Penalty Clauses in Employment Contracts

One area when an employment contract may be unenforceable is when there is a penalty clause which is found to be void.

Penalty clauses are rare. It is a clause where it imposes a detriment on the employee in the event of he / she breaches the contract which is out of proportion to any legitimate interest of the employer,

What type of employment clauses might be a penalty clause?

1. Repayment clauses – these may include for example the repayment of training costs, relocation allowances or enhanced maternity
pay if an employee does not stay in employment for a particular period of time. Courts normally find these clauses reasonable if they are not too excessive and the employee was clear about them.

2. ‘Liquidated damages’ – these are clauses in a service agreement, when payment is made to a director on breach of contract, change of ownership of the company or where a fixed term is not renewed. If the liquidated damages are excessive they might amount to a penalty clause.

3. Bonus clauses, if they withhold a bonus in certain circumstances

4. Clauses don’t always need to involve the payment of a sum of money to be a penalty, any benefit will do.

5. Indemnities in settlement agreements where the employee needs to repay compensation if they bring a Tribunal or breach perhaps a restrictive covenant. Such clauses sometimes are held to be unenforceable.

However, over the years the courts have been reluctant to strike down penalty clauses.

The employer and employee can assess, in advance, any likely loss that may occur if a contract is broken. If the amount is reasonable and a genuine pre-estimate of the loss, then it will be enforceable – this is known as ‘liquidated damages clause’. Much will depend on the facts and circumstances of the termination of employment, and the amounts repayable.

Contact us if you need any help with Employment Contracts

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