Deduction of One Month’s Pay for Failing to Work Notice Not a Penalty

A clause which entitled an employer to deduct a month’s salary if the employee failed to work their notice period was not a penalty and was therefore enforceable.

In Yizhen Li v First Marine Solutions L’s employment contract required her to give one month’s notice and stated that if she resigned without working her full notice, the Company would deduct a sum equal in value to the salary payable for the period not worked. L resigned on notice on 18 July 2012, claiming that she had been constructively dismissed. She claimed that she had sufficient holiday remaining that she did not need to work during her notice period but her employer disagreed. It told her that it would be deducting a month’s salary from the sums it owed her up to her resignation on 18 July 2012. It did not pay her any notice pay.

The employment tribunal found that the employer was not in repudiatory breach of contract and so L had not been constructively dismissed and had simply resigned. L argued that the deduction provision was an unlawful penalty, on the basis that it was intended to punish her rather than compensate her employer for losses arising from her breach in failing to work her notice. It was therefore unenforceable.

The employment tribunal and EAT disagreed. It was for L to show that the clause was a penalty and not a genuine pre-estimate of loss. The fact that:

• the longer L worked during her notice period, the lower the deduction became; and
• the additional costs incurred in replacing L could diminish as the amount of notice the employer received increased

meant that the clause was a genuine pre-estimate of loss. In addition, the sum of a month’s salary was not excessive. The fact that there was no evidence L’s resignation had actually caused loss was not relevant, as the assessment of whether a clause is a genuine pre-estimate of loss has to be made at the time the parties entered the contract, rather than in light of any actual loss.

This Court distinguished this case on its facts from Giraud UK v Smith where a similarly worded provision was found to be a penalty. In Giraud the employee was a driver who was easily replaceable whereas L was a highly skilled project engineer and it was conceivable that significant expense might be incurred in sourcing a replacement at short notice.

The Judge said that he did not want this case to set an unfortunate precedent and indicated that a tribunal considering a clause such as this in future should consider whether the parties really intended it to work in this way or really only intended that an employee who left early would not be paid for the period of notice not worked. This, perhaps surprisingly, was not argued by the parties in this case. The Judge’s comments indicate that courts will look critically at contractual provisions of this nature.

Employers who do intend that they should be able to make a deduction from sums owed to reflect losses arising from an employee’s failure to work their notice should make it clear in the contract that the purpose of the provision is to deal with the additional expenses of recruitment and replacement resulting from early termination. This will help them to demonstrate that the provision is intended to be a genuine pre-estimate of losses arising from the breach of contract and not an unlawful penalty.  This should increase the chances of it being enforceable. As this case demonstrates, provisions of this type are more likely to be enforceable in the case of senior employees who are more difficult and costly to replace.