New judgment on pay in lieu of notice clauses

United Kingdom

On 18th January the Court of Appeal gave its judgment in the appeal of the Employment Appeal Tribunal decision in the case of Cerberus Software Limited v John Rowley. This is an important judgment as it seeks to set out the correct legal analysis for interpreting pay in lieu of notice clauses and impacts the tax situation.

The facts of the case are straightforward. Mr Rowley was summarily dismissed without any good reason from Cerberus in July 1996. He was entitled to 6 months. His contract said Cerberus might pay him lieu of notice as an alternative. They did not do so. He quickly got another, better paid job. Applying the principle of mitigation would reduce his damages for breach of contract to just about GBP3,000. By contrast pay in lieu was worth about GBP23,000. He sued for pay in lieu, relying on the 1995 Court of Appeal decision in Abrahams v Performing Rights Society. Having won in the Employment Tribunal, and the Employment Appeal Tribunal, Mr Rowley lost in the Court of Appeal by a majority decision.

The key termination clause at issue stated:

" Employment under this contract shall continue unless and until determined by the employer under clause 17 above and Appendix 1 or by either party giving to the other not less than 6 months notice of termination.

It is agreed that the employer may make a payment in lieu of notice to the employee. The employee shall not be entitled to any benefit other than pay or money in lieu of such benefits in respect of any period for which he has been paid in lieu of notice"

The Court of Appeal decided that the wording of the termination clause meant that the employer had the right to "elect" whether or not to make the payment in lieu. The clause did not oblige the employer to make a payment in lieu of notice: it merely enabled it to do so. It was different therefore from the clause in the Abrahams case which "entitled" the employee to the pay in lieu. The employee could not sue for the sum payable in lieu of notice as a sum due under the contract (ie as a debt) so his only remedy was for damages for wrongful dismissal. This meant that, although Mr Rowley had been badly treated, his award was subject to his duty to mitigate.

Employers who choose to put a payment in lieu of notice clause in their employment contracts can take some comfort from this Judgment. Well drafted clauses will give employers the option of paying in lieu, but will not compel them to do so. Where the payment in lieu option is exercised, the payment will be fully taxable. But where the option is not exercised and a damages payment is instead genuinely negotiated, up to GBP30,000 should qualify as tax-free.

Payment in lieu clauses are useful, because they enable employers to buy out contracts for a certain sum without breaking the contract. So, the enforceability of non-competition clauses can be preserved.

If you require further advice or assistance on interpreting or drafting termination provisions please contact Simon Jeffreys at [email protected] or Anthony Fincham at [email protected] or by telephone on +44 (0)20 7367 3000.