Drafting Employment Contracts

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Siobhan Bishop: Hello and welcome to our podcast where we are discussing drafting issues in employment contracts. So this podcast will focus on 4 issues with drafting employment contracts, focussing on some of the tricky issues at the start and the end of the employment relationship and how to avoid those pitfalls. I am Siobhan Bishop, a Principal Associate in the Employment, Labour & Equalities Team here at Gowling WLG and I'm joined by Martin Chitty, a Partner in our team.

In this podcast we are going to talk about references, contract variation, termination and bad leavers clauses.

So, we're looking at the beginning and we're really wanting this individual to come on board, having met them, perhaps once, perhaps twice, and we offer an employment term where it's all accepted. Now there's a very common provision that any offer is subject to receiving satisfactory references and how effective is that proviso if you find out later that those references aren't, in fact, satisfactory?

Martin: It's certainly a provision very well worth having because it gives you as the employer an opportunity to change things. If the reference completely undermines the picture that the individual has painted then clearly you want to be able to withdraw the offer; that is why it is made subject to the reference being satisfactory. Now, we all know that those giving references have obligations - honesty, clarity, not to mislead, not to misrepresent, not to undermine the individual and all of those are a separate issue really but they're all actionable in their own way.

There's a recent case on this: Francis-McGann v West Atlantic. Francis-McGann was a pilot who applied for a job and in his application said that he had previously got experience as a captain, which is a particular rank in the airline industry, which meant that West Atlantic assumed a certain level of experience, and he gave the name of a referee.

Now, at the time it doesn't appear that they bothered to check on this because the name given is in fact the formal name of Jabba the Hut in Star Wars and it might have been the case that had they checked unless somebody had changed their name by deed poll, they would have realised that Mr Francis-McGann wasn't quite what he seemed to be. It might be that he just had a quirky sense of humour, or it might be that he was actually trying to mislead them.

More importantly, that might have lead them to an enquiry about what else is not quite right here and as it turned out he hadn't got much relevant experience at captain level, so the additional training they provided wasn't suitable because he wasn't at the level to benefit from it. They then fired him because of that. He sued them for his notice pay which they didn't pay because it was summary dismissal and they counter-sued for the cost of the training course and the company won on both counts because he had obviously lost his credibility.

Now I think there's a wider issue here, whether and to what extent people actually take up references and I think we see a big disparity between different sectors, different clients. Obviously, some areas are regulated and a particular form of reference has to be given and it has to be considered, but in many other sectors the market practice these days is to say very little more than "X used to work here and now they don't" which is of no use at all, so the whole thing has rather fallen into disrepute. Some employers I think don't even bother taking references because they know they're not going to get anything of great use to them.

I think one word to the wise would be this: if you get a very detailed narrative reference in a non-regulated sector, I think you should always be sceptical and you might assume that it's been part of some sort of managed exit programme. Certainly long narrative references are very unusual these days and they would always prompt me to think about ringing the person who gave it and see if you could find out what's gone on behind it.

Siobhan: After finding the right person for the job the employer will want to make them an offer. What are the main drafting points to consider at this point, especially if the employer wants some flexibility for making changes down the line?

Martin: That's a very good question, Siobhan, and I think sometimes people become a little confused in terms of what they think they need to put into a contract.

After all, an employment contract is like any other contract - it's simply an agreement between two parties. So the important point is to be very clear on what your terms are and then if you want the right to make variations as you go along then you need to build that in at the outset.

So as a starting point let's be clear about what the initial offer is and what the initial terms are: things like pay, hours, job role, responsibilities, all of the aspects of the remuneration and, to some extent, restrictions when somebody leaves. We might want to look as well at terms around notice, which we're going to talk about a little later. But the main issues to think about are variations and flexibility, so most contracts, particularly for senior executives, are going to have something in them which allows the employer to change things. It might be the place of work. It might be the hours of work, it might even be remuneration or bonuses. And actually, bonuses and deferred consideration often have provisions in which will allow the employer to change the scheme or the timing of payments, depending upon performance, as the contract proceeds. So those things can all be built in at the start.

Siobhan: OK, so let's assume that all those provisions don't get you where you need to be. What can you do then?

Martin: Well there are probably 3 or 4 basic choices. I'm going to concentrate on two of them because I think they're the most difficult. But like any other agreement, one way of changing it, is to get the other party to agree to it. So I approach you and say "can we change this?" - you agree, we're all happy, and the important part is that we're very clear on what the contract now does and the terms which it contains. So that's the most straightforward and the happiest way of doing it. The most aggressive form of doing it in some ways is at the opposite extreme, where you and I can't reach an agreement, so I decide that I'm going to really up the ante. So what I'm going to do, because I want you to stay but on different terms, is to terminate your employment on notice and say "yes, but at the end of that notice period, here is a new contract which will take effect on slightly different terms" and this is done quite routinely but it has to be accepted I think that it's very much the nuclear option, because you are actually dismissing someone. They may not stay. They may not ever see you in the same light again. And even though they may accept the new provision in the short term, in the long term it has probably damaged the relationship quite severely.

So let's look at those two middle courses and these are both about imposition and the problem with imposition is that you get a complete lack of certainty and clarity and what both parties really need in the employment relationship is certainty and clarity about the terms of the contract.

So the two options are these: one is to impose pretty much without notice - so I say to you Siobhan "this is going to happen as from Monday like it or lump it", or I say to you "this is going to happen in 3 months' time, because that's your notice period, and then I'm going to impose the change". And this might be a change in hours or pay and this does happen quite commonly to be honest, as a mechanism. So the problem you have is uncertainty. So some way down the line we have a dispute and you will say "but I never agreed to that Martin". And my argument is going to be "Well, in the intervening two years, Siobhan, you've come to work every day, you've done what I wanted you to do under the new contract, or you've been paid at the new rate - you can't now say that you didn't accept it as you went along".

And there has been a relatively recent case involving Nottingham City Council on this that has gone to the Court of Appeal, so some changes were imposed by the Council and at the time they were imposed the individuals, through the union, made clear that they rejected the proposal, even though they were going to continue to work. But the Council ran the argument that, well, after two years, surely they can't maintain that position and the Courts said, and I think unsurprisingly actually - I think it was probably the cost of not getting the changes through that drove the council to litigate - but the Court has said very clearly - no, the individuals, through the union, made clear at the time that this was not acceptable and they weren't going to go along with it, although they would continue to work and on that basis the individuals aren't bound by the new contract.

So if you're going to go down this imposition route, you've got to be very clear about what actually you want from it and how you're going to get to that clarity of position and understanding and if that doesn't work for you and nobody likes a loose end, then maybe you ought to consider going nuclear and dismissing and re-engaging, because it isn't actually going to make the situation that much worse.

Siobhan: Ok, thanks Martin. So, you did mention dismissals as being a nuclear option but assuming that we're not at a nuclear option, but jumping ahead to the end of the employment relationship where the employer has decided to dismiss the employee, in this case on written notice, it's really important to know when that notice starts to take effect, not least because then you can calculate the actual termination date and, ultimately if the employee does bring a Tribunal claim, whether that claim is brought in time or not. So, if you send notice of termination by post, when does that take effect?

Martin: In a typical lawyer's way I'm going to say "that depends" because it depends on the circumstances and there's 3 or 4 examples we might look at. So in relation to a prospective unfair dismissal claim, and here we are focussing on what lawyers refer to as the effective date of termination, the position is pretty clear: if notice is given in writing it is not effective until the person sees it. So it's not the question of the date on when it was posted, or the date on which it was delivered, but the date on which the individual actually saw it, and that's the effective date of termination.

In a contractual situation most, certainly executive contracts of any complexity, will have a provision identifying when notice is either deemed to have been served, and that's the right provision, and when it's actually served. But there are some cases where there isn't anything in the contract about how and when notice has to be given. So, a starting point is always to check what does the contract say. Does it require notice in writing? Because if it does and you don't give it, the notice is ineffective and time is not running at all.

But let's assume you've done all that, but in a situation where the contract says nothing at all about when notice reaches the individual, what happens?

There was a case just a few weeks ago in the Supreme Court, the most senior court in the land, on this point which was important because the date of termination was key to the level of payment due to the individual. And here the argument was: when does this happen? Is it when it's posted? When it's delivered? When it's received by the individual and read?

And the Supreme Court quite clearly comes down and says "Well, it's fairly obvious to us that it can only be at the point at which the individual receives it. How else are they meant to know that notice has been given?" So, nothing until that point counts. But you do need to focus on the fact that this case is only applicable where there isn't anything in the contract about how and when notice is given.

And the same issues will also apply in relation to giving notice where you want somebody to work their notice, although increasingly we see that as uncommon. Somebody working out a long period of notice is rarely a happy experience for anybody, or more importantly, where we are putting people on garden leave, or we're triggering some sort of "pay in lieu of notice" clause.

And one thing, just to mention in passing, we're seeing a change in practice with "pay in lieu of notice" clauses. Historically we've seen them very much on the basis that the individual will get a lump sum at or about the time notice is given, that ends the relationship, and that might cover salary or salary and benefits, but the lump sum is paid up front. Increasingly, and part of this is to do with changes in corporate governance, we are seeing a migration towards a situation where, either payment is made on the drip, month by month - so the individual is not getting that cashflow advantage and the company is not suffering the cashflow disadvantage of having to pay everything up front.

We're also seeing an obligation for the individual to mitigate - go out and look for another job and to give credit for their earnings. Now this is a big change, in fact, because mitigation is normally only associated with a breach of contract. There is no breach where you pay under the PILON - you are doing what the contract says you can do. So, putting that sort of provision in and it's worth considering in new contracts - that may reduce your costs over time because the individual has a contractual obligation to go and look for another job and you can argue, if it comes into dispute, that they weren't doing it and they should have done. Now at this point and if you go down that route, PILONs become more and more attractive to employers and less and less attractive to employees, because there is no upside for them - they're not going to get that windfall that historically they might have got because of the lump sum payment up front.

Siobhan: The other thing we look for on exit is that many contracts for senior employees have what is known as a "bad leaver" clause. These clauses are most frequently used when an employee leaves in certain listed and specified circumstances, such as either before a certain particular date or if they are summarily dismissed for gross misconduct. So the aim here is to incentivise the employee to stay for a certain time period, or not to act in a bad way. And if they do either of these things it will affect the employee's entitlement to receive certain shares or other payments. Martin, should payment and remuneration schemes containing bad leaver schemes removing the rights to monies earned if an employee leaves in those circumstances be enforceable?

Martin: Well I think the question of should they be is a bit of a moot point, because what's been made very clear in recent cases, is that they are enforceable. So therefore they are open to the employer to use in certain circumstances. And I think we will see this, which is also a popular move, certain in certain investment led businesses - we will see it as a popular move as more and more elements of consideration within PLC companies need to be deferred as part of the overall remuneration policy in governance changes which is coming into effect this year.

So, how and why do we get to this position? It does seem objectionable that somebody should lose something they see that they've already earned - either because it's money deferred because they sold part of the business, for instances, or where they've had a bonus that they can suddenly lose out on that down the line simply because they do something which they are entitled to do.

The most recent example of this is a case where an individual had a very small shareholding in a company which they had been given. Later, the company was sold, some of the money was held back for a period of time, and that money would either be lost completely or the money would only be released later if the individual left in certain very clearly drafted circumstances. Time passed, the individual decided to leave, perfectly properly, they gave the appropriate amount of notice under the contract that they chose to resign, and the resignation by the individual was one of the issues which made them a "bad leaver" as it's called. There are other ways of defining that - it can be "not a good leaver" or some other form of definition, but let's call it a "bad leaver". So the individual complained to the Employment Tribunal that they should have been paid and that there were various issues around the money being withheld which rendered that provision unenforceable.

The arguments the individual ran were three:

(1) the first was that it was what's called an "unconscionable bargain" - that it really was something which was so outrageous it couldn't possibly be enforced and both the Employment Tribunal and the Employment Appeal Tribunal threw that one out almost immediately on the basis that "well you were gifted these shares, you're not at a negotiating disadvantage because you were legally represented actually on the sale, so you're not going to get over the hurdle from that point of view";

(2) the second was that losing this money simply because you had left was a penalty and penalty clauses, as you will know, are not readily enforceable. The Court there again was very clear on this. The concept of penalty clauses only arises where you've got a breach of contract and here you did something which was in accordance with the contract and your employer did nothing which was in breach, so again you don't get off first base, from that point of view. The issue simply does not arise of it being a penalty;

(3) there was a novel argument in the Employment Tribunal that actually this was an aspect of modern slavery. That the individual was being forced or compelled to work without appropriate remuneration and, again, the Tribunals gave that pretty short shrift, saying "well that's just misconceived I'm afraid, because you were properly paid when you were working, that's what that's about. The issue of whether you are now going to lose out some money which had been in effect 'banked' for later payment which wasn't to do with your employment actually, again simply does not arise, so you lose on all counts".

When it went to the Employment Appeal Tribunal there was a slightly different argument, which was that - and people will be familiar with this - "but this is money due to me: it has been withheld when it shouldn't have been, therefore it's an unlawful deduction of wages under the Employment Rights Act". And there the EAT were again very clear, saying "no, this is not wages - you can't use that mechanism to get money which isn't caught by the legislation itself".

So, at this point "bad leaver" provisions of this type seem to be readily enforceable and they are used, not uncommonly it has to be said, and they are generally extremely one sided. So from an employer's point of view, if you want to retain someone or make it less attractive for them to leave, you can legitimately use this sort of provision.

I think there are arguments here about whether this is an "unlawful restraint of trade" and there have been historic cases which have looked at this in a slightly different context, but in effect you are imposing such a disincentive on somebody to leave that they won't do it and the question is, I think, whether you should be allowed to do that at all - but that's an argument for another day and perhaps another podcast.

Siobhan: Thank you Martin, and thanks for the summary of those issues, particularly highlighting some of the industry changes and the market approach to some of these key clauses. So of course if you have any questions on employment contracts, please do not hesitate to get in touch with Martin or somebody in the team. Thank you.

Martin: Thank you for listening to this Gowling WLG podcast. If you like this episode, please be sure to check out our website: gowlingwlg.com for more useful podcasts and articles, or please leave us a review on i-Tunes. Make sure you subscribe to the podcast and join us for our next episode.