The courts have recently shown themselves
quite willing to interfere in employment contracts to curb the worst excesses
of "creative" drafting. sarah lamont looks at some of the
circumstances in which clauses might be held unenforceable
Generally,
people have the freedom to agree whatever contractual terms they wish. So where
the parties to an employment contract expressly agree on terms, these will
determine the contractual relationship, and the courts will not usually seek to
interfere with them.
Employers
will often attempt to build in flexibility for themselves in case it should
ever be needed. However, there is a warning to be heeded: recent cases have
shown that where provisions are drafted in a way that is either oppressive or
too wide-ranging, the courts can, and do, interfere to hold that such clauses
are legally unenforceable.
It
is important to be aware of the limits on your freedom to contract, not least
so you can take steps to draft contracts in a way which is likely to be upheld.
It is a case of planning for the "what if?" scenario – while
recognising what is realistically achievable.
There
are some clauses which will never be enforceable and no amount of careful
drafting will change that. It is as well to be aware of those. In contrast,
there are some cases where the question of whether you can rely on a clause
depends on the forethought that has gone into the writing of the contract.
Penalty
clauses
It
is important to distinguish between a liquidated damages clause and a penalty
clause. This is because the two can look very similar – but the first is legal
while the second is not. A liquidated damages clause is where the parties agree
that if either side breaches the terms of the contract, it shall pay to the
other a specified sum of money. The key to making such a clause enforceable is
that the sum must not exceed a genuine estimate of the loss the innocent party
would be likely to suffer as a result of the breach.
In
contrast, where the contract states that the party committing the breach is
required to pay an excessive sum disproportionate to the loss likely to be
suffered by the innocent party – so that, in fact, it is designed to
"frighten" the other party into complying with the contract terms –
the clause will be deemed a penalty clause and therefore unenforceable.
An
example of a penalty clause in an employment contract arose in the recent case
of Giraud UK v Smith, 2000, IRLR 763. Smith was employed by Giraud and under
his contract of employment he was required to give four weeks notice. The
contract also provided that, "failure to give the proper notice and work
it out will result in a reduction from your final payment equivalent to the
number of days short".
Despite
this clause, Smith terminated his employment without notice. Relying on the
clause, Giraud refused to pay him the money he would otherwise have been due on
the basis it was entitled to recover from him a sum equivalent to his four
weeks notice pay.
The
tribunal held the provision was a penalty clause because its purpose was to
deter employees from leaving without giving notice. The amount recoverable by
Giraud was not related in any way to the actual loss it might suffer if the
employee failed to give proper notice. Indeed, Giraud was potentially not going
to suffer any loss at all because any money which had to be paid to cover the
four weeks notice period could be set off by not having to pay Smith.
Giraud
appealed to the Employment Appeal Tribunal, which upheld the tribunal’s
decision. The EAT found the following points to be important:
–
The sum the employee was required to pay under the clause was not a genuine
pre-estimate of the loss or damage the employer would suffer.
–
It did not place any limitation on the employer’s right to recover damages for
actual loss in the event of this being greater than the amount specified in the
clause.
–
Effectively it was a case of the company saying to Smith, "Heads I win,
tails you lose".
The
question of whether a sum stipulated is a penalty or liquidated damages is to
be judged on the terms and inherent circumstances of each particular contract
at the time of the making of the contract, not at the time of the breach. Of
course, there is always a risk that a lawful liquidated damages clause may
specify a sum which is more than the loss actually sustained, even where there
was a genuine attempt to estimate likely loss. The courts should not,
therefore, be quick to interfere but where the effects of the clause are
oppressive, they will.
Unfair
contract terms
There
used to be some doubt as to whether the Unfair Contract Terms Act 1977 (UCTA)
applied to contracts of employment. This was mainly because it is used where
"one of the parties to a contract deals as a consumer, or on the other’s
written standard terms of business". The issue was finally resolved this
year in the case of Brigden v American Express Bank, 2000, IRLR 94. The High
Court said it was clear that UCTA was intended to apply to contracts of
employment and that, in most cases, an employee will be "dealing as a
consumer".
This
decision certainly increases the scope for employees to challenge express terms
in their contracts. One instance in which an UCTA argument could be used is
where an employer tries to limit the entitlement to exercise share options
after termination, even where the termination of employment amounts to a breach
of contract by the employer.
However,
UCTA applies only to clauses drafted in such a way that they seem to exclude or
restrict the employer’s liability for breaches, or to allow the employer not to
perform the contract, or to perform it in a substantially different way from
that reasonably expected. The case of Brigden gives some clues as to how the
courts might approach this in the employment arena.
Brigden
was dismissed without a disciplinary procedure. He claimed loss of salary and
contractual fringe benefits for the period of time it would have taken the bank
to carry out the procedure. The bank relied on a clause in his contract which
said, "An employee may be dismissed by notice and, or, payment in lieu of
notice during the first two years of employment without implementation of the
disciplinary procedure".
Mr
Brigden asserted that this provision was unenforceable because it was
unreasonable under section 3 of Ucta. Section 3 states that where one of the
parties to a contract deals as a consumer, or on the other’s written standard
terms of business, "as against that party, the other cannot by any
reference to any contract term: (a) when himself in breach of contract, exclude
or restrict any liability of his in respect of the breach; or (b) claim to be
entitled: (i) to render a contractual performance substantially different from
that which was reasonably expected of him; or (ii) in respect of the whole or
part of his contractual obligation, to render no performance at all; except in
so far as the contract term satisfies the requirement of reasonableness".
However,
the court held the clause limiting the application of the disciplinary
procedure, although expressed in negative terms, was actually a clause setting
out his entitlement and the limits of his rights. It was not covered by the
definition in section 3.
Finally,
the court held that even if the clause had come within the section, it would
probably have satisfied the requirements of reasonableness.
Excluding
statutory rights
Terms
in the contract which limit or exclude statutory employment protection rights
under the Employment Rights Act 1996 are void, subject to limited exceptions
which are set out in section 203 of the Act.
The
most well known exceptions are COT 3 agreements, where Acas has conciliated,
and compromise agreements. Similar provisions are contained in the Sex
Discrimination Act, Race Relations Act, Disability Discrimination Act, Equal
Pay Act, and the Trade Union Labour Relations (Consolidation) Act.
Restrictive
covenants
Restraint
of trade clauses are a category of terms often held to be void by the courts.
The general rule is that all contractual restraints on an ex-employee’s freedom
to work are void, unless they can be shown to be reasonable in terms of
protecting a legitimate business interest – and that they go no further in
terms of duration and geographical extent, prohibition on business activities
and customer contact, than is absolutely required.
This
is therefore another case where careful drafting is crucial. Courts will
construe the clauses in the narrowest way possible and any ambiguity will go
against the employer.
Key
points – penalty clauses
–
Consider the purpose of the clause – if it is genuinely intended to allow you
to recover loss you are likely to suffer, rather than as a deterrent, it should
be enforceable.
–
Ensure the drafting of the clause reflects that purpose: if it is ambiguous it
will be interpreted against you – for example if it could be read as allowing
you to recover more than the likely losses.
–
Beware of clauses concerning the repaying of training fees. You might well want
to recover money spent on training an employee if he or she leaves to go to
another job and your investment is wasted. In most cases this should not be a
problem. However, there may be cases where you are able to gain something from
the training, so take care to draft the clause in such a way as to tie it to
loss actually suffered.
Key
points – unfair contract terms act 1977
–
Employment contract terms are governed by UCTA.
–
An employee can challenge any clause drafted in a way that it seems to exclude
or restrict the employer’s liability for breaches, or purports to allow the
employer not to perform the contract, or to perform it in a substantially
different way from that reasonably expected.
–
The onus will then be on you to show the clause is reasonable.
–
Be clear about what you want to achieve with the clause and ensure the drafting
reflects that, where it is a legitimate aim.
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–
Be prepared to show business reasons for including the clause as that may
assist in demonstrating reasonableness.
Sarah
Lamont is an employment partner at Bevan Ashford in Bristol
