Penalty clause or genuine pre-estimate of loss

The Claimant was recruited from Poland as a care worker. The employer paid a recruitment agency fee and the costs of the flight. The contract contained a clause to the effect that "if the employee’s employment is terminated as a result of the employee’s misconduct… within 6 months of their date of commencement, the employer reserves the right to recoup these costs in full from the employee".

The Claimant was sacked for gross misconduct after less than 3 months and the employer set off the costs it has incurred against her unpaid wages. She issued proceedings for unlawful deduction from wages.

The Employment Tribunal found in her favour that the clause was a penalty clause and so unenforceable. On appeal to the EAT however the clause was considered to be a liquidated damages clause because there was a connection between the amount to be claimed and the maximum loss that could be incurred.

The EAT pointed out that the key point to look at, in deciding whether a clause is a penalty clause or a genuine pre-estimate of loss, is whether, when the contract was entered into, this was designed as a deterrent or a genuine provision for compensation. The EAT also held that the clause has to be constructed on an objective basis and the genuineness and honesty of the parties was irrelevant. It also held that a comparison needed to be undertaken between the amount which could be recovered for loss through an action for breach of contract, and the amount set out in the contract as a fixed sum. If there was a huge gulf between the two, it is more likely that the clause was intended as a deterrent to breach of contract and so a penalty clause. If, however, there is some form of relationship between the figure to be recovered under the contract and the amount of loss it will be considered a liquidated damages clause, as here.

This legal update is provided for general information purposes only and should not be applied to specific circumstances without prior consultation with us.

For further details on any of the issues covered in this update please contact Gemma Ospedale, Partner in Employment on 020 7583 2222