UK: Employee Shareholder Status – Opting out of UK Statutory Employment Rights

It is a general principle that employees cannot opt out of their statutory employment rights. In the UK, this has been eroded by the concept of ‘employee shareholder’ status (or ‘ESS’), introduced into legislation in September 2013.

ESS involves an employee giving up rights to receive specified amounts on any future termination of employment. In exchange, the employee receives free shares in their employer with special tax advantages.

ESS represented an attempt by the UK government to address two separate issues. The first aim was to encourage the increased ownership of shares by employees, allowing them to participate in the success and growth of their employer. The second was to address broader concerns that the UK’s employment regime was too restrictive, and that reducing the statutory costs of dismissing employees would make employers keener to hire in the first place.

ESS was (and remains) controversial for understandable reasons. The legislation introducing ESS was twice rejected by the House of Lords (the UK’s second parliamentary chamber). It only became law following the ‘ping pong’ procedure, when legislative amendments are passed between the two Houses at the last minute until a resolution is reached, which is used relatively rarely for issues of this size.

Where a valid agreement is entered into, the employee shareholder will be treated as an employee but loses key rights to:

• a redundancy payment; and
• a payment if unfairly dismissed (unless there is discrimination).

Together, these could otherwise lead to payments approaching £100,000, depending on service and age (though few receive such high payments), which can therefore make it attractive to employers for employees to waive their rights.

However, ESS just affects statutory rights. Contractual rights can be what the employer and employee agree.

A minimum £2,000 of free shares must be received for waiving these future rights (although up to £50,000 of shares can be provided, but tax would be due on any value above £2,000). Any gains on these shares will also be free from tax when the shares are sold.

Employees of any company and at any level of seniority qualify for ESS (except those who (broadly) already have a 25% interest in the company). ESS can be made compulsory for new employees, which is where it has been most used. An existing employee can choose to give up his rights, but cannot be forced to accept this status.

Other ESS terms are:

• there must be a written agreement between the employee and employer, with a written statement setting out what employment rights are being given up and the rights of the shares
• no payment is permitted from the employee for the shares (which has raised difficult company law issues because companies in the UK cannot normally issue shares for free). The employee can be forced to sell shares on leaving employment, including at below market value
• independent legal advice must be given to the employee at the cost of the employer
• there must be a seven-day ‘cooling off’ period between the advice and the agreement being entered into.

ESS has (so far) not proved popular in practice, although we as a firm have implemented this for various clients.

For most employees, the security provided by the rights not to be unfairly dismissed and to receive redundancy pay is probably worth more than the £2,000 in tax-free shares, which is all that has to be offered.

For most employers, the mechanics involved are relatively cumbersome and the implementation costs are high. Furthermore, many employers do not want large numbers of small shareholdings.

Where ESS has (perhaps unintentionally on the part of the government but as widely forecast by critics) proved popular is with private equity and venture capital firms. The senior management of a company with private equity backing are less likely to be concerned about giving up their statutory employment rights, as they will often be protected by more generous contractual rights. In addition, the tax advantages are extremely useful in protecting the gains they realise, as special classes of share with a low initial value but which can significantly increase on a sale of the company, can be devised. The UK Revenue has also been keen to show the success of the policy and has been agreeing relatively favourable share valuations. Indeed, concerns exist that this is becoming a major source of tax loss/abuse and that ESS may be withdrawn or have its tax benefits capped.

Nonetheless, it remains an interesting development in UK employment law. With growing concern across Europe in achieving increased employment flexibility, ESS will be of interest to other jurisdictions as an example of how taking away statutory rights can help realise this. This is likely to be an increasing cross-European trend over the next few years.