CONTRACTS - 23.08.2017

Should you have a contractual PILON clause?

From an employer’s point of view, it’s advantageous to include a pay in lieu of notice (PILON) clause in staff employment contracts. What are the benefits of doing so and are there any disadvantages?

WHAT’S A PILON CLAUSE?

A pay in lieu of notice (PILON) clause (see Follow up ) generally gives you the option to provide an employee with pay in lieu of notice on the termination of their employment. If you exercise your right under such a clause, the employee’s employment contract comes to an immediate end, i.e. they don’t work out their notice period, you owe salary in lieu and they aren’t obliged to mitigate their loss or give credit for earnings from a new job during what would have been their notice period. Where there’s no PILON clause, you commit a breach of contract by dismissing the employee without giving them proper notice and what you must pay is damages that they would recover for wrongful dismissal. However, in this case, the employee is under a duty to mitigate their loss. So if there’s no duty on the employee to mitigate their loss under a PILON clause, what are the benefits of including it in the employment contract?

BENEFITS OF A PILON CLAUSE

The two key benefits of a PILON clause are:

  1. Your clause wording can expressly confine the PILON payment to basic salary only, e.g. “any such payment will consist solely of basic salary”. This contrasts with breach of contract damages which must include a payment in respect of other benefits that would have accrued during the notional notice period, such as holiday pay, pension rights, commission, etc.
  2. You’re not in breach of contract if you dismiss the employee without notice, so you can continue to enforce other contract terms against them, notably restrictive covenants. On the other hand, where there’s no PILON clause and you commit a breach of contract, this may have the effect of releasing the employee from restrictive covenants.

Pro advice 1. Make sure your PILON clause defines how the PILON payment is going to be calculated and whether any benefits other than salary are to be included. It should also make clear that the employee has no right to receive a PILON payment as the use of the clause is at your absolute discretion, i.e. you can still require the employee to work out their full notice period if that’s what you want.

Pro advice 2. Following Societe Generale, London Branch v Geys 2012 (see Follow up ), you must not only exercise your contractual right to make a PILON payment but also expressly confirm to the employee that’s what you’re doing. A PILON payment into the employee’s bank account won’t be sufficient to bring the employment contract to an end if you’ve otherwise failed to notify them, in clear and unambiguous terms and ideally in writing, that you’re terminating their employment with immediate effect in accordance with the PILON clause.

Pro advice 3. When making a payment under a PILON clause set out in writing how it’s been calculated and when it will be paid (see Follow up ).

TAX DISADVANTAGE

A contractual PILON payment represents earnings and therefore is taxable and liable to NI, whereas damages for loss of notice are currently not generally subject to deduction of tax, up to the £30,000 exemption.

Pro advice. The government is proposing that from 6 April 2018 all payments in lieu of notice equivalent to the amount of basic pay will be treated as taxable earnings, i.e. subject to tax and NI regardless of whether there’s a contractual PILON clause.

Pay in lieu of notice clause

Societe Generale, London Branch v Geys 2012

Letter confirming pay in lieu of notice

With a PILON clause, you won’t be in breach of contract if you dismiss an employee without notice; you can still enforce restrictive covenants and you can limit the payment in lieu to basic salary only. From April 2018 the tax position is also likely to be the same whether there’s a PILON clause or not.

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