Buyers and incoming service providers beware! Share scheme rights arising outside of the employment contract may transfer under TUPE

The Inner House of the Court of Session in Scotland (“IHCS”) has ruled that an employee’s right to participate in a share incentive plan (SIP) which arose outside of his employment contract transferred under TUPE. The transferee employer was therefore obliged to allow him to participate in a substantially equivalent scheme after the transfer.

This case has significant implications for companies drafting their equity based arrangements and who might have an eye on selling assets or outsourcing services in future, and businesses already involved in a sale and purchase of assets or the outsourcing of services.

Background: TUPE and share schemes

Under Regulation 4(2)(a) of TUPE, on a TUPE transfer, all of the transferor employer’s right, powers, duties and liabilities “under or in connection with” a transferring employee’s employment contract transfer to the transferee employer. Therefore, an employee whose employment transfers to a new employer under TUPE is entitled to the same terms and conditions after the transfer. Previous case law (Mitie Managed Services Ltd v French) indicates that where an employee’s employment contract entitles them to participate in a share scheme, the transferee must allow them to participate in a substantially equivalent scheme. This recognises the fact that an employee cannot remain in the transferor’s scheme after the transfer, as the transferee has no control over it.

Ponticelli UK Ltd v Gallagher

In Ponticelli UK Ltd v Gallagher, the IHCS considered whether an employee’s right to participate in a SIP, which arose under a share partnership agreement rather than the employment contract, arose “under” or “in connection with” the employment contract so as to transfer under TUPE.

Mr Gallagher participated in a SIP operated by Total Exploration and Production UK Ltd (“Total Exploration”). This was not mentioned in his employment contract and instead he joined the SIP by entering into a partnership share agreement. When his employment transferred to Ponticelli under TUPE, he argued that he was entitled to participate in a substantially equivalent scheme. The employment tribunal agreed with him, finding that his right to participate in the SIP was part of his overall financial "package" which transferred under TUPE.

Ponticelli appealed unsuccessfully to the Employment Appeal Tribunal and then appealed to the IHCS (which is the equivalent of the Court of Appeal in England). It argued that Regulation 4(2)(a)TUPE did not apply; the fact that Mr Gallagher’s entitlement to participate in the SIP arose from a contract quite separate to the employment contract meant the rights and obligation did not arise “under” or “in connection with” the employment contract and so did not transfer under TUPE. The IHCS disagreed, noting that the wording of Regulation 4 (2)(a) is very wide. It ruled that the employment tribunal had been correct to find that the SIP formed an integral part of Mr Gallagher's financial package with Total Exploration as:

• Contributions to the SIP were made through salary deductions
• For each share purchased by salary deduction, Total Exploration contributed two further “matching shares”
• Other optional benefits included the opportunity to participate in the “free shares” part of the plan which linked the award of further shares to Total Exploration’s bonus scheme, and
• Mr Gallagher would be financially disadvantaged if he were unable to participate in an equivalent scheme with Ponticelli.

Total Exploration’s obligations under the partnership share agreement therefore fell within the scope of Regulation 4(2)(a) of TUPE as his entitlement to participate in the SIP arose in connection with the employment contract. It also ruled that the employment tribunal had been correct to apply the decision in Mitie and rule that Mr Gallagher was entitled to participate in a substantially equivalent scheme.

The Court noted that the restrictive interpretation of Reg 4(2)(a) which the transferee contended for would enable employers to subvert the important protections afforded by TUPE, simply by creating separate contracts to confer various benefits.

What does this mean for your business?

Even where (as is usually the case) rights to participate in a share scheme are dealt with outside the employment contract, they may well be regarded as arising “in connection with the employment contract” resulting in the transferee employer having to provide a substantially equivalent scheme. Although the decision in this case was reached by the IHCS in Scotland, it will be binding on employment tribunals in England and Wales and the Employment Appeal Tribunal in England will almost certainly follow it.

The requirement for the transferee to provide a substantially equivalent scheme is likely to prove costly and could cause considerable practical difficulties, particularly if it does not already operate a similar scheme for its existing employees or cannot offer shares, for example because it is not a company. How you measure equivalence is also unclear and disputes and litigation over whether this has been achieved seem likely.

Our Corporate and Employment Teams can work together to help you review your current equity arrangements to check if they might cause issues for sales of your business and/or your assets or if you wish to outsource services. They can also help buyers and incoming service providers with their due diligence on any relevant employee equity schemes which need to be factored into their business decisions.

For further information on how we can support you with TUPE and share schemes issues, visit our TUPE and share schemes pages or contact your usual Doyle Clayton adviser or Thomas Clark (Corporate Partner) or Declan Bradley (Employment Partner) below.