Repayment clauses: Payback time

How should you go about recovering costs from former staff? Catherine Turner explains how to ensure your repayment clauses are enforceable.

An employer may want to recover  money from a former employee in a variety of situations. For example, if an employee leaves shortly after attending an expensive training course, paid for by the employer, can it recover some of the costs? Can an employer reclaim enhanced maternity pay from an employee who does not return to work, or a termination payment from an employee who lodges tribunal claims, despite agreeing not to?

Employers that wish to recover money in these or similar circumstances need to bear two things in mind. An express agreement with the employee is critical, and care needs to be taken when drafting such agreements. Getting it wrong means that recovery may, in practice, be impossible.

Legal risk

A clause that requires one party to pay the other a particular sum if they break the contract could be regarded as a penalty. If so, it will be unenforceable.

Whether a clause is enforceable will depend on whether it is a genuine attempt to estimate the loss caused by the breach. If not, it will be a penalty.

Relevant factors include:

  • Whether the sum claimed is significantly greater than the largest loss that could have been caused by the breach
  • Whether the same amount is payable in relation to any breach of contract, regardless of how serious
  • Whether the clause is designed to stop one party from breaching the contract, rather than compensating the other for loss caused by a breach.

A number of cases show the importance of these factors in practice.

Termination payments

In the recent case of cosmetics company CMC Group v Zhang, a commercial dispute was settled by a payment of $40,000 (£21,700). The claimant agreed that if he breached the terms of the settlement agreement (for example, by harassing CMC employees or making derogatory comments), he would repay the $40,000. The Court of Appeal found that the clause was a penalty and, therefore, unenforceable –  the money would be repayable in the event of any breach, regardless of how serious or trivial.

Compromise agreements often include a repayment clause in the event of a breach, and the same logic would apply. There is a real risk that an attempt by an employer to recover the full termination payment for any breach of any provision, however minor, would be a penalty, and would not be enforceable.

Training costs

In Neil v Strathclyde Regional Council,  the employee was given paid leave of absence and her training costs were paid. In return, the council  required her to work for two years following completion of her course, or repay a proportion of the costs. The clause was upheld. The repayment reflected the employer’s loss of a qualified employee and the amount to be repaid decreased over time. As such, it was a genuine pre-estimate of loss.

The position might have been different if the employee had to repay the full amount regardless of how much of the two years she had worked. Such a clause would have been more likely to be a penalty, because it would not have reflected the severity of the breach. Proportionality is an important factor in enforceability.

Failure to give notice

The case of transportation company Giraud UK Ltd v Smith reflects how difficult it is in practice for an employer to point to loss caused by an employee leaving in breach of their contract. In this case, the employer attempted to recover a day’s wages for each unworked day of an employee’s notice period. As the employer could employ a replacement reasonably easily, the purpose of the clause was to prevent staff from leaving without giving proper notice. As such, it was unenforceable.

Golden handshakes

The shoe was on the other foot where an employer had agreed to pay its chief executive one year’s salary if it terminated his employment in breach of contract. In Murray v Leisureplay Plc, it was argued that because the employee did not have to mitigate his loss, this was a penalty.

The Court of Appeal disagreed. Although the payment was considered “generous”, this reflected the commercial reality of the situation and the fact that it was difficult to predict what the impact of a dismissal would be on the employee. The sum was not so extravagant that it amounted to a penalty. Although the case went against the employer, it is helpful in showing that the court will have regard to the commercial realities of a situation in assessing whether a clause is a genuine estimate of loss.

Repayment clauses can be a useful tool for employers. However, care needs to be taken when drafting the clause to ensure that it is enforceable. You need to make sure that the purpose of the clause is not to penalise the employee for a breach, and that it genuinely reflects the employer’s loss. Failure to do so may leave the employer unable to recover a thing.

Kathleen Healy is a partner in Freshfields Bruckhaus Deringer’s employment pensions and benefits department

How to avoid drafting unenforceable repayment clauses

  • If possible, ensure that the reason for the repayment is not a breach of contract. This gives a strong argument that the payment cannot be a penalty.
  • Don’t call a payment a ‘penalty’. Although the label the parties have attached to an agreement is not conclusive, it will make it harder to argue that it is a genuine pre-estimate of loss.
  • What is the clause’s purpose? If it is designed to prevent the employee breaching the contract, it is more likely to be a penalty. Keep a note of the reasons for including the clause so that it can be justified if challenged.
  • How have you calculated the sum to be paid? If it is significantly more than the loss you will suffer, there is a real risk that the clause will be a penalty. Again, keep a note of how the sum has been calculated.
  • The fact that it is difficult to estimate what loss would be suffered does not mean that a repayment clause cannot be included. In such a case, it may be particularly important to fix in advance what sum will be paid in the event of a breach. Keeping a note of why a particular sum has been included will be important.
  • If the same amount is payable regardless of the severity of the breach, it is more likely that the clause will be a penalty. Consider what loss could be suffered in relation to different breaches, and reflect this in the clause.
  • If appropriate, reduce the payment over time. For example, the repayment from an employee who failed to return to work for a specified period after maternity leave or training should reduce in proportion to the time actually worked.

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