Out-Law News 3 min. read

EAT: clause in contract deducting a month's pay for failure to work notice not an unenforceable 'penalty clause'

A clause in a contract of employment permitting an employer to deduct one month's pay in respect of a departing employee's failure to work her notice period was not a 'penalty clause', and was therefore enforceable, the Employment Appeal Tribunal (EAT) has ruled.

However, EAT president Mr Justice Langstaff said that employers should be careful to ensure that such terms "better represent the realities of the workplace" to avoid them being interpreted as penalties in future. In this case the employer, First Marine Solutions Ltd; and its former employee, Yizhen Li, accepted the original employment tribunal's interpretation of the clause as allowing the employer to deduct payments from an employee who did not work her notice. Mr Justice Langstaff said that this would not necessarily be true in every such case.

"If a tribunal has a contract such as this to construe in future, it should ask itself whether the parties, in enacting a clause such as this, really intended that, if an employee left not having worked the full amount of notice – irrespective of whether the notice was given by the company or the employee – there should be paid by the employee to the employer a sum equal to the amount of time which was not spent working during that notice period, but should have been," he said.

"I recommend to tribunals who consider such a clause in future that they may wish to think carefully, in the light of the evidence before them in the particular case, whether the parties actually intended a clause such as this to operate as a penalty clause, liquidated damages clause, or simply as a provision that entitled the employer to withhold pay for the period of time not worked during notice. All will, of course, depend upon the particular conclusions and the particular facts, contracts of employment being individual," he said.

The clause only permitted the employer to deduct payments from wages due, not to receive or demand a payment, the judge said. Similarly, it did not oblige the employee to make that payment. This meant that the employer would have had no recourse if the employee "simply upped sticks and left" at the end of a salary period without working notice, or if the employee was dismissed by the employer for a proper reason, he said.

Li was a project engineer and subject to a contract which said that if she did not work her notice, the employer would "deduct a sum equal in value to the salary payable for the shortfall in the period of notice" from her final pay. Following a dispute with her manager, Li resigned. However, she did not work her four-week notice period because she said that she had outstanding holiday. It later emerged that she was not due any holidays, so First Marine deducted four weeks' salary from her final pay.

Although the parties were in agreement about the practical effect of the clause, they disagreed over how it should be interpreted. Li argued that the clause was in effect a penalty, which would make it unenforceable. First Marine said that it was not a penalty, but rather a 'genuine pre-estimate of loss'. This type of clause is generally valid.

Previous cases had established that a sum which is "extravagant and unconscionable in amount" will generally be an unenforceable penalty. However, this is not decided with reference to actual loss but rather by "what was anticipated by the parties at the time they entered into the contract as being likely on termination", the judge said.

"This contract, on the face of the contract itself, was for a very different type of employee," he said. "This was not just an engineer but a project engineer. She was engaged at a high salary compared to that at which would apply to a driver [as in a previous case, in which a similar clause was found to be a penalty]."

"Engineers are not as common as are drivers, and to obtain one at short notice is always likely to be of particular difficulty. Significant expense might be incurred. When the contract as a whole is examined in the context within which it was made, to which reference must be had to decide what the parties intended at the time that they made the contract, it is plain that the fact that she was headhunted meant that the employer placed a particular value upon her services ... There is nothing, on the face of it, which means that a sum of a month's salary is necessarily excessive," he said.

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