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December 18, 2014

UK Employment Alert No 206: How to Terminate Employment and Exercise a Payment in Lieu of Notice Clause

The UK Supreme Court has provided guidance about two issues of importance for employers wishing to dismiss a UK employee: 

  1. What happens when an employer dismisses an employee in a manner that breaches the terms of the employee’s employment contract?  Is the employment relationship immediately brought to an end despite the employer’s breach, or does it continue?
  2. If an employer wishes to rely on a payment in lieu of notice (PILON) clause, is it enough simply to make the payment of money required by the PILON clause, or is something more required?

Background

The Supreme Court considered these questions in a case involving an employee, G, who was told by his employer on 29 November 2007 that he was dismissed without reason but “with immediate effect”.  G was told simply that appropriate termination documentation would follow.

G’s contract of employment entitled him to receive three months’ notice of termination.  It also contained a PILON clause that permitted the employer alternatively to terminate employment immediately by making a payment to G equivalent to the salary and benefits he would otherwise have received during his notice period.  On 18 December 2007, the employer made a payment direct to G’s bank account in an amount equivalent to the PILON but did not inform G of this action.  G discovered the payment within the next few weeks. 

On 2 January 2008, G wrote to the employer saying that he had decided to “affirm” his contract of employment, thereby keeping it alive.  He did so on the basis that it had not, in fact, been validly terminated, either on 29 November 2007, when the employer sought to dismiss him in breach of contract, or on 18 December 2007, when the payment was made.

Can an employer effectively dismiss an employee if it fails to tell him/her how that dismissal is to operate?

The Supreme Court said no.  It is now clear that if an employer does not tell the employee which of the bases for dismissal set out in the contract of employment it relies on, that will be a breach of contract and the dismissal will not be effective unless and until it is accepted by the employee.  Here, the Supreme Court confirmed that it was up to G to decide whether to accept the termination or choose to “affirm” the contract and remain an employee.

Can an employer terminate employment simply by paying the money due under a PILON clause?

Again, the Supreme Court said no.  Employment can be terminated effectively and immediately by proper exercise of a PILON.  But if an employer wishes to exercise a PILON, thereby bringing the employment contract and relationship to an immediate end, it must notify the employee, in clear and unambiguous terms, that it is exercising the contractual right to bring the employment contract to an immediate end and that a PILON will, or has, been paid and make the required payment.

What does this mean for employers?

Employers wishing to dismiss employees should:

  • check the terms of the employee’s employment contract in advance to ascertain how the relationship may be terminated lawfully; and
  • tell the employee clearly (preferably via a well-drafted dismissal letter) which of the methods of terminating the employment set out in the contract it relies on.  If there is a PILON clause, refer to it expressly in the dismissal letter. 

But, what if there is no PILON clause?  There are many employment contracts that deliberately do not have PILON clauses so that sums paid in lieu could be paid tax free (which worked before HMRC cracked down on it).  However, employers operating under those contracts still wish to be able to dismiss with immediate effect, not least when time is of the essence.  Following this case Claimant lawyers will, no doubt, now argue that it means that such dismissals in breach of contract will not be effective if the employee affirms the contract (indeed, following G’s case that would seem to be right).  Therefore, employers would now be best advised to include PILON clauses in new contracts, and even to seek to vary any current contracts for senior employees, to include a PILON clause so that immediate dismissal can be validly effected.  We would be delighted to advise further on this.

© 2014 McDermott Will & Emery

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About this Author

Associate

Paul McGrath is an associate in the law firm of McDermott Will & Emery UK LLP, based in its London office. His practice covers all areas of contentious and non-contentious employment law in the UK.

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Partner

Sharon Tan is a partner in the firm of McDermott Will & Emery UK LLP, based in its London office.  Her practice focuses on all aspects of contentious and non-contentious employment law.

Sharon has extensive litigation experience.  She frequently handles matters such as complex discrimination, whistleblowing and unfair dismissal claims in the Employment Tribunal, the Employment Appeal Tribunal and the Court of Appeal.  She also has significant experience of handling High Court litigation, including injunctions and contractual disputes.

Sharon regularly...

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