Introduction to this document

Pay in lieu of notice clause

In the absence of an express payment in lieu of notice clause, you don’t have the contractual right to terminate employment summarily upon making such a payment. This doesn’t mean you can’t do it, but you do need to weigh up all the pros and cons.

PILON or damages?

In the absence of an express Pay In Lieu Of Notice (PILON) Clause, pay in lieu of notice will be regarded in employment law terms as a payment of compensation in connection with termination of employment, i.e. damages for breach of contract. With a PILON clause, pay in lieu of notice is regarded as wages payable under the contract of employment. So, why does it matter what it’s classed as? Firstly, with a PILON clause, you can limit the amount payable, as our pay in lieu of notice clause does, to basic salary only. Where you have to pay damages for breach of contract, the damages must put the employee in the position they would have been had the contract been properly performed. This means you will have to compensate the employee for the loss of any bonuses, commission, annual leave and other benefits in kind during what would have been the notice period. Secondly, since without a PILON clause you are technically committing a breach of contract if you pay in lieu, there is a high risk that an employment tribunal will hold that you cannot then enforce the other provisions of the contract. If the contract contained post-termination restrictive covenants, this could cause you a major headache if you can’t rely on them. Thirdly, the employee could try and bring a claim for wrongful dismissal against you if you have paid in lieu with no PILON clause, although if you have adequately compensated them for their loss, their claim may have little substance. Fourthly, if you do not have a PILON clause and you terminate employment without notice, other than in cases of gross misconduct, arguably the contract still continues unless the employee actually accepts your repudiatory breach of contract or until the end of the contractual notice period – which means the employee could demand its continued performance until then. And finally, the clause does not say you have to pay in lieu of notice - it only says that you may do so, so the choice is yours. You can still require the employee to work out their notice period even with a PILON clause.


No duty to mitigate

The major downside to having a PILON clause is that the employee is under no duty to mitigate (reduce) their loss where you have paid in lieu subject to a PILON clause, whereas there is a duty to mitigate in relation to a claim for damages for breach of contract, although since you will probably have made the full payment upfront anyway, i.e. on the termination of their employment, in practice this may make little difference. We’ve provided the option for the payment to be made in equal instalments, which you might want to include where the notice period is longer than one month. Whether there’s a PILON clause or not, the tax position now states that you must calculate how much of the relevant termination payment is post-employment notice pay (PENP). PENP is broadly the “basic pay” the employee would have received for any unworked period of notice minus any contractual pay in lieu of notice, but there’s a complicated statutory formula to calculate the actual PENP figure. The PENP is treated as taxable earnings and subject to the full deduction of tax and NI. Similarly, contractual payments in lieu of notice are also treated as taxable earnings and subject to the full deduction of tax and NI.