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Little words that make a world of difference

Janet Gaymer warns that payment-in-lieu clauses in contracts may need rethinking following recent court rulings

Payments in lieu of notice used to be straightforward. Employees were given notice or pay in lieu unless they had behaved so badly that neither were due at all.

However, during the 1990s a series of cases raised questions about payments in lieu and how they worked in practice.

In a leading case involving Abrahams, an employee of the Performing Right Society, the Court of Appeal considered a claim for two years salary under a payment-in-lieu clause in Abrahams contract. The contract stated that, In the event of termination of your employment you would be entitled, other than in the case of dismissal for gross misconduct, to a period of two years notice or an equivalent payment in lieu.

So when the society terminated Abrahams employment because it believed he was in breach of contract, he claimed two years salary. The society alleged that Abrahams had a duty to mitigate his loss by, for example, finding new employment. Abrahams successfully argued that by terminating his employment without notice, the society had effectively chosen the option to make a payment in lieu. Under his contract he was entitled to the payment and was under no obligation to mitigate his loss.

The Abrahams decision, among others, has caused many employers to rethink the wording of payment-in-lieu clauses. Such clauses were not without their disadvantages for the employee. If, as in the case of Abrahams, there was a right to payment in lieu, the employee would have to pay tax on the resulting sum under Schedule E. Payments of damages on the other hand come with the benefit of a 30,000 tax-free slice.

It also became popular for employers to reserve the right to make a payment in lieu in order to ensure the speedy exit of, say, a senior executive. As part of the deal, employers could also insist that the departing executive observe certain obligations, such as not taking details of existing clients with them to any new employer.

An employer who broke a contract (by not giving notice) could not enforce such restrictive covenants. However, where the employer had agreed in the contract to pay in lieu of notice and then did so, the covenants were preserved.

Another Court of Appeal ruling that highlights the possible need for a review of payment-in-lieu provisions was in the case of Cerberus Software v Rowley. It looked at what one of the judges described as a troublesome little point of employment law in fact, it concerned a mechanism which is in daily use by most human resources professionals.

The employer in this case had agreed with the employee that in the event of termination of employment the employer may make a payment in lieu of notice to the employee. The employee, Rowley, was dismissed without notice in a manner which, according to the court, was a travesty of good industrial relations. The allegations made against him were unfounded. After his dismissal in June 1996 Rowley obtained new employment on 1 August 1996. His former employer argued that Rowley should not receive all of the six months money because the income from his new employment should be taken into account. Rowley argued that he was entitled to receive the six months notice money as a debt.

The key to the courts final conclusion lay in the use of the word may in the original contract. This meant that the employer had the right to choose whether or not to make a payment in lieu of notice. Rowley could not insist upon receiving six months salary in lieu of notice. Therefore, the payment to him was in the nature of a damages payment and he had to give credit for the sums he had earned in his new employment, even though the employer had been at fault in the first place.

The moral of the case is therefore clear. If contracts of employment use the word may or any other language which indicates that the employer can choose whether or not to make a payment in lieu of notice, the amount the employer will have to pay will take into account the sums earned by the employee from new employment gained during the period of notice.

As so often is the case in employment law, a word in the right place may make all the difference in the long run.

Email address: janet.gaymer@haynet.com

Janet Gaymer is head of employment law at Simmons & Simmons