Legal update: A deduction for an employee’s failure to serve their notice period was not a penalty clause

30 July 2014

Yizhen Li v First Marine Solutions

This could be a useful decision for employers, albeit with potentially limited application.  Miss Li resigned from her employment with First Marine Solutions, and did not work her notice period.  The employer made a deduction of one month’s salary (£5,000) from Miss Li’s final salary payment, pursuant to a clause in her employment contract.  The deduction was made even though she also did not receive her notice pay for the period she did not work.  This was held by the Employment Tribunal, and upheld by the Employment Appeal Tribunal (EAT), not to be a penalty clause and so was enforceable by the employer.  However, in doing so, the judge expressed to a “very real concern” about the way this particular clause was approached, and made a number of observations.

The dispute arose over clause 12 of Miss Li’s employment contract, which provided that “either the Company or the Employee may terminate the Employee’s employment hereunder by notice in writing of not less than [one month]…If an Employee leaves, without working the appropriate notice, the Company will deduct a sum equal to the salary payable for the shortfall in the period of notice”.

A clause in an employment contract can provide for a pre-determined sum to be payable upon a breach of contract, for example not giving the required contractual notice.  However, unless the clause reflects a genuine pre-estimate of the losses, it will be unenforceable as a penalty clause.  The employee's case was that the clause operated as a penalty, and the burden was on her to show this.  

The EAT had to decide on the question of construction, taking into account the terms and inherent circumstances of the contract in question.  The clause had to be judged as at the time of the making of the contract, not at the time of the breach.  The EAT held that Miss Li failed to establish that clause 12 operated as a penalty.  The EAT was persuaded by the fact that if she had worked part of her notice, the amount of any deduction would be reduced.  It concluded that the costs the employer would incur in replacing Miss Li would diminish as the amount of notice the employer received increased.  Therefore, it held that the clause was a genuine pre-estimate of loss.

The EAT also held that the sum of one month’s salary was not excessive.  It distinguished this case from a previous one, where a similar clause was held to be a unenforceable as a penalty clause.  In that case, the employee was easily replaceable, whereas here the employee was highly-skilled and her perceived value was indicated by her high salary.  The EAT found that it was conceivable that significant expense might be incurred in hiring a replacement for her on short notice.

That being said, the judge recommended to tribunals who consider such a clause in future that they might want 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, a liquidated damages clause, or simply as a provision that entitled to employer to withhold pay for the period of time not worked during notice.  It was not argued before him whether the clause should have been construed as having the effect it was said to have.  He noted that a different construction may better represent the realities of the workplace.  It would normally be understood as fair between the parties that, if an employee were to leave early during her notice period, she would not be paid for the balance of the period.  Further, there is nothing in the language of the clause here which suggested, on the face of it, that the company had in mind the additional expense of recruitment and replacement such as might result from early termination.

The judgment itself therefore has limited application in theory, as the EAT stated that it should not create an unfortunate precedent.  The judge’s observations encourage pro-employee judicial treatment of similar clauses, and so employers should exercise caution in seeking to rely on such a clause.

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