Payment in Lieu Clauses: Employment Contract

Payment in Lieu Clauses

Not withstanding the notice periods detailed in Statutory Rights employers may want to terminate the contract of employment without requiring the employee to work the specified length of notice - e.g. in respect of sales staff and senior executives. In such cases, there must be a clause in the contract entitling the employer to make payment in lieu of notice. Failure to allow the employee to work out their notice period would amount to a breach of the contract, enabling the employee to claim damages and/or revoke other clauses in the contract.

Such damages would usually be equivalent to the contractual pay and benefits the employee would have been entitled to had the notice period been worked. Accordingly, where an employer makes a payment to an employee in lieu of notice, this payment is, in reality, a payment for damages for the breach of contract.

Employers who make such payments can make them on a gross basis - damages for breach of contract are non-taxable. This is often a useful bargaining tool for employers. Such payments often include the value of benefits such as company car, pension contributions etc. Gross payments can only be offered in the absence of a payment in lieu clause in the contract.

However, if a payment in lieu of notice is made in the absence of an express clause, this would amount to a breach of the Employee's contract of employment. The employee may then be able to argue that any restraint of trade clauses or confidentiality clauses contained in the contract, and which apply after termination, are unenforceable.

An employer must decide between being able to offer a gross payment in lieu with the possible dilution of any restraint of trade or confidentiality clause(s), or retaining the purpose of those clauses by restricting payments in lieu to a taxable sum. To achieve the latter the contract must include the relevant "payments in lieu" clause.