Secretary of State v Knight (2013)
Are directors entitled to redundancy?
There is a widely held view and common belief that company directors are not entitled to redundancy pay but in limited circumstances it may be possible.
When a business fails and has to go into liquidation, directors, who have invested time, sweat and money in trying to establish and grow their companies, will feel a sense of bereavement, so it is useful to know that there might be some form of small recompense when falling on hard times. In the Employment Appeal Tribunal case of Secretary of State v Knight, Mrs Knight claimed from the Insolvency Service the redundancy payment which her company, of which she was the Managing Director and sole shareholder, had not paid to her. Initial judgement by the Employment Tribunal found that she was entitled to a redundancy payment of £7,296, but the Secretary of State appealed.
Mrs Knight formed her company in February 1991 but it ceased trading and became insolvent 20 years later, in October 2011. When the business commenced, a contract of employment was drawn up between the two parties. This provided for 40 working hours a week and an annual salary of £20,000 plus discretionary bonuses. The contract however was never formally executed.
Mrs Knight was responsible for sales and marketing and wrote all the tender documentation for contract bids. She actually worked more than 40 hours a week and travelled extensively on behalf of the company.
When the company was operating satisfactorily, Knight was paid £1,000 per month after tax, and any profits were ploughed back into the business.
In the last two years of trading, Mrs Knight, in an effort to keep the company afloat, did not enforce her contractual entitlement to pay and therefore received no monies at all. Due to the company’s plight there was insufficient money to pay her and she therefore forfeited her salary in order that her employees and suppliers might be paid. Unfortunately, this was in vain as the company became insolvent and ceased to trade, giving rise to Mrs Knight’s claim to redundancy.
The Secretary of State’s appeal was threefold but one of the grounds was that with Mrs Knight forfeiting her entitlement to pay, she had changed her position; there was no wage being paid by the company and no mutuality between them which would support the existence of a contract of employment during the last two years of the company’s existence. This point was crucial as it was necessary for Mrs Knight to have been an employee, so that her company would have been under an obligation to pay her a redundancy payment.
The judge stated that the fact Knight decided not to require her company to pay her salary as an employee did not necessarily lead to the conclusion that she must have entered into an agreed variation of the contract or a discharge of that contract. Knight had simply chosen not to enforce her entitlement to pay in order to keep the company afloat. The Secretary of State’s appeal was therefore dismissed.
The key to a claim to redundancy pay is to have a contract of employment right from the outset.
Company directors run limited companies on behalf of the shareholders. They have different rights and responsibilities from employees and are classed as office holders for tax and NIC purposes. Where a person does other work that is not related to being a director, they may have an employment contract and get employment rights, including the National Minimum Wage. However, it is this very right that many directors will not want to expose their companies to, as they will want to retain the right and enjoyment of the flexibility to decide exactly how they extract profits from the company.