Contractors, has the umbrella company model sprung a leak?

Since the inception of the off-payroll legislation, the use of umbrella companies has dramatically increased.

Dual exposure

But two recent judgments have exposed contractor recruitment agencies who frequently used umbrella companies to the risk of mass litigation, writes Martyn Valentine, founder of The Law Place. I explore them, below exclusively for ContractorUK, but the judgments have also exposed the lie of opt-out notices for umbrella workers with potentially far-reaching consequences.

Firstly though, the legal position. While umbrellas exist in a legal vacuum as there is no singular standard for compliance, the Conduct of Employment Agencies and Employment Businesses Regulations 2003 are relevant, as they pose unforeseen risks for recruiters and end-clients who mistakenly regard the umbrella model as a panacea for the 2017 and 2021 off-payroll legislation.

The Exchequer Solutions Ltd ruling, it's worth checking

Recently, one of the two judgments I mentioned at the outset -- Exchequer Solutions Ltd v HMRC, undermined the idea of umbrella companies as genuine employers.

In Exchequer Solutions Limited, the First-Tier Tribunal held that a relationship of employment only existed during periods when umbrella workers were undertaking assignments. The FTT ruled that there was neither an obligation to provide work nor pay umbrella workers during gaps between assignments. As there was no ongoing employment contract, each assignment would be treated as a separate contract of employment, so tax relief was unavailable. This unavailability of tax relief is not the sort of truism of using an umbrella that umbrella salespeople are likely to let-on about, when pitching to unsuspecting contractors, agencies or end-clients.

Genuine employer. Or not?

If loss of expenses allowance for umbrella workers was not enough of a sting, judgments such as Mr T Sodipo v My Locum have illustrated a trend for the employment tribunal to question whether an umbrella company is a genuine employer.

Of course, every case turns on its facts. But the dicta of employment judge Jones in Sodipo is instructive:

"Although the claimant had signed documents with [the umbrella companies] IPS and Elite that referred to themselves as 'contracts of employment', it is unlikely that he was an employee of Sickly, IPS or Elite.”

And continuing, paragraph 70 of the judgment doesn’t relent: “The contracts set out terms and conditions of employment but bore little relation to what really occurred between the Claimant and these organisations. Those companies were based in Liverpool. The claimant worked at the Whittington Hospital. They did not supervise the claimant. They did not provide him with work. They did not control the claimant - even during assignments - as that was the job of whoever was in charge of the ward he was working on for the duration of the shift.”

Danger, SDC, and dead practice

Therefore, an end-client may be labouring under a dangerous misconception that umbrella companies provide insulation against tribunal claims.

Where an umbrella "employee" is subject to a right of supervision, direction or control (SDC), is required to perform the duties personally, and is paid regularly, the employment tribunal may accept jurisdiction for a claim and issue a judgment in favour of the claimant that the genuine employer is the client -- not the umbrella company.

Now to something I’m often asked, which is relevant here. Is the practice of requiring umbrella workers to opt-out of the conduct regulations dead?

My answer? Yes.

Conduct Regs Questions & Answers (cont.)

But then a follow-up can be posed. Why do recruiters require candidates to opt-out of the conduct regulations?

The answer is that the conduct regulations provide a raft of legal protection for candidates that can adversely affect the cashflow of a recruiter or/and umbrella company.

For example, regulation 6 prevents a recruiter from subjecting a candidate to detriment for working directly for a client.

Regulation 10 restricts the charges a recruiter may levy on a client for directly engaging a contractor. And regulation 12 prevents a recruiter from withholding payment to a candidate on certain grounds.

But in Lutz v Ryanair DAC the employment tribunal held that the opt-out in respect of the conduct regulations was ineffective.

The recruiter did not suggest that the claimant take independent legal advice about signing an opt-out notice, and falsely claimed that opting-out was a "no-brainer". Due in part to the inequality of bargaining powers, the opt-out notice was void.

Ineffective opt-out: the consequences

First, umbrellas can no longer rely on opt-notices to delay payment to umbrella workers.

Second (and potentially even worse for them), umbrellas and recruiters cannot likely prevent an umbrella worker from entering into a direct contract with a client, therefore, losing either party potentially valuable cash flow.

My recommendation is that recruiters who require umbrella workers to opt-out of the conduct regulations must ensure that each umbrella worker obtains independent legal advice. For example, a claimant in an employment dispute must take advice from an independent legal adviser -- as required by section 203(3)(c) of the Employment Rights Act 1996. For an opt-out notice to be effective, the same degree of rigour must equally apply. Otherwise, it's open season for umbrella workers to defy opt-out notices and work directly for clients.

Are preferred supplier lists (PSLs) unlawful?

A frequent complaint by contractors is a requirement by recruiters to use an umbrella from the PSL and to opt-out of the conduct regulations.

If there is a connection between a recruiter and an umbrella (or list of umbrellas), a breach of the conduct regulations has potentially occurred. And here ‘connection’ would mean a joint venture, such as an exclusivity arrangement between a recruiter and an umbrella.

If the opt-out notice is ineffective, the contractor may have grounds for a claim against the recruiter. Yet suppose the offer of an engagement is withdrawn on the basis of a refusal to use an umbrella company. In that case, a contractor may argue that an opt-out notice is ineffective and claim damages for the loss of earnings (subject to the duty to mitigate losses) in court. It is a matter for the court to decide liability and quantum of damages. Damages would be calculated on the basis of the daily rate (minus expenses) that the candidate would have earned if the recruiter had behaved lawfully. The contractor has a duty to mitigate loss and should not stop looking for a suitable replacement engagement.

Final thoughts

In many cases, my belief is that umbrella workers can cut the recruiter out of the supply chain and contract directly with the client.

But this area of law is quite complex and certain aspects are yet to be fully tested in court, potentially explaining why – for now at least -- umbrella workers are reluctant to 'rock the boat.' To help out in the instance that individual employees fear that their umbrella has sprung a leak, in their obligations, duties or ethics, my advisory can provide umbrella workers with free particulars of claim with a view to obtaining compensation from recruiters. To me, such a pro bono offering is necessary because, unfortunately, the recruitment industry is afflicted with false umbrella employers and insurance policies straight from the Arthur Daley playbook.

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Written by Martyn Valentine

Martyn has been advising on employment status since 2004 and founded The Law Place Limited in 2010 to provide legal advice to professional contractors, recruiters and tax advisers on IR35, off-payroll, recruitment law and related issues. The Law Place Limited is fully insured to provide legal advice on IR35. As director of The Law Place Limited, Martyn has a 100% success rate in representing clients in HM Revenue & Customs investigations.

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