Illegal Contract Does Not Create Rights

An employee who knows that his or her contract of employment is illegal may not be entitled to some employment law rights, such as the right to claim compensation for unfair or wrongful dismissal. Unorthodox arrangements that breach the law can have the same effect, even if they are made in good faith.

The Employment Appeal Tribunal (EAT) recently considered an appeal after the Exeter Employment Tribunal (ET) dismissed claims for unfair and wrongful dismissal because the contract of employment on which they were based was ‘tainted by illegality’ (Daymond v Enterprise South Devon).

Ms Daymond began working for Enterprise South Devon (ESD), a non-profit making organisation which provides business support and advice, in January 2005, as Director in Charge. Initially, it was thought that she would only be working one day a week but it soon became clear that she was needed on a full-time basis. She was given the option of either being paid via the payroll or of invoicing ESD through a company owned by her. She chose the latter method and therefore avoided paying PAYE and National Insurance Contributions (NICs). This arrangement continued until April 2005 when Ms Daymond was offered and accepted a formal contract of employment as Managing Director, after which she had income tax and NICs deducted from her salary.

In January 2006, Ms Daymond was dismissed. She brought a claim of unfair dismissal and also claimed ‘notice pay’ – i.e. damages for wrongful dismissal. ESD said that she had only been employed since April 2005 and so did not have the necessary qualifying service to bring an unfair dismissal claim. Ms Daymond argued that she had been an employee since she started working for them in January 2005.

The ET found that Ms Daymond had been employed by ESD from January 2005 but judged that she was not entitled to pursue either claim because the contract she relied on between January and April was tainted by illegality. The arrangements for payment during that period involved a breach of the parties’ obligations under the Taxes Acts. There was, however, no finding as to whether Ms Daymond deliberately sought to avoid paying tax.

Ms Daymond appealed against the decision. The EAT agreed with the ET that she was precluded from bringing a claim for unfair dismissal. She had actively chosen to participate in an arrangement which was unlawful. Whether or not she did so in good faith was not relevant. If someone chooses to use non-standard arrangements of this kind they must take the consequences of their actions.

As regards Ms Daymond’s claim for ‘notice pay’, the contract of employment under which she was working at the time of her dismissal was not tainted by illegality. The EAT therefore judged that the ET had been wrong to dismiss this claim on the basis it did and it should be remitted to the ET to be decided on its merits.