Smith v Reliance Water Controls Ltd.

Julian Smith, the appellant, worked for Reliance Water Controls Limited, the respondent, from September 1996 until he was summarily dismissed on 15 January 1999. He was a sales representative. The respondent is a wholesale supplier of plumbing and bathroom products. Until January 1998 the appellant was employed under a contract of employment. There is no dispute about this, although there appears to have been no written record.

At the end of 1997 the appellant approached Mr Hickman, the respondent’s Finance Director, with a request that he continue working for the respondent but on a self employed basis. The reason for this request was that following separation from his partner he had been assessed and then reassessed by the Child Support Agency (C.S.A) for maintenance for their children. The reassessment was under appeal because the appellant considered, as in the event was proved correct, that the reassessment was too high and in the meantime he was vulnerable to a deduction from earnings order. The appellant’s evidence was that if his request was not met there was no point in his continuing to work for the respondent and that he would have to leave.

Mr Hickman discussed the request with Mr Roche, the Managing Director, and a new agency agreement was signed. The main issue before the judge, and on this appeal, is whether the true effect of this agreement was to make the appellant self employed or whether the reality was that he continued, as before, to be an employee of the respondent. The distinction is of importance because if the appellant continued to be employed he is entitled to modest damages for wrongful dismissal whereas if he was self-employed the Commercial Agents (Council Directive) Regulations 1993 (“the Commercial Agents Regulations”) apply and his compensation is likely to be rather more substantial.

The appellant’s relationship with the respondent ended on 15 January 1999 when Mr Roche wrote to him saying: “I am obliged to terminate your services for gross misconduct and breach of contract, with immediate effect.” However, Judge Cavell found there was no ground for summary dismissal and that he was entitled to damages. The judge did, however, find that despite the written agreement purporting to change the appellant’s status to self-employed from January 1998, he had remained throughout an employee of the respondent under a contract of service.

The judge did not in his judgment spell out the terms of the new agreement, that operated from January 1998, although he plainly had the new agreement in mind. The agreement began by setting out the territory in which the appellant was to act as an agent on behalf of the respondent. Then it set out the appellant’s sales targets for the first six months of 1998 and defined the meaning of sales. There followed the obligations of the appellant. These were:

There is no doubt that the initiative for a change of status came from the appellant. The judge found that the respondent was prepared to accommodate him because he was at the time regarded as a valued employee. The company did not want to lose him. The judge, however, rejected the submission that the arrangement was mutually beneficial. This finding cannot in my view stand with the finding that the appellant was a valued employee the respondent wished to keep. Nor does the judge explain what his answer is to Mr Hickman’s memorandum to Mr Roche of 12 November 1997 in which he says the proposal has benefits to both sides and then identifies them.

The purpose of the memorandum of 12 November 1997 was to show Mr Roche that the proposal would not operate to the financial disadvantage of the respondent. Mr Hickman spelt out the cost of employing the appellant under the then current arrangement and it amounted to £30,722. This figure was arrived at by adding together the constituent elements of salary, commission, pension contribution, employer’s national insurance contribution, expenses, the cost of his car and its fuel. This equalled 4.41% on an annual budget of £696,538 which Mr Hickman rounded up to 4.5%. He said:

The judge recognised that a number of consequences followed from the agreement.

The respondent no longer accounted for the appellant’s PAYE and National Insurance.

The appellant was no longer eligible for the company pension scheme.

The appellant lost his entitlement to death in service benefit.

The critical findings of the judge appear at paragraphs 10 – 13 of his judgment. The only reason for changing to agency status was to accommodate the appellant because he was a valued employee. Accordingly, the respondent wished to keep each side’s obligations as close as possible to those that had existed before the change. The sales targets remained essentially unchanged and were calculated in the same manner as for other sales representatives. He was treated in the same manner as other representatives performing the same job. They all had to submit weekly call plans and provide monthly reports and report to sales managers.

There is, it seems to me, no half way house between concluding on one hand that the agreement was a sham and that both parties intended to treat what they knew full well was a contract of employment as one where the appellant was self employed, and on the other looking objectively at what had in fact been agreed between the parties to see on which side of the line it fell in the light of the authorities. It has not been suggested this agreement was a sham. It would of course be wholly improper to pretend the appellant was self-employed, knowing full well that he was in reality employed, with all the consequences for the C.S.A, PAYE and National Insurance. On the other hand there can be no objection to the appellant and the respondent genuinely so arranging his status that he was not vulnerable to a deduction from earnings order. One might add not least when, as subsequent events have shown, it would have been for the wrong amount. It should be borne in mind that there were disadvantages as well as advantages to the appellant in becoming self-employed. For one thing, the risks to him were greater.

Given that the arrangement between the parties was not a sham, the agreement itself becomes the best material from which to gather the true relationship between them: See Lord Denning M.R. in Massey v Crown Life Insurance [1978] 2All ER 576,580B citing Inland Revenue Comrs v Duke of Westminster[1936] A.C.1.

In my judgment the judge misled himself by paying too much attention to the motive for the new arrangement and too little to what the details of it actually were.

The distinction between a contract of service and a contract for services is one that has troubled the courts in different contexts on many occasions. In Ready Mixed Concrete (South East) Limited v Minister of Pensions and National Insurance[1968] 2QB 497, 515C MacKenna J said this:

As Lord Denning M. R. said in Massey v Crown Life at 580F the way in which the parties draw up their agreement and express it may be a very important factor in defining what the relationship was between them. If they declare that he is self-employed that may be decisive. The hurdle in the path of the respondent is the third of Mackenna J’s three conditions. This contract contained a number of provisions that were inconsistent with it being a contract of service.

The fundamental submission of Mr Patchett-Joyce, for the respondent, is that the change to the contractual arrangement between the appellant and respondent was one of form rather than substance. He submits that in effect nothing changed. Both before and after the new arrangement the appellant called on existing customers, followed up sales leads, responded to inquiries, called on potential new customers, sought out new contacts, followed up leads and generally negotiated and secured sales. This submission overlooks the various contractual terms that were only consistent with self-employment. It is not suggested that the various provisions to which I have referred in paragraph 8 were not in fact operated as the agreement provided.

In the court below Harvey on Industrial Relations and Employment Law was cited to the judge and in particular the passages setting out the various tests for determining whether a worker was employed or self employed. As Harvey rightly points out, no single test or feature of the arrangement is conclusive. All the so-called tests should be regarded as useful general approaches, but in every case it is necessary to weigh all the factors in the particular case and ask whether it is appropriate to call the worker a servant (see A7 para 47). In my judgment that is what the judge should have done but failed to do in the present case.

The judge appeared to rely on the so called economic reality test whereby if the worker can be shown not to be an independent contractor, then by elimination he must be employed under a contract of service. The judge cited a passage from Harvey (A6 para 44) stating that the particular advantage of the economic reality test is that it enables the court to see through the disguise with which the parties sometimes clothe their relationship. The problem with this is that the agreement was not a sham. The advantage for the respondent of entering the agreement was that this was the one way the company could keep the appellant whom they regarded as a valued employee. The question is whether, by the agreement, he was indeed hired as an independent contractor. The judge did not apply the test posed by Cooke J in Market Investigations Ltd v Minister of Social Security[1969] 2QB 173,184:

The appellant was personally responsible for expenses incurred in promoting the respondent’s products unless he first obtained the respondent’s written agreement.

He was not committed to spend any particular proportion of his time promoting the respondent’s sales. His obligation was to meet 80% of the sales targets.

He was permitted to represent manufacturers whose products did not compete directly with the respondent’s products.

The respondent paid the appellant a commission, not a wage.

Sickness and holidays would come out of the appellant’s time i.e he would not be paid when ill or on holiday.

The appellant was no longer provided by the respondent with a car, a mobile phone or a pension. All these were the appellant’s own responsibility. Nor was there any death in service benefit which was available to employees.

The agreement was terminable summarily by the respondent for conduct on the part of the appellant that, had he been an employee, would have amounted to gross misconduct.

The judge found that Mr Roche wanted control over his salesmen and there is no doubt that the respondent did exercise a considerable measure of control over the appellant. Control is certainly a factor that militates in favour of a contract of service rather than a contract for services. The measure of control that was in fact exercised over the appellant is not, however, apparent from the written terms of agreement. It may be that the appellant acceded to the degree of supervision that in the event prevailed, but in my view he was not obliged to do so by the agreed terms.

The appellant’s first ground of appeal is that the judge failed to identify the true terms of his appointment. In paragraph 4 of his judgment the judge referred to the written agreement by mentioning its location in the bundle of documents but he did not identify each of its terms, preferring to conclude that the appellant was being treated no differently after 1 January 1998 from before. The judge also appeared to accept (para 28) that such changes as there were, were equally consistent with an intention to create the appearance of self-employment as they were with self-employment itself. He rejected the appellant’s arguments (see para 33) that there were express terms of the agreement pointing to self-employment as “in reality, the label”.

In my judgment the error in the judge’s approach was to reject the written agreement as a sham or front for covering a true arrangement to continue as before. It simply was not open to him to find that “neither party intended a real change of status” and that the respondent was “putting a label on the relationship which essentially remained the same as before.”

The judge, having found that the decision was made to enter the agreement because the respondent thought sufficiently of the appellant not to lose him, it was plain that there were benefits in it for both sides. The documents, and in particular Mr Hickman’s memorandum to Mr Roche of 12 November 1997, simply do not support the conclusion that the arrangement was a mere sham and indeed Mr Patchett-Joyce disavows such a submission.

It was therefore incumbent upon the judge to look carefully at the terms that had actually been agreed between the parties to see how they planned to operate from 1 January 1998. It is not suggested, for example, that the appellant was to be paid a salary rather than a commission, that he was to continue to use the respondent’s vehicles and mobile phone or that holidays and sickness would continue to be paid by the respondent.

It is also of note that during the course of 1998 the appellant’s commission was increased from 4½% to 5%. The appellant, in writing on 5 June 1998 to request increased commission, referred to his debt to the respondent for the opportunity to carry on working on a non-employed basis. This hardly seems consistent with the judge’s finding that the appellant himself did not intend a real change of status. The same can be said of a letter written by Mr Roche to a customer after the appellant had been dismissed in which he said that the appellant was an agent paid on a commission basis and the company believed its customers would be better served in future by an employee who was a full time sales professional.

It is also to be noted that the respondent certified to the revenue in the appellant’s P45 that he had left the respondent’s employment on 31 December 1997. Further evidence of the respondent’s belief as to the status of the agreement is to be found in the original defence filed in these proceedings. The respondent admitted paragraphs 1 to 3 of the particulars of claim and that the Commercial Agents Regulations were applicable. Paragraph 1 of the particulars of claim contained an express averment that the appellant was a self-employed commercial agent under the agreement. Mr Roche signed a warranty of his belief that the facts stated in the defence were true. Permission was later given to amend the defence on terms and whilst it is true that a party’s belief of the effect of an agreement does not determine its meaning, in this case there is not only the respondent’s stated belief but also the clear terms of the agreement itself.

The second ground of appeal is that the judge erred in drawing the inference that neither party intended to effect any change in the appellant’s status from an employee to an agent. I have already covered the substance of this ground which, in my judgment is made out. The agreement was not a sham and had the judge examined carefully all the constituent elements of the agreement he would have been driven to the conclusion that both parties intended a change of status.

The third ground is that the judge failed to apply the correct test for determining a person’s status as an employee or agent. The judge referred to the five tests set out in Harvey and said that he was satisfied the tests of personal service and control were satisfied (para 34). These tests equate to the first two of the three conditions spelt out in Mackenna J in Ready Mixed Concrete. The complaint of Mr Michael Taylor, who has appeared before us for the appellant, is that the judge considered the control test in the light of the control that the respondent in fact exercised over the appellant rather than that which it was contractually entitled to exercise. In my view there is force in this complaint. His next complaint is that the judge was wrong to find that the appellant satisfied the economic reality test and that he was employed as part of the respondent’s business or organisation. He said that the appellant could be a servant and he was satisfied there was no good reason for holding he was not (para 38). In my judgment such a conclusion was not open to the judge in the light of the following provisions of the agreement:

Payment on a commissions basis.

Entitlement to take up non-competing agencies.

His liability for promotional expenses that were not agreed in writing before they were incurred.

His responsibility for the main tools of doing the job namely a car and mobile phone.

As Harvey points out at A[47] the modern approach to the issue with which this case is concerned is that no one test or feature is conclusive. All the so- called tests are useful general approaches, but in every case it is necessary to weigh all the factors in the particular case. Had the judge done that in the present case he would have concluded that there were numerous factors inconsistent with the existence of a contract of service (the third condition posed by MacKenna J in Ready Mixed Concrete).

In my judgment therefore the judge was in error in concluding that after 1 January 1998 the appellant remained an employee under a contract of employment. He should have held that the appellant became self-employed under the new agreement and that the Commercial Agents Regulations applied.

There was no challenge by the respondent to the judge’s finding that the criticisms of the appellant fell far short of constituting grounds for summary dismissal.

There is, however, one further issue with which it is necessary to deal. Mr Patchett-Joyce submits that if the appellant, as in my view he did, became a commercial agent, he acted in breach of his duties to act dutifully and in good faith and that such failure disentitles him to compensation under the Commercial Agents Regulations. The respondent relies on paragraphs 3(1) and 5(1) of the regulations. Paragraph 3(1) provides:

Paragraph 5(1) provides that the parties may not derogate from, inter alia, regulation 3.

Mr Patchett-Joyce addressed us on the width of the duty of good faith. It is however, unnecessary to deal with his arguments in respect of this because, even accepting his submission in full and taking the duty at its widest, the facts of this case do not in my judgment come anywhere near falling within it. The appellant’s alleged failures that are said to amount to a breach of duty are (1) failing to disclose the fact that the original CSA maintenance assessment was under appeal and (2) failing to inform the respondent of the progress and success of that appeal. As to the former, the unchallenged evidence was that the appellant told his immediate manager. As to the latter, what happened on 1 January 1998 was a change on a once and for all basis. There was no reason for the appellant to believe it was of any interest to the respondent whether he won the appeal or not. There was no evidence that the changed arrangements were in any way dependant on the result of the appeal. In my judgment the respondent’s contention of lack of good faith does not reach first base. Accordingly, I would allow the appeal.

What remains in this litigation is the assessment of damages. I consider that this will best be achieved in the Birmingham Mercantile Court where Judge Alton has considerable experience of the type of issues that are likely to be raised. If the parties are able to resolve the question of damages by Alternative Dispute Resolution so much the better. The costs already incurred in this litigation appear disproportionate to what is at stake and it is to be hoped that the remaining issues can be resolved without further heavy expenditure. The sooner the litigation can be concluded the better.

Lady Justice Arden: I agree.

Lord Justice Schiemann: I also agree.

Appellant’s appeal allowed

Respondent’s cross-appeal dismissed

Matter be transferred to Judge Alton’s list in the Birmingham Mercantile Court for assessment of damages

Respondent shall pay Appellant’s costs of the appeal and cross-appeal, such costs to be assessed on a standard basis if not agreed

Respondent shall pay appellant’s costs of the trail in Worcester County Court, such costs to be assessed on a standard basis if not agreed

Respondent shall pay appellants £5000 by 4:00pm on 13/08/03 on account of the costs awarded at paragraph 4

Costs of the trial at Worcester County Court to be reserved to the trial judge

Application for permission to appeal to the House of lords refused.