Employee Shareholder Status: An Old Solution to a New Unfair Dismissal Risk

Seismic changes are coming to employment law, which will make it far riskier to dismiss employees, particularly those who are highly paid, or have valuable benefits such as share options. But could a little-used legal reform from over a decade ago hold the key to de-risking these changes for employers?

The end of the unfair dismissal compensation cap

Currently, employees with more than two years’ service have the right not to be unfairly dismissed. In so-called “ordinary” unfair dismissal claims, an employment tribunal can award compensation which reflects the employee’s financial loss flowing from their dismissal. However, the amount of compensation an employee can recover is capped at the lower of a year’s pay and an amount which rises with inflation each year, currently a little over £123,000. In other kinds of claims (such as discrimination, or dismissal for being a whistleblower), this service requirement and cap on compensation does not apply. But for a high-earning employee whose claim does not fall into one of those categories, the prospect of pursuing a capped unfair dismissal claim is not that attractive.

The compensation cap has a significant impact on exit negotiations for senior executives. Provided the employer can steer clear of uncapped claims, both sides usually understand that the employer’s total liability from a dismissal will not be more than around £123,000, and the employee’s grounds for arguing for a higher payment, from a legal point of view at least, might be limited. For a C-suite executive, this upper ceiling might represent only a small proportion of their total annual compensation.

Why uncapped unfair dismissal claims matter for employers

However, from 1 January 2027 the service-requirement is being reduced to six months and the cap on compensation is being abolished altogether. An employment tribunal will therefore be able to order an employer to pay an amount which properly reflects the employee’s loss, up to an unlimited amount. Losses relating to profit share, bonuses, shares etc. will therefore be in issue like never before. The largest employment tribunal award to date is just under £5million. That record will easily be broken once the unfair dismissal cap is lifted.

The historical significance of the change should not be understated. It will be the first time since unfair dismissal was introduced by the Industrial Relations Act 1971 that compensation has not been subject to a cap.

But another piece of legislation from the past might provide some relief from this new risk for employers.

Why employee shareholder status never took off

You’d be forgiven for never having heard of Employee Shareholder Status. Introduced in 2013 by then-Chancellor of the Exchequer George Osborne, the premise was very simple – employees would receive shares from their employer, worth a minimum of £2,000, in return for which they would give up certain employment law rights, chief of which was unfair dismissal. When ESS was introduced, the shares benefited from very favourable tax treatment. The first £2,000 of shares was exempt from income tax and the shares were exempt from capital gains tax when they were sold (provided they were worth less than £50,000 at the time of grant).

At the time of introduction, the take-up of ESS was not significant. In the first seven months of the scheme being in existence, HMRC recorded just 40 companies making use of ESS.

Why employee shareholder status never took off

For many employers, ESS was something of a solution in search of a problem. There already existed tax-advantaged ways of incentivising employees through an ownership stake in the business, such as EMI options. The unfair dismissal rights that employee shareholders gave up were already subject to the compensation cap, and ESS still left open the possibility of a departing employee bringing uncapped claims relating to discrimination and whistleblowing, for example.

Anecdotally, companies using ESS were mostly interested in the additional tax advantages, rather than removing some limited rights from the legal relationship with their employees.

In late 2016 the Government ended the tax advantages of ESS for all new entrants to the scheme, and indicated that it would abolish ESS itself when the opportunity allowed.

Could employee shareholder status make a comeback?

The removal of the tax reliefs meant that ESS fell into disuse. However, the Government never followed through on the commitment to abolish it altogether, and it therefore remains on the statute books and available for employers to use.

It has the potential to be an elegant solution for managing the risks which the changes to unfair dismissal will introduce. In relation to performance-related dismissals, for example, there is an uneasy tension between the practical reality of terminating certain kinds of employment relationship, and what an Employment Tribunal is looking for before it will agree that a dismissal is fair. A portfolio manager in a hedge fund, for example, knows that if their investment portfolio drops below a certain level, their employer will cut the amount of capital available for them to invest, and if it drops further their employment will be terminated. An Employment Tribunal, on the other hand, will expect dismissal to be preceded by a formal “performance improvement plan” which may take a number of months to conclude, and involve a significant amount of management time. Similarly a CEO who has lost the confidence of the company’s investors would expect to be given their marching orders, but from 1 January 2027, a company which does not place them on a lengthy PIP before terminating will face an uncapped unfair dismissal claim.

For those, and similar, situations, ESS starts to look a lot more attractive for employers.

Implementing employee shareholder status – practical considerations

Implementing ESS involves the following considerations:

• The employee must be given shares worth a minimum of £2,000. In a private company, valuing the shares can be a difficult and expensive process if no recent valuation has been undertaken.
• The employee must not give any additional consideration for the shares. However, the company’s articles of association can provide for the shares to have leaver rules, restrictions on transfer etc. and the shares need not have voting rights.
• The employee must be given written particulars relating to the shares which comply with certain requirements.
• The employee must receive independent legal advice on the employee shareholder agreement which the employer must pay for, whether or not the employee enters into the agreement.
• An existing employee cannot be forced to become an employee shareholder – and such employees have protection against detriment and dismissal for refusing to become an employee shareholder.
• Because of the limited initial take-up of ESS, there are no test cases about it, and uncertainties in the legislation have not been settled through caselaw the way that other questions arising from legislative rights have been. There is no consensus, for example, on what happens to an employee shareholder who subsequently goes through a TUPE transfer.

A resurfacing solution for a new employment law landscape

Although the legal requirements for creating employee shareholders are detailed, they are not at all disproportionate to the benefits of avoiding an uncapped unfair dismissal claim from a senior or high-earning employee. If ESS is implemented as part of, for example, a private equity investment, many of the documents needed will be subject to renegotiation in any event and an up to date valuation of the company will be available – so the significant benefits of ESS for the investor can be obtained for a modest amount of additional work.