Employment contracts sometimes contain a clause that allow the employer to deduct a month’s salary if the employee fails to work out their notice period. In Li v First Marine Solutions and Moutrey, the Employment Appeal Tribunal (EAT) held that the meaning of a contract term allowing an employer to do so has to be decided as of the date the contract was made, not the date of the breach.
Mr Moutrey set up First Marine Solutions (FMS) in 2009 to service the oil trade by providing mooring solutions and rig move and installation services. He headhunted Ms Li in July of that year as he had worked with her before and valued her abilities as an engineer.
After a dispute with Mr Moutrey, she resigned on 18 July 2012. She gave notice but argued that she did not have to work her notice because of outstanding holiday leave. In a letter the following day, Mr Moutrey pointed out that she had already taken more than her entitlement and that he was deducting one month’s salary for failing to give the correct notice under clause 12 of her contract. On 25 July she said that she was prepared to work her notice from that date but he refused, having already engaged a consultant to replace her.
Clause 12 stated that Ms Li could terminate her employment on one month’s notice, but that if she left without working her notice, the company would deduct a “sum equal in value to the salary payable for the shortfall in the period of notice.”
She argued that the clause operated as a penalty (a payment of money not necessarily related to the actual loss) and was therefore unenforceable; the company argued that it was enforceable as liquidated damages (a genuine pre-estimate of damage).
The tribunal found that Ms Li failed to work her month’s notice and was wrong to claim that she was entitled to accrued holidays which would cover the period. As FMS had to engage someone of the same calibre through an agency to replace her at short notice, clause 12 was not a penalty clause to stop her breaching her contract but a genuine pre-estimate of the loss that it would incur if she left without working her notice.
The clause was therefore enforceable and FMS was entitled to deduct £5,000 from the final payment it made to her. Ms Li appealed on the basis that the Tribunal had failed to consider documents, presented after oral evidence but before closing submissions, indicating that FMS was attempting to hire her replacement a week prior to her resignation.
The EAT dismissed the appeal, holding that the meaning of a contract term has to be decided as of the date the contract was made, not the date of the breach. “An agreement is made when the agreement is first instituted. It cannot change its meaning simply because there has been a breach. The meaning of the clause could not be affected by what was, in practice, the amount of loss actually incurred”.
In this case, the EAT accepted that the clause acted as a genuine pre-estimate of the company’s loss because the more Ms Li worked of her notice period, the more the amount of the deduction diminished. In the circumstances, a month’s salary was not an excessive sum. The onus was on Ms Li to prove that clause 12 acted as a penalty clause and she had failed to do that.
The EAT added that, in future, tribunals should think carefully about what the parties really intended when they drafted these types of clauses.
This case confirms the relevance of existing authorities on identifying contractual penalty clauses and the fact that the meaning of such a clause should be established from evidence of what was intended by the parties at the time the contract was entered into.
The case also confirms that the burden of proof rests with the person who is subject to the alleged penalty clause.