  George Osborne's October 2012 announcement of a new form of employment status, the "employee owner", was a surprise but it immediately garnered enormous interest.  However, the hasty consultation which followed showed that business and employee concerns far outweighed any enthusiasm it might have generated.  92% of respondents had either mixed or negative views about the anticipated take-up of employee owner status by companies and individuals, and amongst others, the Employment Lawyers Association's submission set out a raft of issues it suggested needed further consideration. 

The Government has amended its proposals following the consultation exercise, but it is perhaps indicative that the most notable change to arise from the Government response is the new name for the status, now “employee shareholder”.  Many other concerns have not been addressed in any meaningful way or, in some cases, at all. 

Recap of the proposal

The essential outline of the new employee shareholder status is that individuals will receive at least £2,000 fully paid up shares in their employer company, but not retain certain employment rights.  Most importantly, the right to claim unfair dismissal (except in special cases), the right to a statutory redundancy payment and the statutory right to request flexible working will all be foregone.  The Government has sought to play down any suggestion that there is some quid pro quo or trade off between the issue of shares and loss of employment protections, expressing the slimmed down rights to be a feature of a new more straightforward employee shareholder status.  However, much of these proposals seemed eerily familiar to employment law practitioners.  

As part of the ‘Red Tape Challenge’, the Government’s campaign to free businesses and society from excessive regulation, the venture capitalist, Adrian Beecroft, produced a report detailing recommendations to simplify employment law.  Among other things, it recommended that compensated ‘no fault’ dismissals should be introduced.  It is probably fair to say that this and other of its proposals were regarded as highly controversial, and the Government confirmed it would not be seeking to implement them.  However, for at least some employees its key tenets may now be adopted, albeit they will be tied to the undoubtedly laudable policy aim of encouraging an increase in employee ownership. 

The employee owner proposals raise some complex employment, taxation and company law issues, but the Government made it clear from the outset that employers would be able to use the new employment status from April 2013. Consultation on the proposals opened on 18 October 2012 and closed on 9 November 2012, a much briefer window for consultation than usual; presumably based on the need to fast track proposals to enable the Government to meet its April 2013 deadline. 

The Government response was issued on 3 December 2012, and its executive summary recognised the broad concerns raised:

3.      Whilst a very small number of responses welcomed the scheme and suggested they would be interested in taking it up, a number of specific issues were raised through the consultation. These relate to concerns about the potential impact on individuals and how the shares would work. There was a strong concern that individuals were losing important employment protections and that they might be coerced to take on employee owner status. There was also a concern that employee owner status could be misused by businesses, and that the tax advantages could be abused.

4.      There was a particular concern that the new status would be complex and costly to operate, with uncertainty around valuation and income tax implications for individuals. These were viewed as likely to deter take-up. The Government is considering options to reduce income tax and National Insurance contribution liabilities that arise when employee owners receive their shares. Those who thought there would be some take-up suggested that it would be limited to micro-businesses and some growing companies.

Notwithstanding the strength and level of the concerns, in particular in relation to the potential for abuse and coercion of employees, the Government has to date failed to address these issues meaningfully.  Its consultation response simply emphasised the ostensible "voluntary" nature of the scheme, and promised to ensure appropriate guidance would be provided for all involved.

Taking on a new employment status

There is already a complex differentiated and yet potentially overlapping array of employment statuses (employees, workers and independent contractors), all of which enjoy different protections under employment law, and a veritable pantheon of further employment distinctions e.g. agency workers, fixed term employees, casual workers, temps.  Employers and employees already struggle to understand and then apply the current regime appropriately.  Introducing employee shareholders will add to this complexity.  While the Government’s assurance that it will provide clear guidance on the subject is welcomed, it does not go far enough to addressing the problem and unfortunately it seems inevitable that parties will resort to the Employment Tribunal to address such disputes. 

A key recommendation of the ELA in its response to the consultation was that employees should receive independent legal advice prior to agreeing to accept the new employee shareholder status, before they give up significant rights which otherwise could only be waived by way of a statutory compromise agreement.  This matched the majority of other submissions on the point.  Of 34 which commented specifically on the issue, 23 indicated that independent advice was required.  However, full or careful the guidance which the Government suggests will be available, the failure to require independent advice and to limit an employer's ability to make "take it or leave it" offers of employment linked to employee shareholder status mean that many individuals will face making a decision constrained by a classic imbalance of power. 

For employers setting up and running an employee shareholder scheme, there will be a significant one off and also ongoing administrative costs.  In addition, one of the areas of greatest complexity is share valuations: employee shareholders must be awarded shares worth at least £2,000 or, as the Government response itself notes, it would be open to a Tribunal to find that they were simple employees with all attendant employment rights.  However, the Government does not propose to legislate to tackle share valuations and only promises more guidance. 

Without sufficient clarity there is a clear risk that, rather than reducing litigation, employment disputes will instead be replaced by litigation regarding share valuation, and in a fully costed court regime.  These burdens and concerns are likely to deter many employers from adopting the scheme.  Indeed, for many small companies there are inherent difficulties in both valuing and then finding the potential cash required to buy out departing employee shareholders.  While the proposal is explicitly aimed at small, fast growing businesses, the ELA and others responding to the consultation considered that the complexity and the costs make it more likely to be attractive to larger, sophisticated employers. This does raise an obvious question as to its true policy impact. 

Protection for departing employees?

The incentive for individuals in accepting employee shareholder status is the promise of at least £2,000 of shares in their employer, with a capital gains break in shares to the value of £50,000.  The ELA and others suggested in their response to the consultation that when an employee shareholder leaves, shares should be bought back at market value.  If employers are instead allowed to repay a fraction of the share value on exit, or designate the terms on which employees will be "bad leavers", employee shareholders will not have benefited in the manner that the scheme claims to promote.  Without adequate safeguards, it also leaves employee shareholders vulnerable to unscrupulous employers.  

The Government’s response in turn simply highlights its belief that sufficient mechanisms already exist to govern share forfeiture mechanisms.  It fails to recognise that employee shareholders are in a particularly vulnerable position as they have given up their most valuable employment rights solely on the basis that they will benefit as a shareholder.  While it confirms that the initial share valuation should take into account potential restrictions on the sale and transfer of the shares, this may simply add to the complexity of the valuation exercise without adequately addressing the possibility that employee shareholders may be arbitrarily dismissed and then obliged to forfeit their shares without any return on their potential value. 

Equality, tax and other issues

The ELA set out a number of concerns with the extent of the equality impact assessment undertaken in relation to the Government's proposals, and the response to the consultation addresses these in some measure.  However, its essential conclusion is one of uncertainty, and it fails to respond fully to the submissions by a number of those participating in the consultation that the proposal to remove the right to request flexible working will disproportionately affect women. 

The Government has also acknowledged the need for further consideration of the tax treatment of the proposals, and in particular the potential income tax charge related to the initial issue of shares to employees.  While details of the capital gains tax exemption have been put forward, there remains uncertainty on this point.  The essential benefit of this scheme for employees depends almost entirely on the favourable tax position for the new status, and it leaves in further doubt the workability and actual attraction it will hold for the vast majority who are not founders or senior management investors. 

Other issues identified, such as the potential difficulties arising in redundancy situations, particularly those to which collective consultation obligations apply, the manner in which transfers of employee shareholders under TUPE might operate and the issues arising from employees with different statuses working alongside each other, go wholly or largely unanswered. 

Conclusion

A key policy goal set out with the Government’s proposals is the improvement of labour market flexibility, by removing the threat of employee litigation from employers who would otherwise recruit.  However, the responses to the consultation confirmed that such risks are not the primary barrier to recruitment.  Introducing the possibility of a new employee shareholder status may enhance the options available to employers and employees in some circumstances, but generally those businesses which are uncertain about hiring will not be persuaded to adopt a more confident approach by a scheme which has significant upfront costs and the potential of an immediate minimum £2000 pay out for employees who do not work out.  It is also difficult to understand how introducing this new employment status, with a myriad of complexities only partially identified in this article, can achieve the Government’s overarching aim of reducing red tape. 

A new employee shareholder status may unlock the door to significant benefits for some, but for all the reasons set out the likelihood of widespread adoption of this scheme, or of the achievement of the Government's stated policy aims, seems very much in doubt.  The fear for those who wish to promote the benefits of employee ownership is that this proposal may taint an ideal which need not be in any way linked to the removal of employment rights. 

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