Repayment clauses

OVERVIEW

  • This guide looks at what constitutes a repayment or clawback clause; what can be repaid via such a clause; whether such clauses are actually enforceable in law; the relevant employment cases on repayment clauses; some drafting tips to consider if you want to use such a clause; and lastly how to go about enforcing such a clause.

WHAT IS A REPAYMENT CLAUSE?

  • Often called ‘clawback’ clauses, repayment clauses are used for a variety of reasons, for example:
  • to withhold or recover payments from employees under a performance-related pay scheme if a material adverse event occurs following an action by them/the business, e.g. they are paid a significant sum, but this is subsequently found to be based on misleading or misstated accounts
  • to recover or withhold some or all of the costs you have incurred for something which will benefit the employee (e.g. training fees or relocation expenses) when that individual then leaves the business quickly thereafter and the business does not gain the anticipated benefit of the incurred cost
  • required by a regulatory body or because your business is listed, e.g. UK companies listed on the Main List of the London Stock Exchange must explain in their annual report and accounts whether there are any such clawback provisions applicable to each element of their directors’ remuneration package
  • as a deterrent to stop employees from leaving the business – this however is unlikely to be enforceable

WHAT CAN BE REPAID/CLAWED BACK?

  • Subject to the question of enforceability (see below), there are no legislative limits on what can be repaid. In most cases they relate to training fees and relocation fees paid for the benefit of the employee.
  • Avoid double recovery. If your clause covers relocation costs, you cannot include costs which you always incur anyway, and which benefit or cover other staff members. So, for example, for a business which is an existing sponsor for immigration purposes and has already incurred that cost because it covers a number of employees, it would be unreasonable to try to recover the cost for the entire system on a new employee. In comparison, if your business has only gone through the sponsorship process for the new employee, then it could be reasonable to include that cost in the repayment clause.

IS THE REPAYMENT CLAUSE ENFORCEABLE?

  • Employees may argue that these clauses are unlawful penalty clauses and/or amount to unlawful restraint of trade and the business cannot therefore enforce them. However, that is not necessarily correct.
  • These clauses will be enforceable if they are a ‘genuine liquidated damages clause’. Conversely, if the clause is a ‘penalty clause’ and unlawfully restricts the individual from working, it will not be enforceable.
  • A liquidated damages clause compensates the wronged person for the breach of contract. In comparison, a penalty clause is penal because the innocent party requires payment of a sum which is typically more substantial than the damages they could recover in common law, with the intention of deterring the employee (for example) from breaching the contract.
  • However, don’t simply dismiss a clause’s enforceability simply because it isn’t, on initial reading, a genuine pre-estimate of loss. You need to consider the context of the situation, whether this is a complex situation where the innocent party might have a legitimate interest for wanting the contract to be performed properly, and the employee might have taken legal advice and negotiated the terms of the repayment clause.
  • Such a clause could still be an enforceable repayment clause. In 2015 the Supreme Court in Cavendish Square Holding BV v El Makdessi and Parking Eye v Beavis said that repayment clauses will not necessarily be penal (and therefore unenforceable) simply because they are not a pre-estimate of loss or are a deterrent. Rather, whether the clause is enforceable will depend on whether the ‘means by which the contracting party’s conduct is to be influenced are “unconscionable” or “extravagant” by reference to some norm’.

CASE LAW ON REPAYMENT CLAUSES

  • The courts have shown that liquidated damages clauses can be made validly between employer and employee. Some examples are set out below.
  • Proportional repayment of training fees if the employee leaves within a certain timeframe (Neil v Strathclyde Regional Council [1984] IRLR 14 and Cleeve Link Ltd v Bryla [2013] EAT 0440/12).
  • An employer had to pay a senior employee one year’s salary if he was unlawfully dismissed because of the high value his employer put on his services and loyalty, even though the sum in question was greater than the loss suffered by the company. (Murray v Leisureplay plc [2005] IRLR 946).
  • Clawback of wages for failure to work notice period was enforceable in Li v First Marine Solutions Ltd [2014] EATS 0045/13. The EAT, albeit uneasily, agreed it was not a penalty clause, taking into consideration the seniority of the individual, their high salary and the difficulty and cost the business would incur in replacing her. The EAT noted the parties’ intention was important, i.e. whether the clause was to be a penalty clause, a liquidated damages clause or a deduction clause.
  • The courts have taken a robust approach towards employees who have benefitted from a contract but then try to have the damages clause deemed unenforceable as a penalty clause. For example, in Iman-Sadeque v BlueBay Asset Management (Services) Ltd [2013] IRLR 344, the High Court noted that the contract (a compromise agreement) was not penal because it contained rights and obligations which could be to the advantage and disadvantage of either party, and to which both had freely agreed to enter into, and it was also possible that the employee’s breach could result in greater losses for the company than the repayment sum identified in the contract.

DRAFTING TIPS FOR REPAYMENT CLAUSES

  • Give proper thought to the situation and set out reasonable terms. The courts are likely to take into account notes detailing the business’ assessment of the situation and thought process, so keep records of these and set out your rationale in correspondence with the employee. Keep a copy of their consent to the terms.
  • Consider having the terms in a separate contract to the employment contract. If the employment contract is invalidated for any reason (e.g. the business breaches the employment contract and the employee can argue they have been constructively dismissed), then the business can still seek to enforce the separate repayment terms.
  • In the contract explain:
  • what the clause relates to, e.g. payment of training costs directly linked to their field of specialism
  • that the parties agree it’s intended to be a liquidated damages clause and is not to deter or punish the employee from leaving their employment
  • how the repayment sum was determined
  • the commercial justification for using this approach (e.g. loyalty and services are valued, staff stability, confidential property protection)
  • the compensation to be paid (if applicable) and any repayment schedule. It’s best to use a sliding scale so that the sum repayable reduces over a reasonable period. If a business is paying for an employee to study and the course is two years in length, a repayment timeframe might be similar in duration, e.g. 100% if the employee leaves in the first 6 months, 75% in the 6 months after that, reducing to 0% after 2 years. If the timeframe is not reasonable, the clause may not be enforceable
  • Confirm that the specified compensation is a genuine pre-estimate of the loss (if applicable).
  • Phrase the clawback as a conditional primary obligation rather than a secondary obligation triggered by a breach.
  • Always get the employee to read the terms, take legal advice on the terms if they wish and sign and return the agreement to the business. It will be more difficult (but not necessarily impossible) to enforce a repayment agreement which has not been signed by the employee.
  • Ensure your employment contracts have a clause permitting you to deduct sums owed to the business from money due to be paid to the employee by you. This clause is lawful and can be used to recover at least some of the sums owed to the business if exercised in good time. Best practice is to inform the employee that you are going to exercise the clause.
  • Be mindful of your normal practice: if you never enforce this clause for any male employees but then try to enforce it against a departing female employee, the individual could argue that is discriminatory. Equally, if the business has incurred fees but received grants from other bodies or public authorities to cover the costs, then the fees should be reduced; it will not be reasonable to seek duplicate recovery from the employee.

ENFORCING REPAYMENT CLAUSES

  • Repayment clauses are normally enforced through the civil courts. Alternatively, if an employee brings a breach of contract claim against you in the employment tribunal, you could bring a counter breach of contract claim against them in your ET3 response. It is best to take legal advice in such situations.
  • Avoid the courts if you can: it’s better to remind a departing employee about their obligations in good time and enforce the clause amicably.
  • If the employee breaches the clause, be careful that your actions/omissions thereafter do not constitute an acceptance of their breach because this potentially could invalidate your ability to enforce the clause later on.