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Employee Shareholders - Would You Sell Your Rights?

About The Author

Emily Clements (Former Team Member)

Emily is a Durham University Law graduate due to start as a paralegal in the London Banking & Finance Department of a Silver Circle firm in October 2014, and currently has her targets set on qualifying as a solicitor.

John Lewis is often praised for its unusual structure – an organization where every employee is a stakeholder and takes home a percentage of profits. This has clearly worked for John Lewis as the UK’s 4th largest company, but can it work for all companies?

On 1st September 2013 s205A Employment Rights Act 1996 came into force in an effort to introduce a new form of employee status. A somewhat controversial provision, with numerous downfalls and causes for concern when you start exploring the reality of its proposals; it is unsurprising that criticism is rife.

The provision introduces the concept of ‘Employee Shareholders’; encouraging employees to sacrifice important employment rights in return for the benefit of a portion of the company’s shares, with the additional benefit of favourable tax treatment. The rights that will be waived include the fundamental right to claim for unfair dismissal, subject to the exception that any dismissal must not breach the Equality Act 2010 or be regarded ‘automatically unfair’ under the ERA (for example: pregnancy, discrimination or acting as a trade union representative). Statutory rights to request flexible working of any kind, including taking days off for training, will also be lost, along with the right to redundancy payments. Is this scheme simply encouraging employees to sell their rights? I would argue so, especially given the shares must be forfeited upon leaving the company. Furthermore, it is encouraging employees to take a huge risk on account of the likelihood that if a company were to undertake a redundancy exercise, those on an employee shareholder status would be inherently vulnerable.

Arguments that this is a mutually beneficial and innovative scheme to encourage employee feelings of participation and involvement in the companies they work for subside when you start to look at the details of the scheme. There is nothing to say the shares given must enable any voting or dividend rights. Further, there is no restriction on the type of shares eligible to use under the scheme. This leaves us wondering how much the employee really stands to gain from taking on this status.

A supposedly key ‘selling point’ of the scheme is based on the ‘favourable’ tax treatment for employees, but how much benefit can actually be accrued here? The existing value of the bait is the offer of shares worth a minimum of £2,000, which is then sugar-coated by the provision that if and when sold, any profit would be exempt from capital gains tax up to £50,000 worth of shares and there is an allowance for an exemption on income tax for the first £2,000. However, closer inspection reveals that as soon as an employee is presented with shares over this £2,000 value, they find themselves immediately liable to pay income tax. In practice this means any employee shareholder receiving anything over the absolute minimum £2,000 (which is likely to be the majority) is then being charged income tax. As for capital gains tax, the first £10,600 capital gains is exempt anyway for any person regardless of employee shareholder status in any individual tax year. Therefore an employee shareholder receiving the minimum share value of £2,000 is gaining little from this provision, unless the shares were to miraculously increase and sell for more than 500% of the original acquisition price in order to exceed this £10,600 boundary. Besides, it should not be forgotten that it is not out of the question that the value of the shares will fall, which would obviously even further diminish any benefit of the scheme for a shareholder.

The underlying issue, understandably receiving heavy opposition from the Trade Unions, is the loss of protection for employees. Whilst the government aims to create a third form of employment status alongside ‘employee’ and ‘worker’, little attention is paid to a background of labour law already in a state of turmoil. The definitions of various forms of ‘worker’ are blurring, and flexible working is leading to less and less essential protection for workers, since workers begin to fall outside the scope of the traditional employer-employee relationship and therefore outside of statutory protections. For me, this is just the latest offspring of a veiled attack on workers’ rights.

The somewhat minimal safeguards include an obligation for the employee to take legal advice (paid for by the company) and a mere seven-day cooling-off period before signing the contract, neither of which seem sufficient. Although existing employees cannot legally be pushed into this, and one of the six conditions of any agreement requires ‘mutual agreement’ between the parties, companies may be able to exercise their natural leverage over prospective recruits and coerce them into an employee shareholder contract; undermining any justification based on ‘choice’. The status is retained even if and when the shares are sold. The only way out of it is to change the contract. This surely is a classic example of an employer using his stronger bargaining power to manipulate an employee out of some of his most basic rights.

Whilst so far I have painted the picture mainly in the employer’s benefit only, I am scarcely convinced it is a good deal for companies either. There are many hidden costs such as amendments to Articles of Association, costs on termination of employer shareholder employment and share valuation costs. Also not forgetting the potentially disproportionate cost of advice, which falls on the shoulders of the company and persists as a mandatory requirement even if the employee does not then agree the contract.

So what could we propose as an alternative which could genuinely provide a mutually beneficial scheme for employees and employers alike?

  1. Perhaps we should only be offering these types of schemes to the most senior employees who could actually potentially use their acquisition of shares in the company to have greater influence and involvement. This may consequently benefit the company if their senior employees have more to gain from performing their job to a high standard.
  2. Furthermore I would consider the £2,000 minimum share value too low. As demonstrated above the tax ‘benefits’ are of little help to employees who have been awarded the current minimum share value and in most larger companies will be unlikely to render a low-value employee shareholder in a particularly different position in terms of influence to a normal employee (aside from the fact the shareholder finds themselves with less protections).
  3. Make it a requirement that voting rights are attached to employee shares, and that the minimum employee shareholding is at least the minimum shareholding required to vote in a particular company’s articles of association

Conclusively, I feel section 209A is at worst, unworkable and damaging, and at best, highly niche. An initial goal of the government to benefit the smaller, ‘fast-growing’ companies is unlikely to be achieved given the minimum £2,000 requirement and other costs to the employer. There could surely only ever be any kind of benefit for a senior employee of a company who may receive large share awards, and find himself/herself in a stronger bargaining position, thereby potentially diminishing the loss associated with reduced employee protections.

It cannot be disputed John Lewis has been successful as an employee owned business. However the legislative model does not live up to the same standard. John Lewis was born this way, with the intention of making every employee an important part of the business. This legislative model on the other hand has the potential to allow employers to reduce the rights of their workers, which is without a doubt a contradiction to the John Lewis ethos.

This should not be allowed to become a common new form of employee status or we risk workers being conned out of their essential rights for little repayment.

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Tagged: Commercial Law, Employment Law

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