With executive severance packages and redundancies in the news , and several significant law cases already this year , it is timely to review the state of play in this area.
Payment in Lieu of Notice ("PILON") Clauses
Many contracts of employment contain these clauses. Following Abrahams -v- Performing Rights Society [1995] IRLR486 ( Court of Appeal ), there was a view that employers were bound to pay out in full under a PILON clause, whether or not they exercised it. The Court of Appeal's decision in Cerberus Limited -v- Rowley [2001] IRLR 160 however confines Abrahams to its own unusually worded clause, in holding that , under the usual form of wording , the employer has a choice between exercising the PILON clause or facing damages for breach of contract. A damages claim can of course be mitigated, but no mitigation is possible under the usual form of PILON clause.
Damages for Breach of Contract
The long established principle is that the maximum claim is the value of the pay and benefits that would have been earned during the notice period under the contract and this was confirmed by the House of Lords in Johnson -v- Unisys Limited [2001] IRLR 279. But in the wholly exceptional case where the ex-employee has been "stigmatised" by his former employer, Malik -v- BCCI [1997] IRLR 462 (House of Lords) decides that further damages can be awarded. It seems also from comments made in Johnson that injury to feelings caused by the manner of dismissal may be a head of loss in a statutory unfair dismissal claim.
The concept of "mitigation" is much understood. It does not provide for a reduction in compensation where the employee "contributed" to his own dismissal by poor performance falling short of a breach of contract. It only allows a reduction to take account of his earnings from any new job in the notice period.
Redundancy
Redundancy is a potentially "fair" reason for dismissing someone , for the purposes of the statutory unfair dismissal claim. But it does not excuse the employer from complying with the contract of employment. So, a redundant employee may still have a claim for damages for breach of contract.
Redundancy also has a very specific meaning under Section 139 of the Employment Rights Act 1996 (and a different wider meaning for the purposes of informing and consulting employee representatives!) Subject to satisfying the eligibility tests, redundant employees will be legally entitled to statutory redundancy pay ("SRP") on top of their contractual entitlements. The current limit on weekly pay for the SRP calculation formula is £240, so the maximum amount of SRP payable under that formula is £7200
Company Directors and Severance Pay
The Companies Act imposes a number of constraints. First s312 prohibits any payment of compensation for loss of office without prior approval of the shareholders. Second, s316(3) creates an exception for bona fide damages for breach of contract or by way of pension for past services. Third, s310 declares void any release of the director from liability for negligence, default, breach of duty or breach of trust. There are further special rules where the loss of office is connected with a takeover of the company.
What little case law there is says that s312 does not apply to payments which are written into the contract. But if such payments are excessive in their context , they might be challengeable at law as ultra vires the directors or as a penalty clause.
Severance Pay and Tax
First, SRP is always tax free by virtue of s579 of the Taxes Act, but it counts against the £30,000 available tax free under s148 Taxes Act.
Second, the tax break under s148 for up to £30,000 tax free only applies if the severance payment "is not otherwise chargeable to tax" i.e. if it escapes the ordinary Schedule E charge on emoluments. The tax break is not therefore automatic, and several recent cases illustrate that the gateway to s148 is narrow.
EMI Electronics Limited -v- Coldicott [1999]IRLR 630 (Court of Appeal ) establishes that PILON payments under PILON clauses are fully taxable, even in the context of genuine redundancy.
Richardson -v- Delaney (High Court, 11th June 2001) decides that, where the termination of employment itself is by mutual agreement, the compensation payment is also fully taxable. This can be avoided by firing the employee in breach of contract first and then negotiating a financial settlement of (just) the legal claims resulting from the firing.
There is of course, a direct benefit to the employer from the payment falling within s148 - namely the saving of employer's NICs on the compensation payment.
Severance payments to employees who are retiring (whether early or at NRD) will also be fully taxable, because of specific provisions in Inland Revenue Statement of Practice 13 of 1991.
On the other hand, additional redundancy pay, whether under an agreed scheme or a company policy will fall into the beneficial regime under s148 under Inland Revenue Statement Practice 1 of 1994.
Conclusion
This is an area where care must be taken to ensure the optimum route is followed.
