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Are repayment provisions in contracts of employment unenforceable penalties?

12/03/2014 | Andrea London

Background

The increasing costs of training and recruitment and the desire by employers to avoid such costs by organically growing their employees’ skills has led to a marked increase in the use of repayment clauses in contracts of employment. Employers want to have the best and well-trained staff, but don’t want to be left “high and dry” if the employee leaves to join a competitor shortly after a long recruitment process or as soon as their employer-funded training is completed.  However, some repayment clauses are drafted with a heavy hand and are overly onerous upon the employee.  Not surprisingly, employees seek to circumvent burdensome repayment clauses, sometimes by alleging that they are a penalty clause and so, unenforceable.  This, in turn, potentially leads to a prior repayment becoming a claim by the employee for an unlawful deduction from wages.

The enforceability of such repayment provisions contained in contracts of employment was recently considered by the Employment Appeal Tribunal (EAT) in Cleeve Link Ltd v Bryla UKEAT/0440/12.  The principles determined in this case are not new, but Cleeve specifically dealt with the issue of whether a repayment clause of the kind often used in contracts of employment was enforceable against the employee, or not.

Facts

In Cleeve the repayment provision in question provided that if Ms Bryla terminated her contract or if she was dismissed for misconduct within the first six months’ of her employment, Cleeve (her employer) could recoup the total cost incurred in recruiting her (which included flying Ms Bryla to the UK from Poland and training costs) from any money due to be paid to her under her contract. After six months’ of employment, the amount that could be recouped would be reduced by one sixth following each completed month of employment; so that by the time she had been employed for twelve months, the repayment clause would cease to be operative.

Ms Bryla was dismissed after three months’ employment for gross misconduct at which time she was owed approx. £1,200 in unpaid wages. Cleeve relied on the repayment provision in Ms Bryla’s contract and recouped the full amount of recruitment costs against her unpaid wages. Ms Bryla consequently brought a claim in the Employment Tribunal for unlawful deduction from wages. The Employment Tribunal held that the repayment provision was a penalty clause and so, was unenforceable. Therefore the deductions made by Cleve from her wages were unlawful. On appeal to the EAT, however, it was held that the Employment Tribunal had erred in its finding; that the clause in question was a valid liquidated damages clause and not a penalty clause. It was, therefore, enforceable against Mrs Bryla.

Penalty or liquidated damages?

A liquidated damages clause is a clause in a contract which specifies a fixed or determined sum to be payable on a breach by one party to the other (innocent) party. If a liquidated damages payment constitutes a penalty, it will be unenforceable against the party in breach.

Case law has clarified that in order for a clause to be a liquidated damages provision rather than a penalty, it must be a genuine reflection of an employer’s pre-estimate of loss that it is likely to suffer if the employee breaches that provision. If an employer is unable to quantify the exact loss that would be suffered, a best guess of the likely loss would be satisfactory. In Cleeve the EAT restated that the test to be applied here is an objective test, although regard may be given to the thought processes of the parties at the time of contracting.

The key to a repayment sum being regarded as a genuine pre-estimate of loss appears to be that the sum specified must be compensatory and not ‘in terroreum’ or simply a deterrent to breaching the contract (see Dunlop Pneumatic Tyre Co. Ltd v New Garage and Motor Co. Ltd [1915] A.C. 79; and Murray v Leisureplay [2005] EWCA Civ 963). In Cleeve, the EAT reiterated that in order for an Employment Tribunal to determine whether a repayment sum could be construed as a deterrent rather than compensatory, it would be necessary to compare the amount that would be payable on a breach under the contract with the actual loss that might be sustained if the breach occurred. If there is a significant difference between the two sums, then it is likely that the clause is indeed a deterrent and therefore a penalty which would be unenforceable against an employee.

There is also a presumption that a clause is a penalty if there is a lump sum payable by way of compensation to an employer on the occurrence of one or more of several events, some of which are serious and some relatively minor (see Elphinstone v Monkland Iron and Coal Co. Ltd (1886) 11 App Cas 332. 342).

Unlawful deductions from wages

There are very limited circumstances in which an employer can lawfully make deductions from a worker’s wages. These are set out in section 13 of the Employment Rights Act 1996. Any deduction from a worker’s wages is unlawful unless (i) the deduction is required or authorised by that statute or is contained in a relevant provision of a worker’s contract of employment or (ii) the worker has previously consented in writing to the deduction. In relation to a deduction contained in a relevant provision of a worker’s contract, although most contracts contain a standard deductions clause, reliance on such clauses should be treated with caution, as under the legislation, they are not generally sufficient to simply enable an employer to make deductions without first notifying the employee in any event and potentially requiring further specific consent.

Practical tips for employers

When including any kind of repayment provision in an employment contract, it would be advisable for an employer to consider the following points:

1.     Ensure that the amount quoted to be payable on breach and/or accordingly deducted from an employee’s wages is a genuine pre-estimate of the loss that would be suffered by the employer if the employee breaches the clause.

2.     Consider whether the repayment sum stated on a breach is comparable with the actual loss that might be suffered if the employee was in breach; a clause might be unenforceable if the two amounts are vastly different.  The key is that the clause should not attempt to deter an employee from breaching their employment contract, but to genuinely pre-estimate the level of loss to the employer if they did.

3.     Bear in mind that the clause will be construed on the basis of its construction and as at the time the contract was entered into and not at the time of any breach.

4.     If the clause attempts to recover the same amount on the occurrence of a number of events (some major, some minor) that could each give rise to a different level of damages, it would be presumed by a court to be a penalty clause and be ineffective. It would therefore be advisable to include different sums for different types of breaches.

5.     It would be beneficial for an employer to keep any calculations made in relation to the amount stated in the repayment clause as, should the matter become the subject of a claim, this would form evidence of a genuine pre-estimate of loss at the time the contract was formed.

Conclusion

As Cleeve illustrates, if a repayment provision is found to be a penalty clause then, as it will not be enforceable and monies deducted pursuant to it will entitle the employee to raise a claim for unlawful deduction from wages.

Cleeve reiterates and emphasises that when employers include repayment provisions in their employment contracts, the clauses should be carefully drafted in order to increase the likelihood that they will be enforceable. Clearly, the line between an enforceable liquidated damages clause and a clause which is a penalty and unenforceable remains a very fine one.

This bulletin should not be taken as definitive legal advice on any of the subjects covered.  If you require legal advice on any of the subjects covered or on any employment matters please contact Andrea London on 020 7955 1433 or andreal@rosenblatt-law.co.uk

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