Legal Q&A: Sham contracts

Q What is the legal test for deciding whether an individual is an employee or not?

A When deciding this, an employment tribunal will take into account those factors that indicate the existence of a contract of employment. These include: the degree of control exercised by the employer - the greater the control, the more likely that a contract of employment exists; whether there is a mutual obligation on the employer to provide work and the employee to do the work - if not, there will be no contract of employment; the duty of personal service; the tax and National Insurance arrangements; and any restriction on the ability to work for other employers.

Q How do legal protections and employer liabilities vary according to an individual’s status as either "self-employed", "worker" or "employee"?

A Self-employed: most employment law statutory protections do not apply. However, a self-employed person can benefit from anti-discrimination legislation. Employers need not take out employer’s liability insurance in relation to self-employed individuals nor make National Insurance contributions or deduct tax from payments.

Worker: No right to unfair dismissal protection, nor the right to statutory redundancy payments. However, workers have certain minimum entitlements such as the right to at least the statutory minimum wage and statutory holiday.

Employee: Enjoy the greatest level of protection, including the right not to be unfairly dismissed and the right to statutory maternity/paternity leave. Only employees can benefit from the automatic transfer of their employment to a purchaser of their employer’s business under TUPE (the Transfer of Undertaking (Protection of Employment) Regulations.

Q What is meant by a "sham" contract?

A Essentially, "sham" is a term used by the courts to describe either an entire contract, or a provision within a contract, where the parties to the contract have jointly agreed to deceive a third party. This might be to make it appear as if there is a certain legal relationship between them such as that of contractor/client, but which neither party intends to exist. Alternatively, a sham contract may also exist without any joint intention to deceive, but the court deems that in reality neither party to the contract intended the contract, or a provision in the contract, to have any binding effect.

Q In what circumstances might a contract be deemed to be a "sham"?

A One example is where a contract states that, if an individual is absent, they are under an obligation to provide a substitute to carry out the work - ie, there is no obligation to carry out the work personally. But if neither the individual nor the company ever intends the individual to be obliged to provide this substitute, a court may determine that this provision is a sham. This might result in the status of the individual changing from self-employed to worker or employee.

Q What are the risks and penalties of relying on a contract that may be deemed to be a "sham"?

A Unanticipated employment protections such as unfair dismissal and statutory redundancy payments may apply. Terminating a number of employees may trigger consultation obligations under the collective redundancy regime and selling a business may trigger TUPE information/consultation. Failure to comply could result in a penal protective award of 13 weeks’ actual pay per affected employee. HM Revenue & Customs may be able to recover un-deducted taxes and National Insurance contributions, together with interest and penalties, and a PAYE inspection might result.

Q Is there any helpful case law for companies who want to use agency workers?

A In the recent case of James v London Borough of Greenwich an agency worker brought an unfair dismissal claim when the end-user council terminated its contract with the agency. The individual argued that her agency contract was a sham and that she was an employee of the council. The Employment Appeal Tribunal found that passage of time alone does not establish any mutual obligations between a worker and end-user. To imply a contract of employment into a tripartite worker/agency/end-user relationship it will be necessary to show that the worker is no longer working pursuant to the agency arrangements, but as a result of mutual obligations binding the worker and end-user.