Selling your rights... for what?

Following the myriad changes in employment law from 29 July, including the introduction of fees and new Employment Tribunal Rules (Journal, July 2013, 14), together with a new limit on compensatory awards, the pace continues through the Growth and Infrastructure Act 2013. This will alter the options for employers wanting to give a stake in their business to their employees.

Shareholder employees

The Government’s intention (eventually encapsulated in s 31 of the 2013 Act, adding a new s 205A to the Employment Rights Act 1996) was to create a new category of employee, the so called “employee shareholder”. This will allow an employer to offer an employee (or prospective employee) shares in the employing company in exchange for certain employment law-related rights. For practitioners, a working knowledge of the new law (which comes into force on 1 September) is useful as they may need to advise employers and potential “employee shareholders”.

In terms of the legislation, there are four criteria to be met for an individual to become an employee shareholder. An agreement must be reached between the individual and the employer. Fully paid up shares in the company (or parent), for which the individual has given no consideration, must be issued to the individual. These must (at the date of issue) have a value of at least £2,000, and the individual is also entitled to a written statement setting out both the implications of the status for employment rights and the rights attached to the shares.

In return for becoming a shareholder employee, the individual waives certain fundamental employment rights. These include the right to claim unfair dismissal or receive a redundancy payment, though not their rights relating to circumstances which would amount to automatically unfair dismissal or a breach of the Equality Act 2010. The notice an individual requires to give to return from maternity, adoption or additional paternity leave is also extended to 16 weeks. The right to seek flexible working is also significantly restricted.

What protection?

Existing employees will have protection from detriment and/or dismissal if they refuse to accept an offer to become a shareholder employee. However, no such rights apply to prospective employees, and this could be a source of abuse, especially in the existing economic climate.

Other than the requirement that the shares have a minimum value at date of issue, there are no other minimum criteria/rights that need apply to the shares. The Government has reserved the power to regulate by secondary legislation how companies may buy back shares from employee shareholders, but aside from some provisions specific to employee shares in the wider regulations relaxing the rules regarding companies buying back their own shares, no such legislation has been published, and certainly nothing which would preserve rights or value for employee shareholders.

The Act’s passage through Parliament was, to put it mildly, troubled and a number of additional protections had to be added to allow the provisions to be passed. These related to what the individual has to be told by the employer and what advice they are required to seek.

Potential benefits for employees

Given the lack of specificity as to the rights which must attach to employee shares, the main benefit to a person becoming an “employee shareholder” would appear to relate to tax. The Finance Act 2013 makes provision for two specific tax benefits. Ordinarily, an employee receiving shares from an employing company at a consideration less than their value would be receiving a benefit which would be subject to income tax. This would no doubt dissuade many employees from accepting shares. For employee shares specifically, the Finance Act provides for an effective exemption from income tax in respect of the first £2,000 by value of shares which the employee receives under the new scheme.

The Finance Act provides for a further benefit on a sale of shares by the employee. Under the proposed rules, there is the potential for an employee to realise up to £50,000 on the sale of their employee shares without this being subject to capital gains tax. The CGT exemption in particular has led to some speculation that, at the very least, companies may use the new regime in order to remunerate senior managers in a tax-efficient manner, although the tax benefits will not be available to a person who is a significant shareholder in the company.

Potential risks for employees

As stated above, the rights attaching to the employee shares could be extremely curtailed.
It is therefore possible that employees could be asked to accept shares which, for example, have no voting rights, deferred or no rights to dividend, and restrictions on their transfer. While the requirement to get independent advice was meant to minimise the risk, there must still be a concern that individuals could be giving up their employment rights in exchange for shares without appreciating that they may not receive any return at all from such shares. The rights attaching to shares can be rather complex, and one can clearly envisage employees accepting shares while being under a misapprehension as to their entitlement, e.g. in terms of their rights to share in the profits of the company.

There is also the question of actually realising value in the shares, a common problem in private companies. Leaving aside potential restrictions on transfer, there is often no market in such shares, as there is no party looking to purchase. The Government has partially addressed this by simplifying the procedure used when a company buys back its own shares, but companies may not wish to or may not be able to do so.

Larger private companies with an extensive employee share ownership may have an employee benefit trust which can create such a market, but in smaller private companies such a market is often created either through the articles of association or through an agreement between the shareholders, very often linked to the cessation of employment. However, the type of provisions used to allow exiting employees to realise value in their shares can also be used to minimise the value that can be realised by such employees.

The price will often be fixed or set according to a formula, and the price differentiated according to whether the employee is a “good leaver” (a common example being retirement) or a “bad leaver” (e.g. a dismissal on the grounds of gross misconduct). There is little to prevent companies from putting into place provisions which contain a very wide range of situations in which employees will be required to sell shares at a nominal price on the cessation of employment.

Additional employee protections

The written statement to be given to the individual must contain certain specific information, including what employment rights are being lost and what rights (if any) attach to the shares to be received in exchange for this waiver. Thereafter, there must be a cooling off period of at least seven days to allow the individual to consider the offer, and (probably most importantly from the profession’s point of view) the individual requires to have obtained independent advice “as to the terms and effect”.

This means that the adviser’s duty in part equates to that applicable to a settlement agreement (what practitioners used to know as “compromise agreements” but which have received a rebranding under the Enterprise and Regulatory Reform Act 2013). The employer is responsible for “any reasonable costs” incurred by the individual in obtaining the advice, irrespective of whether the person actually becomes an employee shareholder or not.

Even with these additional protections, there are still unanswered questions and the burden on advising practitioners is considerable. Care will require to be taken when advising individuals as to the benefits they will obtain in accepting employee shares in return for a waiver of employment rights.

Given the responsibility and risk on the independent adviser asked to advise an individual, which goes beyond the scope of what would be required for a settlement agreement, it is also debatable what would be the “reasonable cost” chargeable in these circumstances. The profession should be careful not to underestimate the extent of the advice that will be needed, and requiring this to be done for an amount similar to the standard £250 to £350 paid for settlement agreements seems unrealistic.

Uncertainty

Given the many different rights with which shares can be issued, if the Government had been serious about trying to widen employee share ownership, perhaps a good starting point would have been using the Growth etc Act to provide for a standard class of “employee shares” which would carry certain basic rights and protections in return for tax benefits. Instead, the lack of certainty as to the rights attaching to employee shares under the Act creates an issue for practitioners asked to advise employees which could limit the use of the intended scheme.

Media reports suggest that few employers may wish to take advantage of such schemes. Equally, given the rights being sacrificed, employees may also be reticent over taking part. As with all new ideas, viability and popularity of the scheme will be something to be assessed later. Whether it will lead to more work for the profession also remains to be seen.