Contract lawyer (UK) Roger Sinclair Egos Ltd – IR35

Mutuality of obligation, in relation to a contract of service, is generally taken to mean an obligation on the employer's part to provide work and an obligation on the employee's part to perform it. Its existence can clearly be seen in any long-term contract of employment and it normally causes no problems. Its presence in a long term contract is a pointer to a contract of service. The absence of this degree of mutuality of obligation does not however mean that a contract will be a contract for services.

Problems can arise with individuals who enter into occasional short-term engagements where there is no obligation to provide, and perform, work, or who work regularly for someone whilst maintaining there is no continuing obligation to provide or accept work.

The important point is that it does not matter for NICs / tax purposes whether there is a series of short-term contracts of employment or one umbrella contract of employment. Even where a contract is short-term, once there has been an agreement between the parties to offer and undertake work there will be 'mutuality of obligation' for the period regardless of how short that period is. After all, a worker is most unlikely to carry out any work unless there is a contract (written, oral or implied) under which he or she can expect to receive payment.

The concept is rather more relevant in Employment Protection Law situations where many benefits and rights only accrue after a specific period of continuous employment. There it will often be very relevant whether work is carried out under a separate series of contracts (where no benefits may accrue) or under a single 'umbrella' contract which amounts to a continuing contract of employment (where benefits and rights may well exist). This is the reason for the case law on the subject.

An individual short-term engagement can be either a contract of service or a contract for services (or some other contract) but the fact that there is no obligation on the engager's part to provide work is neither here nor there.

The statement in ESM1071 is, at best, misleading. It must be naïve to suggest that the bare minimum of obligation required for the formation of a contract is sufficient to overcome the hurdle of mutuality of obligation. It is clear that an obligation to perform a particular and specified service, in return for an agreed payment, may not of itself necessarily create sufficient mutuality of obligation to underlie a contract of service.

Expressed another way, if one accepts the principle that a contract for services (1) can exist, but (2) can be prevented from being a contract of service by reason of lack of mutuality of obligation, then it logically follows that the minimum degree of obligation required for a simple contract to exist is not necessarily sufficient to amount to the degree of mutuality of obligation required for the contract to be employment. Thus the degree of mutuality of obligation required in a contract of employment must be something more than that, more than the obligation in a simple contract for services.

The question then is, how much more?

It may be that where a confidentiality agreement or some other document is signed by the individual personally with the Client, this may contribute towards at least the individual's share of the mutuality of obligation – although O’Murphy v Hewlett Packard[2] suggests that such an agreement may not be sufficient, and that what is required is the mutuality of the employer accepting an obligation to provide work, and to pay for it; and of the employee accepting an obligation to do it.

It may also be that the question of whether the contractual arrangements require the individual to carry out the work personally, this may also so contribute - note that this is more restrictive that the test for IR35 itself, which requires either (a) that the individual be required to carry out the work personally, or (b) that the individual in fact carries out the work personally.

For so long as a contract of employment subsists, there are

· ongoing obligations on the part of the employer to provide suitable work, or pay a retainer if work is not available; and

· ongoing obligations on the part of the employee, to do the work; and

· ongoing mutual obligations of ‘trust and confidence’ – on the part of the employee, to serve the employer in good faith (ie not to act against the interests of the employer’s business); and on the part of the employee, not to destroy the relationship of trust and confidence between the parties (ie not to act so as to destroy or seriously damage the relationship without reasonable and proper cause).

These obligations

· will be implied from the fact of the employment relationship, if that relationship is in fact established;

· (if they can all be shown to exist) may suggest that the relationship is in fact of employment, in the absence of other inconsistent terms; and

· (if any of them can be shown NOT to exist) may suggest that the relationship cannot in fact be employment.

The fact that mutuality of obligation is an essential element in an employment relationship was affirmed by the EAT in Stuncroft v Havelock (4^th February 2002). In that case, Havelock claimed a redundancy payment, and for 7 years had accepted assignments at short notice as a driver. Both he and the engager had treated the relationship as self-employed for tax purposes. Havelock’s admission that he was not obliged to accept work from Stuncroft (usually offered at short notice) was fatal to his claim that there was an (underlying) employment contract, and therefore he was not entitled to a redundancy payment. What is interesting is (1) the ongoing widespread misunderstandings as to the essential nature of MOO, illustrated by the fact that the Employment Tribunal chairman (legally qualified) had himself only regarded MOO (or its lack) as a persuasive factor – a point on which the EAT set him straight – and (2) the (by implication) reinforcement of the principle that this issue is all about obligations, and it is therefore the underlying nature of the obligations that is important, not what actually happens in practice (Havelock had not in fact declined a task offered in 7 years). However it should be emphasized that this is another case considering the ongoing relationship, and tells us nothing about the question of whether the tasks themselves were short term employments or contracts for service – although I note that both parties had accounted for tax on the basis that Havelock was self-employed.

In the case of Clark v Oxfordshire Health Authority [3] it was said:

'an obligation on one party to accept and do work if offered, and an obligation on the other party to pay a retainer during such periods as work was not offered, would…be likely to suffice.'

It may well also be that an obligation on one party to accept and do work if offered, and on the other to offer a reasonable share of work where available (but not necessarily extending so far as the payment of a retainer) would also be sufficient.

The statement in Clark may not be a complete statement of the law in this respect, in that it disregards the issue of mutual trust and confidence.

In Synaptek, the following was said:

21. The main point on which Mr McDonnell relied as showing that the Commissioners had misdirected themselves as a matter of law was their treatment of the question whether there was sufficient mutuality of obligation in the notional contract for it to be recognisable as a contract of service. In paragraph 6.7 of the stated case the Commissioners had recorded Synaptek's contention on this point in the following terms:

"6.7. EDS were not obliged to provide work for Synaptek and Synaptek were not obliged to work EDS. A mutuality of obligation, normally essential to a contract of service, was according absent."

22. This passage appears to have been a reflection of written submissions made by Mr Stutchbury where similar words occur in the content of the comment that "At the end of this contract I will leave for another company, as I came to EDS from another company. When the job is complete I will move on as I have done for the past 10 years for something more interesting and/or with more money" and, following a reference to O'Kelly v Trust House Forte, that "EDS will dispose of Synaptek's services once the contract with BA [Benefits Agency] expires. There is no obligation for Synaptek to continue working for EDS and EDS are not obliged to provide work. There is also a 4 week termination clause so EDS can terminate the contract early".

23. These passages suggest that the argument being advanced before the Commissioners related to the existence of any obligation on EDS to enter into the contract in the first place rather than to the question whether there was any obligation on EDS to provide work during the currency of the contract. The only way in which the Commissioners dealt with the argument was in the first sentence of paragraph 5.5 (iv) of the stated case, implicitly rejecting the submission.

24. Before me Mc McDonnell directed his fire at the question of EDS' obligations to provide work during the currency of the contract. He submitted that, on the true construction of the NESCO agreement (assuming equivalent provisions to be found in the notional contract between EDS and Mr Stutchbury) there was no such obligation on EDS. He submitted that the effect of the contractual provisions, properly construed, was that EDS was perfectly free during the currency of the contract not to provide Mr Stutchbury with any work.

25. There is now a considerably body of authority on the question whether an obligation on the employer to provide work is necessarily and in all cases an indispensable attribute of a contract of employment, see Nethermere (St. Neots) Ltd v Gardiner [1984] 1RLR 240, McLeod v Hellyer Brothers Ltd [1987] 1RLR 232, Clark v Oxfordshire Health Authority[1998] 1RLR 125 and Montgomery v Johnson Underwood Ltd [2001] 1RLR 269. It is unnecessary in the present case to examine these since Mr Sheldon on behalf of the Inspector accepted that if, taking the period of the notional contract as a whole, EDS was under no obligation to provide work, the necessary element of mutuality was indeed lacking for that period.

26. The argument that EDS was under no such obligation was founded entirely on the provision in Clause 6.4 of the NESCO contract that:

"In any event no payment will be made by NESCO to the Company in respect of any contractual period not actually worked including notice periods"

Mr McDonnell submitted that this provision had effect irrespective of the reasons why any contractual period had not worked: it might be simply because EDS had been unable or unwilling to provide work.

27. In my judgement that is not the correct way to read this provision. Its purpose is to emphasize that payment is dependent not only on the completion of proper timesheets and invoices, but also on actual work having been done. It does not, in my judgement, detract from the obligation on the client reflected in Clause 4.3 to "allocate work to the Company". Moreover, if the contract is read as containing on obligation on the client to provide work, it is quite impossible to see what purposes is served by the termination provisions in Clause 8.

In Propertycare v Gower (EAT 2003), Judge Peter Clark said:

Thus in order to avoid the implication that there is an opportunity to provide work, one may need to be clearer than simply saying that payment will only be made for work that is in fact done; and termination provisions may need to be carefully worded so as to avoid the implication that there is in fact an obligation to provide work.

Where such obligations exist, then an employment-type relationship may be suggested - or at the least, the irreducible minimum is overcome, at least in that respect.

Where such obligations do not exist, case law suggests that the relationship cannot be employment, since mutuality of obligation is fundamental to the employment relationship.

In the PCG Judicial Review case, it was said::

'Further it cannot be right for the Revenue simply to conclude, as it does in another such guidance document, ESM 0514, that "mutuality of obligation" is not a relevant issue:

"Do not consider this factor when reviewing a work status, unless the engager or worker raises if'.

It has now recently been emphasised, by the House of Lords, in Carmichael v National Power j2l [1999] 1 WLR 2042, that the test adopted in Nethermere (St Neots) Ltd v Gardner [1984] ICR 612 CA by Stephenson LJ, of an "irreducible minimum of mutual obligation" is another central piece of guidance in the analysis of whether there is employment or self-employment.

Of course there is in fact no contract between the client and the service contractor, and thus no obligation on either party owed to each other, but it must be significant, when applying the common law test, to consider whether, looking at the actual relationship, and a notional contract, between the client and the service contractor, any obligation would be owed by the client..

Attention was drawn by Mr Barling QC to the recent Court of Appeal decision in Montgomery v Johnson Underwood Ltd (9 March 2001 unreported), in which Buckley J, giving the leading judgment, indicated that it is

"inevitable that different tribunals will from time to time, reach different conclusions on very similar facts. But, unless the objectives of clarity and predictability in law are to be abandoned altogether, the principles upon which they base their decisions should be as clear as possible and adhered to.'

For my part I regard the quoted passage from Ready Mixed Concrete [[1968] 2 QB 497] as still the best guide, and as containing the irreducible minimum by way of 'legal requirement for a contract of employment' to exist. It permits tribunals appropriate latitude in considering the nature and extent of' 'mutual obligations' in respect of the work in question and the 'control' an employer has over the individual. It does not permit those concepts to be dispensed with altogether. As several recent cases have illustrated, it directs tribunals to consider the whole picture to see whether a contract of employment emerges". [4]

Mutuality has two aspects, and may be considered (1) as helping to establish whether or not there is an overall relationship of the employment type, which extends beyond the engagement in question; and (2) as helping to establish whether of not the engagement in question is itself of the employment type.

As to the overall relationship:

· Mutuality of obligation is often of more relevance in the employment law arena, where it can be a helpful factor when considering whether numerous very short term engagements (eg 1 day each) are capable of causing an overall relationship of the employment type, embracing those short term assignments to arise.

· Where this form of mutuality of obligation is present, it may allow for the possibility that there is a more general and overall contract of employment; the door is then opened to consideration of the other factors.

· Where this form of mutuality of obligation is not present, case law suggests that there cannot be a more general and overall contract of employment, since this form of mutuality of obligations is an essential element in the employment relationship.

· The Revenue seek to suggest that even if there is no overall contract of employment, the individual short-term contracts may themselves amount to contracts of service. They may, or may not, be right in this, If they are right, then whether such short term contracts do in fact amount to contracts of service, or for services, is another question, and to be decided on its own merits.

· Whilst the presence of mutual obligations extending beyond the present contract may be an indication of an ongoing employment-type relationship, the absence of such obligations - or the express disclaimer of them - tells us nothing about the nature of that relationship itself. It may be that, whatever the ongoing relationship (or lack of it) may be, a short term engagement may be either a contract of service, or for services (or of course some other form of contract), and the absence of ongoing mutuality does not help us to decide that issue - which is what we really want to know.

As to the individual engagement itself:

· it may be helpful to consider what the position would be if on a particular day, work were to 'run out'; would the engager be required either to offer alternative work within the individual's abilities, or to pay for the remainder of the day, or not? And (given the 'mutuality'), would the individual be obliged to accept alternative work, within his abilities, if offered?

· If yes (ie engager required to offer or pay, AND individual required to accept), then there may be sufficient mutuality of obligation to allow for the possibility of the engagement itself being of the employment type - and thus to open the door to consideration of the other factors.

· If no (ie engager required neither to offer nor pay, OR individual not required to accept), then case law would seem to suggest that the engagement cannot be of the employment type, since mutuality of obligations is an essential element in the employment relationship.

· Note the question is if the engager would be required to offer work or to pay; in this context, since we are considering the hypothetical relationship between Client and Individual, the Client would appear to be the engager. In a situation where (1) the Agent is required to pay the Company a retainer, but (2) the Client is not required to pay the Agency a retainer, this would seem to suggest that there is no mutuality as between Client and Individual - and thus again the engagement cannot be of the employment type, since mutuality of obligations is an essential element in the employment relationship. This point should however be regarded as uncertain.

· Consider also whether on any given day the Individual is obliged to work - or whether (s)he is free to decide whether or not to do so. Or would be in breach of any implied obligations if (s)he were to decline to do so. If not, then this (apart from being relevant to the Control - When factor) may also suggest a sufficient lack of mutuality of obligation to show that, whatever the relationship between engager and individual may be, it cannot be of the employment type.

· A notice period may suggest there is mutuality of obligation - on the other hand an engagement which terminates automatically when the project is finished, or (more so) if the client unilaterally cans the project, or which can be terminated by the client without notice, may well have insufficient mutuality of obligation.

Comment

What would the position be likely to be in relation to this factor for a hypothetical employee? Mutuality is of the essence of a contract of employment. However, if the engagement is for a short term, the mutuality would not generally extend beyond the end of that term (although it would be present during that short term) - unless, possibly, there were frequent such short terms, and mutual obligations arose to offer and accept work.

What would the position be likely to be in relation to this factor for a hypothetical obviously self-employed person or consultancy (eg Andersens, or by PWC, or EDI?). Logic and experience suggests

· (ongoing mutuality) that a hypothetical obviously self-employed person or consultancy would probably not expect - or be entitled to expect - that on one contracted task finishing, the engager would be under any obligation to offer another; and nor would the Individual be obliged to accept another, were it to be offered. So it is unlikely that there would be any ongoing mutuality.

· (mutuality during the assignment) that a hypothetical obviously self-employed person or consultancy would probably not expect - or be entitled to expect - that if eg if work dried up on any particular day, other work would be offered, or that he would be required to accept any other work that might be offered, or that he would be paid in lieu of working once the work had dried up. So it is unlikely that there would be any mutuality in respect of the assignment in question.

· However, it should also be borne in mind that such relationships as 'preferred supplierships' may give rise to a form of ongoing mutuality, but without in any way inferring an employment type relationship.

Do the facts here actually provide a helpful pointer towards either view?

If you're another lawyer or an accountant reading these pages, I'd be happy to discuss any points arising with you - particularly if you'd like to debate any points where you disagree with my views - mail me!

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[1] http://www.inlandrevenue.gov.uk/manuals/esmmanual/part1000/esm11071.htm

[2] O’Murphy v Hewlett Packard, Employment Appeal Tribunal, reported 10^th October 2001

[3] Clark v Oxfordshire Health Authority 1997 EWCA 4792

[4] R v PCG Ltd 2^nd April 2001

Mutuality of obligation

The issue

The issues here would appear to be whether there is anything either in the contract, or in the actual relationship between Individual and Client, in relation to this factor which

· helps towards a decision on whether that relationship, had it been direct and without a company in between, would have been an employment contract - a contract of service - or a contract for services, or

· would be inherently inconsistent with a contract of employment.

Legal issues, and the Revenue Guidelines

The Revenue's guidelines are silent on this point.

The following paragraphs are extracted from the Employment Status Manual, section ESM1071: [1]