Calling time on sham contracts in employment

The Court of Appeal has moved away from the language of shams when deciding whether an individual is an employee. It is a welcome development, says Jason Braier.

2009 has been a much better year for those arguing they are an employee than 2008, with the departure from the unrealistic position on sham contracts set up in Consistent Group Ltd v. Kalwak [2008] IRLR 505.

In Protectacoat Firthglow Ltd v. Szilagyi [2009] IRLR 365, and more recently in Autoclenz Ltd v. Belcher [2009] EWCA Civ 1046, the Court of Appeal consigned the Kalwak approach (hopefully) to legal history. The recent decisions should sound a note of caution to local authorities engaging workers on zero-hour contracts to ensure that the contractual positions are not merely an attempt at convenient illusion.

The issue at hand concerns employers’ efforts to avoid the employment rights consequences of employee status by including within contracts terms inconsistent with the Ready Mixed Concrete-defined nature of employment. Example terms include provisions allowing the contracting individual to substitute another person to perform the job in his place, and those providing for no obligation on the company to provide work or on the individual to undertake any work offered.

It may of course be that such terms are included in a contract for genuine reasons, and that the company intends to abide by them and to govern their relationship with the individual worker accordingly. It is not unusual, however, for companies to insert such terms merely to seek to avoid Employment Tribunal jurisdiction.

Before the recent Court of Appeal decisions, the task of a person claiming to be an employee in such circumstances was very difficult indeed.

The problems started with the definition of a sham in Snook v. London and West Riding Investments Limited [1967] 2 QB 786. In that case Diplock LJ explained, in the context of a fake hire-purchase agreement entered into to provide security for a loan on goods, that for there to be a sham there has to be a common intention between the parties to the contract to give third parties the appearance of creating legal rights and obligations different to those the parties actually intend to create.

This contractual concept was imported by the Court of Appeal in Kalwak into the employment contract context. The importation of the Snook sham ignored the practical realities of the drafting and acceptance of employment contracts. Employees – especially low-level employees – very rarely get a say in the drafting of their contracts of employment. Subject to possible negotiation of salary, working hours and holiday time, when a person is offered employment the contract is usually on a take it or leave it basis. The parties do not start from an equal bargaining point. The employee has no input in the drafting of terms. If the employee even reads the contract properly before signing, he is usually unlikely to appreciate the implications of terms intended to convey the appearance of a contract for services rather than a contract of service.

In short, the application of the sham doctrine to the employment context in Kalwak set a requirement for collusion that is rarely likely to be met. The Kalwak position thus had the potential to deprive of the rights consequential on employee status many who looked like employees and acted like employees and were treated like employees until termination.

The Court of Appeal in Protectacoat rowed back from reliance on the sham doctrine by concentrating on “whether or not the words of the written contract represent the true intentions or expectations of the parties, not only at the inception of the contract but, if appropriate, as time goes by”. This approach recognises the inappropriateness of the bilateralism of the sham doctrine to the employment contract context. Moreover, by not replacing the bilateral approach by a unilateral approach but moving away from the emotiveness of the “sham” altogether, the Court of Appeal allowed claimants to avoid a necessary requirement to show bad motive on the part of the respondent.

The fluidity of the “as time goes by” part of the test (in contrast to Kalwak, where the Court of Appeal concentrated solely on the terms at the inception of the contract) allows for a claimant to show that notwithstanding what the contract may say, the relationship has never been conducted in accordance with the controversial terms or, even more helpfully to the claimant, the relationship has been conducted in a manner contrary to the controversial terms. In such circumstances, the Court held it open to Tribunals to find that the true relationship defines the contract, rather than the contractual document itself.

In Autoclenz, the Court of Appeal reinforced its Protectacoat position. Smith LJ clarified that the “as time goes by” element of the test focuses on whether evidence during the currency of the relationship shows that the parties have either expressly or impliedly varied the contractual agreement. Just because the contract provides for a term that is never exercised does not mean that the term is not genuine and falls outside the true intentions of the parties. A substitution clause, for example, may never have been tested within the period of work.

The Protectacoat and Autoclenz approach reflects that in another area of inequality of bargaining power, namely the landlord and tenant sphere, where in Street v. Mountford [1985] AC 809 the House of Lords held a landlord could not avoid the legal implications of a lease by labelling it a licence or inserting clauses inconsistent with the document being a lease for the purpose of obviating the consequences of such legal definition.

The move towards substantive contractual construction means local authorities entering into contracts for services with those who could potentially be characterised as employees would be wise to ensure not only the genuineness of clauses incompatible with employment but also that that genuineness can be evidenced in practice, both by allowing its exercise if requested to do so and by relevant policy documents to explain the approach to such requests.

Jason Braier is a barrister at Field Court Chambers (www.fieldcourt.co.uk).