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Is the protection of a directors employment rights being considered when discussing remuneration?
Insolvency Practitioner Ryan Holdsworth, Graywoods Leonard Curtis
When a company enters into an insolvency process, a director may be able to claim for arrears of wages, holiday pay, redundancy pay and notice pay as set out in the Employment Rights Act 1996. In many cases the Redundancy Payments Service (“RPS”) will ‘step into the shoes’ of the employer and make payments to a director up to certain statutory limits.
However the RPS has recently raised questions about a directors employment status based upon how they were remunerated prior to the date of insolvency. The main argument raised by the RPS stems from a director remunerating themselves a sum below the National Minimum Wage (“NMW”) through the payroll.
Remuneration – Salary and Dividends
In many cases we see a director is remunerated through a combination of payroll salary and dividends from distributable reserves. This approach is usually applied for tax saving purposes. In certain circumstances this method may also assist with cash flow given that monthly payments to HM Revenue & Customs for PAYE/NIC arise from directors with salaries over the personal allowance limit.
Employee or Office Holder
There is a legal requirement under the National Minimum Wage Act 1998 to pay an employee national minimum wage. If an employee is paid less than the NMW then a director may be committing an offence.
There are additional criteria which the RPS looks into to assess the employment status of a director but here we are focussing solely on the rejection of director’s claims due to the NMW argument.
In order for the RPS to calculate the weekly wage of an employee, the RPS examine the average salary over the previous 12 months. A request for information from a company’s payroll and copy bank statements help the RPS to assess the weekly amount paid to a director.
If a director is paid less than the NMW then the argument is that they are classed as an office holder and not an employee. As such they will not benefit from the employment rights for individuals when a company becomes insolvent.
RPS Correspondence
The RPS ultimately pays any claims from employees once a company enters into an insolvency process up to statutory limits. A recent decision to reject a claim from a director who was remunerated below the NMW was challenged and the following reply was received from the RPS:
We consider a number of indicators to determine employee status such as pay structure, holiday arrangements, entitlement to sick pay, notice periods etc when making a decision. A key factor we consider is whether a director renumerated themselves as an employee or an office holder. As per the National Minimum Wage Act (1998) a director must pay themselves the National Minimum Wage (NMW) if they are an employee.
The above position of the RPS has evolved over time especially when it has come to accepting and paying out claims from directors. Additional forms to complete and increased scrutiny has always been associated with directors’ claims.
Case Study
Below is a working example of a current case where a directors claim was rejected by the RPS.
- Company entered into administration in April 2023.
- The company was incorporated in January 1985.
- The directors P60 for tax year to 05 April 2023 showed pay in employment of £16,964.
- Director increased wage to £5,964 gross per month in final month of tax year.
- Recent accounts stated £12,000 Directors Remuneration with an additional £40,000 of dividends.
- Based on this new salary the director may have been entitled to £19,290 redundancy pay and other benefits such as wages, holiday pay and notice pay.
- The director’s claim was rejected with the reasons above being cited.
The issues above become a problem only when a company enters into an insolvency process and a director’s claim is rejected by the RPS – however we are seeing the rate of rejections increase with the rise in insolvency cases.
The RPS have stated that a director can challenge their decision at an Employment Tribunal. As the rejection of directors’ claims for the reasons stated has only recently occurred, we have not seen any Employment Tribunal rule in favour of a director who is paid below NMW.
The working example above has potentially seen the director relinquish their entitlement to at least £19,290 in redundancy pay despite being employed by the company for nearly 30 years.
Whilst safeguards may already be in place to ensure that directors understand the advantages and disadvantages of certain methods of remuneration it may be worth revisiting these to ensure that they take into account the current position of the RPS. These matters come into play when a company enters into an insolvency process which can be, in some circumstances, be without warning.
For further information get in touch with the Graywoods team on 0114 285 9500 or team@graywoods.co.uk.
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