Rebecca Lynch: Employee Shareholder Scheme – The pitfalls

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Rebecca Lynch

While the new employee shareholder scheme may seem a positive move from the government to remove red tape and burdens on businesses, in reality implementing such a scheme and ensuring it meets the requirements is far from straightforward and the benefits for employers may not be as good as they first appear.

The basic premise of the scheme is that employee shareholders give up their rights to claim unfair dismissal (except automatic), the right to a statutory redundancy payment and the right to request flexible working or study leave. In return they receive shares in the Company worth a minimum of £2,000.

To some, this may seem like an innovative development; a way to avoid the risk of employment claims and to attract ambitious employees in a competitive market whilst not increasing up front recruitment costs.  Those employees who sign up will have a vested interest in the company, which in theory should motivate them and boost their productivity. However, once one delves deeper into the detail of setting up such an arrangement, a number of potential pitfalls arise

Weighing up the costs 

The employer will need to consider if the cost of setting up the scheme is proportionate to the benefit in light of the amount of employees involved. For instance, if there are only a few employees interested, the burden of amending the Company’s articles of association and gaining shareholders consent to proceed may prove cumbersome.

One of the main conditions of this scheme is that the employee must take independent legal advice and the employer is required to pay the employee’s “reasonable” legal fees. This is not dependant on the employer signing up to the scheme and it could prove expensive for the employer given that each employee will likely need both corporate and employment advice. This will be a cost in addition to an Employer’s own legal fees.

Employers will also need to ensure that the value of the shares issued to employees is more than £2,000. If for whatever reason they fall below this value, the employee will have the benefit of all their employment rights, as well as the shares. Accordingly, private companies may need to factor in the cost of a valuation each time to ensure this threshold is met.

Is litigation still likely?

While most employers would welcome the chance to avoid the risk of litigation, which can be time consuming and expensive, the employment rights being surrendered under this scheme are quite limited in comparison to the position for non-employee shareholders.  A disgruntled employee shareholder could still raise a number of claims such as discrimination and whisteblowing, which may be more expensive to defend.

In addition, in the first two years of employment, the employee is giving up very little.  As of 6 April 2012 employees need two years continuous employment to accrue unfair dismissal rights, the right to a statutory redundancy payment and 26 weeks of continuous service before they have the right to request (not be granted) flexible working/study leave. Therefore, whether or not the employee is an employee shareholder, the employer can dismiss them during the first two years without the risk of an unfair dismissal claim or the obligation to make a redundancy payment. Furthermore, it could even prove more difficult to dismiss an employee shareholder, than an ordinary employee during this period due to the possible expense of unravelling the shareholder arrangement.

If an employer wishes to dismiss an employee after two years of employment, there is usually a good reason for it. In any event, it is likely that the costs of doing so, for instance a redundancy payment, would most likely cost far less than implementing the shareholder scheme in the first place.

The right to request flexible working/study leave applies to ordinary employees after 26 weeks service and an employer may welcome the opportunity to reject such a request straightaway (on the basis that employee shareholders have no right to request).  However, the legislation does not address what would happen if the employee then asserts a discrimination claim (which you cannot waive under the scheme) in reaction to an employer’s refusal to grant flexibility. In essence, the risk of a discrimination claim undermines this benefit and means that employers should think twice before rejecting such a request, even for an employee shareholder.

Dealing with termination of employment is not easy at the best of times; however, terminating the employment of an employee shareholder involves an extra layer of complication. The share purchase agreement should document how the employee’s shares will be dealt with on termination, however in practice, untangling the arrangement, together with any necessary valuation of the shares, could be a messy and expensive affair.

If exits are acrimonious and an employee is engaged under these arrangements, it could add a secondary layer of dispute/negotiation. Disputes over the shares themselves would be outside the remit of the employment tribunal and would mean litigating in the High Court where there are costs consequences.

Therefore, despite the initial attraction of the employee shareholder scheme, employers should first weigh up the advantages of offering such a scheme in light of the size of their business and its resources against the potential pitfalls. Our experience in practice to date is that whilst there is some interest in the scheme, particularly from new start-ups, the take up has so far been very low.

Rebecca Lynch is a partner at Davenport Lyons’ Employment department.

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