© Winston & Strawn London 2008. These notes are provided free of charge as a convenience to attendees of the Bootlaw series of seminars. They relate to the laws of England and Wales only. They do not purport to offer advice, or to be fit for any particular purpose. For this reason, they are supplied with no warranty, express or implied, of any type. We accept no liability for their use and you should obtain independent legal advice in connection with the issues discussed. We hope you understand why we cannot accept liability for the use of these notes when we are not aware of the circumstances of their use. Please contact Barry Vitou if you have any questions about their use and application. You are granted a limited licence to copy the documents for internal use in your organisation only, and you undertake to keep the copyright notice and disclaimer portions of the document intact (if applicable).
Employment Law 101
Barry Vitou Speaking Notes 29 April 2009
So you wanna do a Start Up? Your sat in your day job and your secretly plotting your next start up. Do's and Don'ts. Or to be more specific some don'ts! Moonlighting. Does anyone remember the cheesy sit com with Bruce Willis and Cybill Shepherd? Don't Moonlight during working hours. When you are at work, you should be working for your employer. So, for example, you should not be devoting time to your start up on company time. Why? First because if your employer discovers you spending every waking moment in the office working on your start up then you will get the boot. Don't use the bosses stuff You should also avoid using your employers computers etc. in the context of starting up your new enterprise. Why because if you use your employers computer and other items to create your business you could be creating, at least, an argument that that belongs to your boss. In 2007 a court held, for example, the contacts held and stored in outlook belonged to an employer by virtue of them being stored on the employers computer. Be Creative….On Your Own Time…Intellectual Property Also, be aware, that broadly speaking that under the Patents Act 1977 and the Copyright Designs and Patents Act 1988 any IPR that you create during the course of your employment will belong to your boss. What does during the course of your employment mean? At the very least it means your boss owns it if you do it on his time. If you do it on your own time but its in the same line of work as your employer's business then it may also fall within this category.
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So, in line with our usual advice. Use common sense. Invest in your own computer, only do your start up work on your own time. Clearly distinguish between your employers work and your start up work. An employment contract may go further. For example some clauses go so far as to say that any IPR created by the employee belongs to the employer. By way of example we've had letters in from very expensive London law firms claiming that their clients own domain names off the back of a clause like this. Its rubbish. Obviously. But it still costs a couple of thousand pounds at least to get them to go away. If you have a clause like this may be have a word with us and we'll suggest some options. Confidentiality Clauses A number of you have asked about these. Confidential Information. Customer lists, the secret recipe for Coke etc. You should never take these. If you do, expect to spend lots of money on lawyers, to be on the receiving end of an injunction to stop you from using it. And potentially expect to have to pay an account of profits made from it with damages to the person you took it from. So generally a bad thing to do. Do I have to have an employment contract. The short answer is yes. What if you haven't. Broadly speaking if someone asks for one and rushes of to the Tribunal they can get one. I've never seen anyone do that and I have seen plenty of start ups flout this rule. All I'd say is this. You can subscribe to very basic employment law compliance site which will give you basic employment contracts and advice for very little. They are all over the web. I'm not going to advocate that you ignore the issue. Because, from a good housekeeping perspective it is clearly a good idea to have the agreement with your employees in writing. Spend a fairly small amount of money and subscribe to one of these sites. But, if you are unfortunate enough to be on the receiving end of a claim, or it’s a little bit more complicated than the standard stuff have a word with your favourite lawyers… I want to have some people work for me. Should they be employees or consultants? There are three key differences. Tax, employment rights and intellectual property. If you have an employee then; • • • you will be responsible for the deduction of PAYE and National Insurance. your employee will have employment rights and intellectual property created (broadly) will belong to the employer.
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None of this will be the case for a contractor. How do you work it out. There are no hard and fast rules. But various tests are applied and broadly speaking the Inland Revenue and the Employment Tribunals apply the same criteria. What sort of things look like an employee. Well there's Danvers for one. Or may be not. So for example, if you exert control over the employee. You tell them when they have to be in the office. They must (within reason) perform the tasks that you set them, you supply the equipment, they receive holiday pay, they receive sick pay etc. etc. then you have an employee on your hands. On the flip side: if your consultant is asked to perform a task. he she does it whenever they want. They do not have regular hours. They accept the risk of the transaction (their pay is irregular) they provide their equipment no sick pay no holiday etc. etc. then they look much more like independent consultants. Yippee. No tax and national insurance (for the start up) and no employment rights. If you get it wrong and the person working for you is an employee then you will not be compliant with the rules about deducting PAYE tax and National Insurance contributions with the risk of penalties and fines and unhappy experience if the Inland Revenue decide to carry out an inspection. Think of a trip to the dentist to have your wisdom teeth out. Without anesthetic. Breaking Up is Hard to Do…or may be not… What happens to the shares. Options Touching briefly on the shares point. If you've granted options then the ability to exercise will be governed by the Options. Many say that the options lapse but its really up to you. Shares We've touched on Good leaver bad leaver before. Articles can also force a shareholder to sell his shares to the other shareholders if they leave. The solution is that you are obliged to offer up a proportion of your shares to your co-founders – the precise amount will depend on how the articles have been drafted which should factor in how long you have been with the company and can also depend on the manner of your departure. We call this a “Good Leaver/Bad Leaver” clause. A bad leaver is someone who leaves for a pretty bad reason – for example gross misconduct. A good leaver is anyone else. The compulsory transfer can also kick-in in other situations for example, when a shareholder dies or goes bankrupt, which means you don’t end up with a random co-shareholder, such as
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the beneficiaries of your co-founders or even worse, his creditors. The price of the transfer is usually a pre agreed formula or in the case of bad leavers sometimes its zero! A final word on dismissing employees Not going to say too much on this. In a nutshell, if things aren't working out then act. Broadly if someone has less than a years employment it is relatively straightforward. After 12 months it is basically an expensive nightmare!
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Danvers Baillieu Speaking notes 29 April 2009
Interns If anyone here was at the GeeknRolla conference last week, they would have heard Andy from Huddle speaking about hiring a team of peers. During his presentation he helpfully put up a slide dealing with the whys and wherefores of using interns in your start up. Given that some of you have asked about this subject, it is definitely worth five minutes or so to drill down into some of the legal background to this subject. In his presentation Andy made the statement that you can have unpaid interns but that “conditions apply”. I know he would agree that this is a bit of a simplification – there are no hard and fast rules and no easy guidelines for you to follow: it’s a grey area. The shades of grey apply particularly in relation to the requirements of the National Minimum Wage Act 1998 – the introduction of which was a key manifesto pledge of New Labour in the 1997 election, back in the day when they actually tried to keep their manifesto pledges. The Minimum Wage Act says that anyone who is a “worker” – not an employee – is entitled to the minimum wage. Anyone know what that is: £5.73 for workers over 22 and £4.77 for 18 to 22 year olds. A worker is either someone with whom you have an employment contract or has “A contract (which may be express, implied, oral or in writing) to personally do or perform work or services for another, provided that the other is not a customer or client of a profession or business undertaking carried on by the individual.” Section 54, NMWA 1998 Against this backdrop, the justification for having an unpaid intern is they are under no obligation to you to perform any work or service. At one end of the scale you have kids doing shadow placements, where they literally do not work, but just observe – clearly no use to a tech start up – but at the other end you have people working hard, for free, doing essential jobs which means they are completely relied upon – which is probably illegal. If you are going to give someone meaningful work to do, it makes sense that they should be given the chance to learn as much as possible – so a bit of shadowing, training and so on, not be put under pressure – in particular, they may need to be working in the evenings to make ends meet so you should not expect to take precedence over that. You can also mix it up a bit, and if there are discrete projects where they could be paid by the hour (e.g. making sales calls, data entry etc) then there is no reason not to offer that to them. If your arrangement was ever looked at by HMRC, which is responsible for enforcement of minimum wage rules, the decision would turn on the facts of the case. If you were investigated, the chances are you would be given the opportunity to compensate your workers and agree to comply with the rules going forward before any penalty is levied.
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Finally, if an intern is adding value, think about turning him or her into an employee within a reasonable timeframe.
Shares and tax This is a big topic in its own right, but basically boils down to one key point, which is: shares are a form of remuneration if they are issued to employees and tax is payable on the difference between the price paid and the market value. In this context, “employee” is anyone who works for the company AND any director, including non-executives. Taxes payable include National Insurance – and where an income tax liability is created, it is the company’s responsibility to apply PAYE, even if the actual liability is that of the employee. This liability can be avoided by implementing a Enterprise Management Incentive scheme, which, if certain criteria are met, allows employees to be given shares at a fixed price, which will be below market without an income tax liability. Typically, EMI schemes cover a pool of shares which if all issued would represent 10% of the company. With that amount on offer, most employees are not going to have more than a small fraction of 1% but you might need to offer more like 2 or 3% to an important hire. EMI schemes are structured with options, so as well as the basic grant of the option, you will need to think about the vesting schedule, or in English, how long someone needs to stick around before they can exercise the option and actually become a shareholder (max ten years). A key difference with Company Share Option Plans (a “CSOP”) is that with a CSOP, the grant and the exercise are both tax free if the option has been held for more than three years, however, CSOPs have much lower limits on the amounts of options that can be granted as well as other restrictions which make them less attractive to entrepreneurial young/high growth companies. Also, the tax man will look at the price per share, not an overall change of percentage. For example – two founders have one share each – they are 50%/50%. An investor wants 10% and will pay £100,000 for this. To achieve this, the founders issue the investor with 10 shares and issue themselves with 44 each so the share percentages are now 45%/45%/10%. A normal person would see this as each founder giving up 5% of the company. The tax man would see it that the shares are now worth £10,000 each and each founder has just taken 44, which is a taxable benefit of £440,000, on which income tax of 40% (or now 50%) is payable plus 12.5% employers NI = large number for Alasdair Darling. So unless you want to be responsible for single handedly rescuing the nation’s finances, it is important to avoid doing this! The way to avoid this is to issue the 44 shares each well ahead of the investor coming in, or to split the £1 shares into 100 penny shares, and then issue 20 penny shares to the investor. Alternatively, if the investor takes preference shares whilst the founders have ordinaries, then different valuations can be more easily justified.
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Restrictive Covenants Very briefly on restrictive covenants on your employees, if you are going to have them, they have to be reasonable – legally the test is that the restriction must be the minimum required to protect the legitimate economic interests of the Company. If a restrictive covenant is deemed unreasonable by a court, then it will viewed as a restraint of trade and will be struck out in its entirety. The judge will generally not amend the clause to make it reasonable, although the so called “blue pencil” where the clause is only marginally offensive – but more often than not in favour of the employee. 6 months is about the maximum length of time we see although 12 month clauses are regularly upheld by the courts. The trick is to ensure that the restriction is properly drafted in that it relates to (1) the actual business of the company – in other words, don’t try to prevent your ex-employee from doing things your company doesn’t do or dealing with people who your company doesn’t do business with and (2) make it specific to the employee, so again relate it to people, customers and businesses the employee has actually dealt with in the period before termination. Insurance and Health & Safety issues As an employer you are broadly responsible for the health and wellbeing of your employees during the time they are working for you. There are armies of people out there whose job it is to monitor health and safety issues in a million and one ways and it is fair to say that the bigger the company, the more time and energy is spent on managing these issues. In the context of a tech start up, there are a few particular things which you should look out for. (1) RSI and posture related problems. Give your employees proper screens and make sure their desks are set up in the right way so they don’t all get bad backs. Get those trackball mice in for your designers if they need them. It makes good sense to look after everyone. Equally, make sure all your electrical equipment is safe, including gadgets brought in by employees (2) Discrimination and harassment are huge topics, which I am not going to go into. Let me just say this: an informal atmosphere and having fun in the workplace is the essence of a start-up – just don’t let it turn into some discrimination claim when the banter gets out of hand. If you have employees, you must have insurance cover with an authorised insurer against liability for bodily injury or disease sustained by employees and arising out of and in the course of their employment in Great Britain. Certificates must be displayed where employees can see them and old certificates kept for a whopping 40 years! You should also have occupiers liability insurance in respect of your premises – so visitors and contractors are covered as well.
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