Penalty clauses

05 Sep 2014

The EAT has revisited the old chestnut that is employees leaving without working their notice. Some employers try to mitigate the damage through the employment contract but Li v First Marine Solutions Limited and Moutrey shows that this is not as simple as it appears.

Yizhen Li was an Engineer. She was responsible for a contract in Egypt providing oil rig mooring, moving and installation services. She was paid £50,000 per annum. Her contract provided for termination on one month's notice and that:

If an employee leaves, without working the appropriate notice, the company will deduct a sum equal in value to the salary payable to the shortfall in the period of notice.

Miss Li accepted a better paid job elsewhere. She gave four weeks' notice asserting (1) this was more or less equivalent to one month; and (2) her accrued holiday exhausted her notice period so she didn’t have to work her notice. There was a dispute about holiday entitlement but the employer accepted Miss Li's resignation, engaged a temporary replacement and deducted a month's pay from her final salary and expenses. The Employment Tribunal found Miss Li wasn't entitled to the accrued holiday she claimed and had in effect resigned without notice.

The legal argument concerned the effect of the liquidated damages clause. Was it a genuine pre-estimate of the loss or was it an unlawful penalty?

Both the tribunal and the appeal tribunal upheld the clause.  It was not a penalty because:

  • Miss Li was a highly skilled, qualified and experienced Engineer fulfilling a pivotal role in a very important contract;
  • The employer put a premium on retaining Miss Li which was reflected in her contract;
  • The employer was forced to engage an agency employee at short notice and extra cost; and
  • The employer was not in a dominant bargaining position when the contract was agreed.

However the President of the EAT had misgivings and made some important observations:

  1. Tribunals must construe contracts against the reality of the employment in question. Did the parties really intend that an employee leaving without proper notice should make a payment to the employer by reference to the shortfall? The normal fair proposition is no work; no pay meaning the employee might forfeit pay for time not worked but will not be required to make a real payment to the employer.
  2. Tribunals must look at the text of the clause to see if it reveals a clear intention to recover additional expenses of a temporary replacement or recruitment.

Our view…

The Courts have never liked penalty clauses; First Marine was lucky. The President has given clear guidance that generic clauses are unlikely to work in future. Employers who want to take this sort of protection must invest in a bespoke contract designed to reflect the reality of their circumstances.