Pitfalls of payment in lieu of notice (PILON)

A recent Court of Appeal decision has brought into sharp focus the importance for employers of properly defining in their contracts what is payable under a payment in lieu of notice clause (a ‘PILON’), and of ensuring there is consistency between PILON and bonus clauses.

In Locke v Candy & Candy, Locke was entitled to a bonus of £160,000 after 12 months of employment. His bonus clause stated that he "must be employed by the company in order to receive the bonus". His contract was terminable upon six months' notice and included a PILON clause, which simply reserved the right for the company to make a payment in lieu of notice. Locke was dismissed 10 days before his bonus fell due and was paid his basic salary only, in lieu of his six months' notice. However, he claimed he was also entitled to the bonus, arguing that the PILON clause entitled him to the same payments he would have received had he worked his notice period.

The Court of Appeal dismissed his claim. As the PILON clause didn't specify how the payment in lieu should be calculated, the Court looked at the contract holistically. It held that it was clear, reading the bonus provision, that Locke had to be employed in order to receive the bonus. Therefore, the payment due under the PILON clause could not include the bonus payment.

While ultimately the employer achieved its desired outcome, this litigation could have been avoided had the PILON clause simply specified what sums would be payable in the event of the employer terminating by making a payment in lieu of notice. As it was, the employer only avoided a conclusion that the PILON should include the bonus because the court was prepared to consider the contract as a whole and take the wording of the bonus clause into account.

When drafting employment contracts, it is advisable to consider including a PILON clause, to allow termination to be effected immediately. When an employment relationship has broken down, it is often important to be able to get the employee out of the business as soon as possible. Whether an employer can lawfully do so, however, will depend upon the terms of the contract. An employer has no right to summarily terminate the employment by making a payment in lieu of notice unless that right is expressly set out in the contract. In the absence of such right, proceeding in this manner will put the employer in breach of contract. In such circumstances, the employee could claim damages, which, in Locke's case, would have included his bonus payment.

If the employee's contract does contain a PILON, the payment they are legally entitled to receive will depend upon the wording of the clause. In order to avoid a dispute, it is important to properly define what is payable upon termination, whether salary only, salary and benefits, or salary and bonus and benefits, especially where a bonus forms a large part of an employee's remuneration. If it provides for salary only, an employee will not be entitled to any bonus payment which falls due during a notice period, provided their employment is terminated before the payment date.

If, however, the PILON clause is silent as to what the payment should comprise, calculating what is due in respect of the notice period may prove more difficult, as in this case. In such circumstances, a court will look at the other terms of the contract. Employers should therefore ensure that bonus provisions and PILON clauses are consistent, to avoid any future disputes about what is payable upon termination. Bonus clauses should set out clearly the circumstances in which bonus will be paid, including what happens when employment ends part-way through a bonus year, so that there can be no room for doubt. This may provide either that the employee will only receive the bonus if they are still employed on the payment date, or it may pro-rate the bonus for departing employees.

By taking time to ensure that contractual provisions regarding remuneration and termination are clear and consistent, the scope for disputes, which may result in costly litigation, can be significantly reduced.

Kate Dunn is employment solicitor at law firm Shepherd and Wedderburn