Back to the future? Do the new unfair dismissal rules mean it is time to revisit employee shareholder status?

Employee shareholder status, the brainchild of George Osborne when he was Chancellor of the Exchequer, was introduced in 2013. Employee shareholders subscribed for free shares from their employer with a minimum value of £2,000.  They could do so on a tax-favoured basis. There was no tax on award of the shares and (potentially very) favourable capital gains tax treatment on disposal. In return, the employee shareholder was required to agree to give up certain employment rights, principally the right to bring an unfair dismissal claim and the right to a statutory redundancy payment. 

The aim was to create a new class of employee with a stake in the company but without the same employment rights as normal employees. The accompanying tax benefits were intended as a means to incentivise shareholding and encourage entrepreneurialism.

These arrangements were largely unsuccessful.  Take-up was limited and the tax benefits available were withdrawn for employee shareholder agreements entered into on or after 1 December 2016.  As a result, employee shareholder arrangements largely fell away. 

Importantly, however, even though the tax breaks have been withdrawn, employee shareholder status remains on the statute book. Notwithstanding its chequered history, the impending removal of the current cap on compensation for unfair dismissal introduced by the Employment Rights Act 2025 and scheduled to come into force on 1 January 2027 may be an ideal opportunity to give these arrangements a new lease of life.         

How does employee shareholder status work?

An individual has employee shareholder status only if the following conditions (set out in section 205A Employment Rights Act 1996) are satisfied:

• the employer and the individual must agree that the individual is to be an employee shareholder;
• in consideration of that agreement, the company must issue or allot to the individual fully paid-up shares in the company, or procure the issue or allotment of fully paid-up shares in its parent undertaking, which have a value, on the day of issue or allotment, of no less than £2,000;
• the company must give the individual a written statement of the particulars of the status of employee shareholder and of the rights which attach to the shares in question (the content requirements for the written statement are set out in the legislation); and
• the individual must give no consideration other than by entering into the agreement.     

The agreement is only effective if, before the agreement is made:

• the individual receives legal advice as to the terms and effect of the proposed agreement; and
• at least seven calendar days pass after the giving of that advice before the agreement is entered into.

The employer must also bear the reasonable costs incurred by the individual in obtaining the legal advice (although this is not a condition for the employee shareholder agreement to be effective).

What are the consequences of the application of employee shareholder status?

Individuals who agree to become employee shareholders forfeit certain, but not all, employment rights. In particular, an employee shareholder may not claim unfair dismissal (although automatically unfair dismissal protection (e.g. against dismissal for asserting a statutory right) is preserved, as are rights in relation to whistleblowing and discrimination). There is also no right to a statutory redundancy payment and an employee shareholder does not have the right to request flexible working.   

Why might employee shareholder status be worth re-considering?

The impending removal of the cap on compensation for unfair dismissal means that employee shareholder status may become an attractive option for employers operating in business sectors where employees typically acquire share interests as part of their overall remuneration package.  The most obvious example of this is the private equity industry.    

It is standard for senior employees (commonly referred to as ‘managers’) working for private equity portfolio companies to be expected to participate alongside the private equity funds by acquiring ordinary shares in the corporate entity in which the private equity funds invest (the managers’ interests are frequently described as ‘strip’ and sweet’ equity).  Assuming the investment is successful, the managers will then be able to sell their equity interests at the same time as the PE investor and benefit from any gain in value. 

However, managers can normally be required to sell their equity interests earlier if dismissed before the PE investor ‘exits’ the investment.  Depending on the reason for departure, the amount payable on sale may be less than the full market-value for the shares at the date of termination. In addition, outgoing managers will also lose the opportunity to participate in (potentially significant) future gains in value during the period post-termination.  Currently, the cap on compensation for unfair dismissal means that there is limited recourse for those managers unless they can link their treatment to discrimination or whistleblowing. With the cap removed, employees will have a much more straightforward legal route to recover substantial compensation for their losses.    

In principle, it ought to be possible to address this by making the award of equity to management conditional upon their agreement to become employee shareholders.  By agreeing to this, managers would lose the right to bring an unfair dismissal claim if they are subsequently dismissed.  The rationale for asking managers to agree to become employee shareholders is that the equity arrangements carry very significant upside for them, and that it is reasonable for the employer to protect itself so that its liability on termination of employment is limited to the negotiated contractual terms. 

Each of the conditions applicable to employee shareholder status described above ought to be capable of being satisfied in relation to a private equity investment.  The trickiest condition is the requirement that the individual must provide no consideration other than the written employee shareholder agreement itself.  Typically, managers will be required to pay for the shares they acquire.  This is both because the PE owner is normally keen to ensure that management have ‘skin in the game’ – that is, a stake in the success of the investment - and also to avoid an income tax charge arising on subscription of the shares by reference to the difference between the market value of the shares and the amount paid.  

However, it ought to be possible to structure the equity arrangements so that the statutory conditions for employee shareholder status are met, while at the same time requiring the relevant manager to make a real investment in the business and minimising adverse income tax consequences. 

It remains possible, of course, that the Government might decide to close off this opportunity for businesses to protect themselves against unpredictable unfair dismissal claims by repealing employee shareholder status.  However, it is unlikely that legislators had highly paid executives in mind when they decided to remove the cap on compensation for unfair dismissal.  And any repeal ought not to apply retrospectively to an individual who has already become an employee shareholder.     

Is this only limited to private equity investments?

In principle, no. Any company that makes equity available to its senior employees could try to structure their arrangements in a way that complies with the employee shareholder status regime and thus have employees waive their unfair dismissal rights. 

This would be more complicated for listed companies because of the various legal and governance overlays that apply – for example, the remuneration policy regime and the fact that most listed companies do not award up front equity but rather options or conditional awards over shares (the grant of which is not sufficient for employee shareholder status purposes). However, there are structures that could be explored. 

Does this work only for employees at the point they are being hired?

Not necessarily. In principle, even existing employees can enter into an employee shareholder status agreement. It is however less obvious that companies will want to ask their current employees to give up unfair dismissal rights. 

We would be very happy to explore with you in more detail how employee shareholder status could work for you.  We would also be happy to share our thoughts on other arrangements to mitigate the effect of the removal of the cap on unfair dismissal compensation.

If you would like to discuss this further, please contact the authors of this blog or your usual Freshfields contact.