Employee Entitled to 3 Months Notice Despite Employer Making Ex-gratia Payment

Payments made purely in connection with the termination of employment will be free of national insurance and, to the extent that they do not exceed £30,000.00, also free of income tax.  However, notice pay and payments in lieu of notice paid in accordance with terms and conditions of employment are contractual payments and therefore subject to tax and national insurance.  For this reason, some employers choose to dismiss employees without notice, thereby in breach of contract, and pay them damages equal to the net pay that they would have earned had they worked their notice.  Dealt with properly, no tax or national insurance (including employees’ national insurance) is payable in these circumstances, and this can produce substantial savings for the employer.

Publicis Consultants UK Ltd intended to adopt this approach when dismissing its employee, Ms O’Farrell, by reason of redundancy.  Ms O’Farrell, who was entitled to three months notice, was dismissed with just four days notice.  Publicis notified Ms O’Farrell in writing that she would be paid (i) an ex-gratia payment equal to three months salary; (ii) a statutory redundancy payment; and (iii) in respect of accrued but untaken holiday.  Payments (i) and (ii) were confirmed to be free of tax and national insurance deductions.

Ms O’Farrell submitted claims to an employment tribunal that the Company had committed a breach of contract by failing to pay her her three months notice pay.  The employment tribunal upheld her claims and the Company appealed to the Employment Appeal Tribunal, arguing that the ex-gratia payment amounted to damages in respect of Ms O’Farrell’s dismissal without proper notice.

The Employment Appeal Tribunal held that, on a correct construction of the letter confirming the payments, the payment was truly ex-gratia, i.e. a gift and the Claimant was contractually entitled to an additional amount equal to three months notice pay.

Employers seeking to dismiss in breach of contract would be well advised to make it clear in a letter outlining a severance payment, that such a payment is inclusive of damages for dismissal without notice.  Further, if the employer is contractually entitled to make a payment in lieu of notice, the letter should make it clear that it has elected not to exercise its right, and is dismissing in breach of contract in order to prevent any later claim by the Revenue for tax, national insurance, interest and penalties on the amount paid.  It may be prudent to make any enhanced severance payment conditional upon the employee entering into a compromise agreement, which would not only clarify the nature of the payment, but also – if properly drafted - compromise any claims the employee might have, including a claim for notice pay.

An important point worth noting is that a breach of contract will invalidate any post-termination restrictive covenants and confidentiality provisions in place.  Therefore, if an employee is considered to be a commercial threat, employers should not dismiss employees to whom such post-termination obligations would apply without notice in breach of contract, unless the employee has entered into a compromise agreement which repeats the provisions and confirms that they will remain in force notwithstanding the fact that the employment has terminated.

Employers are encouraged to take advice from a specialist employment lawyer before any dismissal in order to avoid potentially significant liabilities in connection with breach of contract, unfair dismissal and/or unlawful discrimination and to ensure that the most suitable method of termination is applied.  We often find that the tax savings which result from our advice in connection with a dismissal will exceed – sometimes by a considerable margin – the cost of the actual advice.