Czech Republic: Managing director and invalid employment contract, work injury

It should be noted that this decision does not relate to a long-term problem with the concurrence of functions, i.e. the (im)possibility of performing the function of a managing director in an employment relationship, but reflects a situation where the managing director performs non-parallel work, i.e. work outside the function of a statutory body.

In the case in question, the plaintiff was a limited liability company, the sole shareholder of which was also its managing director. As a representative of the company, this director entered into an employment contract with himself as an employee for the work of assembly foreman. The managing director (as an employee) suffered an accident during the performance of his work. As an employer, the company claimed the damages incurred from the insurance company (here especially compensation for loss of earnings and pain), due to the employer's statutory insurance for the damage caused to employees by an accident at work within the meaning of Decree No. 125/1993 Coll. However, the insurance company refused to compensate the damage, pointing out that no employment relationship had been established between the company and the managing director.

The ensuing dispute reached the Supreme Court, which dealt mainly with two issues: i) whether the employment contract is valid and an employment relationship has been established between the company and the managing director as an injured party, and ii) whether the employer's statutory insurance scheme applies to the relationship between the company and the injured party for damages in the event of an accident at work.

Regarding the validity of the employment contract:

Following the existing case law, the Supreme Court confirmed that an employment contract entered into by the same person on both sides, even if acting in different positions, i.e. once as an employee and once as a managing director(employer's representative), is invalid due to an insurmountable conflict of interest.

Situations where the managing director enters into an employment contract with himself are common in practice. This is typical for start-ups and smaller companies, in which the shareholder performs the function of a managing director while at the same time personally working for the company (e.g. personally provides services to the company's customers).

The conclusion of the Supreme Court on the invalidity of such contracts raises considerable problems, as it de facto forbids the legal employment of a managing director in one-person companies.

From the author's perspective this conclusion is not justified for the following reasons.

• It is highly questionable whether there is any conflict of interest at all. If the managing director is at the same time a shareholder in the company and employs himself, his interests as an owner cannot be harmed in any way, because the salary paid is provided from his equity (albeit through a company owned by him).
• In addition, the conclusion of an employment contract is a true legal reflection of the work performed for the company.
• From the viewpoint of impacts on the sphere of levies (state revenues), the wage arrangement is equivalent to the remuneration of a managing director and even less advantageous than the payment of these funds in the form of a pay out of share in the profit. Thus it cannot even be argued that the law is circumvented or that the interests of the state are damaged.

Given the above, the position of the Supreme Court appears formalistic and causes considerable problems in practice. This situation is completely unsolvable for smaller companies, which have only one executive who is directly involved in the provision of the company's services. It also raises other questions, such as whether the executive should have a work permit in the case of a person who is not otherwise allowed to work in the Czech Republic without one. The fate of statutory insurance, especially pension insurance, is also unclear, i.e. whether the social security administration will raise this argument many years down the line and will dispute the right to old-age pension.

In the author's opinion, this problem should be resolved in the future in accordance with Section 54 of Act No. 90/2012 Coll., on Business Corporations (Business Corporations Act). These provisions address the issue of conflicts of interest, including a situation where the managing director enters into a contract with a company that he represents. Therefore, if the managing director follows these provisions, the contract should be valid and the negative consequences outlined above should be prevented.

Regarding employment without a valid employment contract:

The Supreme Court has concluded that if an executive performs work for a company based on an invalid employment contract, a so-called actual employment relationship arises between him and the company. If, in these circumstances, personal injury occurs within the scope of work, it is an accident at work within the meaning of the Labour Code and the company is liable to the executive for the damage incurred and is obliged to compensate him to the extent and under the conditions of the Labour Code.

Under normal circumstances, this damage would be compensated from the employer's compulsory insurance for damage caused by an accident at work. However, in the case of an actual employment relationship, the Supreme Court concluded that such damage is not covered by the insurance in question and the insurance company is thus not obliged to compensate it to the employee. This conclusion is based on the fact that in Decree No. 125/1993 Coll., the establishment of the "first employment relationship" is stated as a condition for the creation of the insurance.

The Supreme Court's conclusion is overly formalistic and difficult to defend in practice. First, the decree provides that the creation of insurance depends on the existence of an employment relationship. If a person, as an employee, performs work for the employer even without a valid employment contract, it is undoubtedly a relationship that has the essence of labour law. The Supreme Court itself states that the actual employment relationship must be settled in the same way as the employment relationship and grants the employee, for example, the right to compensation of wages, holiday, etc. It is therefore not entirely clear from the decision why such an employee should be excluded from the statutory insurance. The issue of the validity of the employment contract and the so-called actual employment relationship is not reflected in the decree at all, i.e. the decree does not mention it as a reason for refusing performance, it is not a legal exclusion from insurance, and the refusal of insurance was inferred purely by the Supreme Court, without justification and reflection of practical implications.

In addition, the decision does not in any way reflect that the employee has special legal protection and that the invalidity of a legal act cannot be to the detriment of the employee unless it is caused solely by him/her. The exclusion of an employee from the statutory insurance due to the invalidity of an employment contract (here, moreover, for invalidity inferred only in a judicial manner and not, for example, for the absence of an essential element of the employment contract) is undoubtedly to the detriment of the employee. If we add that the employer paid premiums for the employee for the duration of the employment, the conclusion of the Supreme Court seems inexplicable.

Therefore, the Supreme Court's conclusion does not seem to be correct. Failure to provide statutory insurance leads to a significant deterioration in the employee's position. Insurance companies will now examine the validity of employment contracts and tend to refuse compensations due to their defects. This creates a real risk that the employee will not receive compensation for an accident at work. Especially in the case of serious accidents at work with permanent consequences, the costs associated with treatment and compensation for earnings can be enormous and the employer may not be willing or able to meet such obligations. Nor can it be ruled out that the employer will dispute his liability and the employee will thus have to assert his claims in court. On the one hand this will delay the satisfaction of his/her claims by several years and, on the other, give rise to considerable costs and uncertainty about the outcome of the dispute.

However, the risk also arises on the side of the employer, who despite paying the statutory premiums duly and in good faith, may be obliged to pay for the entire damage itself, which may be financially devastating especially for smaller companies.

The following conclusions, therefore, derive from that decision:

1. It is problematic if the employment contract is entered into by the same person on both sides. In the opinion of the Supreme Court such a contract entered into before 31 December 2013 is invalid. A contract entered into after this date should be valid if concluded according to Section 54 et seq. of the Business Corporations Act.
2. If the employee performs work for the employer without a valid employment contract, he/she performs it in a so-called actual employment relationship.
3. If an employee suffers an accident while performing work within an actual employment relationship, it will be considered an occupational injury and the employee is entitled to compensation from the employer in accordance with the Labour Code.
4. As the employment contract was invalid and the employee works in "actual employment", the employer is not entitled to compensation of work injury costs from the insurance company (within the framework of the statutory liability insurance), regardless of whether it paid insurance premiums for the injured employee.

Recommendation:

If the statutory body wishes to enter into an employment contract with a company represented by him, he should proceed in accordance with Section 54 et seq. of the Business Corporations Act. Given that the validity of such an employment contract may be disputed, it is recommended in all cases to arrange commercial accident insurance, which would be paid by the company and which would cover at least part of the damage to the statutory body in the event of an accident. For other employees, careful preparation and checking of employment contracts can only be recommended, so that their invalidity does not have fatal consequences for both employees and employers in the event of an accident at work.