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Repayment and Penalty Clauses in Contracts of Employment

Repayment and deductions clauses are useful tools for employers. They can be used to clawback training costs and other debts, as a disciplinary sanction, an incentive to stay in employment for longer or as a deterrent to breaching the contract of employment. There are some considerations when drafting these clauses to ensure they are enforceable.

Making a deduction

Employers rarely bring proceedings against an employee for monies owed or damages for breach of contract as it is often not commercially sensible due to the cost involved, the employee’s ability to pay and employers may not wish damage employee relations by having the reputation of pursuing employees for losses. Deductions from wages are therefore the most common way of recouping monies.

Article 45 of the Employment Rights (NI) Order 1996 provides that

An employer shall not make a deduction from wages of a worker employed by him unless—

(a)the deduction is required or authorised to be made by virtue of a statutory provision or a relevant provision of the worker’s contract, or

(b)the worker has previously signified in writing his agreement or consent to the making of the deduction.

Any ‘relevant provision’ of the contract the employer wishes to rely on to make a deductions must be provided to the employee in advance of the deduction and in cases of disciplinary, in advance of the offending conduct. So where an employer wishes to make deductions from wages it must have a written term allowing it to do so, otherwise any deduction will be unlawful.

Article 45 is subject to exceptions including allowing the employer to deduct overpayment of wages or expenses, certain types of disciplinary proceedings, deduction by reason of a court order or statutory provision.

There are also specific rules relating to recovery of cash shortages in the retail sector (Articles 49 -54).

Penalties

A clause will be unenforceable if it constitutes a penalty – a punishment for failure to comply with the contract. Where the payment / deduction is not for a breach of contract – e.g. clauses where training costs are payable on termination within a certain period but there is no requirement to stay in employment then there will be no penalty. The court will not usually interfere with a bargain agreed between the parties to make payment on the performance of an event. However, where monies are payable on failure to perform or breach of contract then the court will look at whether the payment has the nature of a punishment by considering -

first, whether any (and if so what) legitimate business interest is served and protected by the clause, and

second, whether, assuming such an interest exists, the provision made for the interest is nevertheless in the circumstances unconscionable, extravagant, exorbitant or incommensurate (Cavendish Square Holding v El Makdessi; ParkingEye v Beavis [2015] UKSC 67 The appeal of these two cases were heard together because they raised similar issues concerning the principles underlying the law relating to contractual penalty clauses).

The underlines the approach that clauses which operate to make payment of monies, other than on breach of contract will not be a penalty and should be enforceable.

The most common clauses relating to payment/ deduction on breach of contract are where an employee leaves without serving the appropriate notice period. In these cases the court will consider what legitimate interest is being served e.g. to compensate the employer for the loss incurred by the employee leaving early. Often employers include such a clause to act as a deterrent. This may be the effect of the clause but case law suggests this is not enough to amount to a legitimate interest. The intention of the parties will be construed as at the date of the contract and not the date of the breach. The starting point for determining this is of course what the clause itself says and so it is a good idea to state the intention of the clause to illustrate that it is not by way of penalty.

What level of payment constitutes a penalty?

In addition to serving a legitimate interest, the sum payable should not be ‘unconscionable, extravagant, exorbitant or incommensurate’. Cases prior to the Supreme Court rulings in Cavendish Square Holding v El Makdessi; ParkingEye v Beavis [2015] UKSC 67 used the test of whether the sum payable was ‘a genuine pre estimate of loss’. The problem with this approach is that it is not always possible to determine at the date of the contract what level of loss will be incurred at the date of any breach and this may cause a gap between what was estimated and the actual loss suggesting the clause is a penalty. The Supreme Court widened the approach and suggested that where the sum wasn’t ‘unconscionable, extravagant, exorbitant or incommensurate’ i.e. as long as it isn’t excessive and bears some resemblance to the loss suffered by the employer then it should be upheld.

The courts recognise the difficulty with measuring such breaches even at the date of the breach never mind in advance, and accept that even if the pre -estimate does not reflect the subsequent loss it should not be an obstacle to upholding the clause, subject to the ruling of the Supreme Court that it is not unconscionable, extravagant, exorbitant or incommensurate.

It may be a good idea to for the repayment clause to reflect the reasons for the level of repayment as well as the reason for requiring it.  However, it is up to the party who breached the contract to show that the clause was a penalty; that the payment is ‘unconscionable, extravagant, exorbitant or incommensurate’, not for the employer to show it isn’t. Where an employer has a specific and identifiable cost arising from the breach e.g. cost of a replacement or recruitment agency fees then this should be outlined as it will make it more difficult for the employee to argue the clause is a penalty.

For any queries in relation to this article or for further advice on employment law, please contact Kiera Lee, Director and Head of Employment at Mills Selig.

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