Can employers deduct from pay if an employee fails to provide or work their notice?

If an employee terminates their employment without providing due contractual notice, can an employer make a deduction or require payment from the employee as compensation?

The frequent inclusion of forfeiture clauses in employment agreements suggests that employers are keen to ensure the obligations and costs of providing (or failing to provide) notice are reciprocal.

Forfeiture Clauses

Forfeiture clauses are often included in employment agreements to compensate for an employee’s failure to provide notice. Commonly, that if the employee fails to provide notice, the employer is entitled to deduct an amount equal to the period of notice due e.g. if the notice period was 2 weeks, this would mean that the employee would not be paid for the work completed in the 2 weeks prior to terminating their employment in addition to forfeiting payment for the notice period that was not provided and/or worked.

However, these provisions create tensions with the Minimum Wage Act, which requires an employee to be paid minimum wage for all hours worked and the Wages Protection Act which prohibits unreasonable deductions. These statutory provisions override any contractual agreement.

Some employers include forfeiture clauses solely as a deterrent. However, an employer who has a particular interest in an employee working out their notice may be motivated to act on, or seek enforcement of the clause.

Empty Threat, or Enforceable?

In terms of enforceability, the Employment Court has previously confirmed that where a forfeiture clause sets out a “genuine covenanted pre-estimate of damage” it is enforceable as a liquidated damages clause. Where it doesn’t, the clause is deemed a penalty provision and is unenforceable. It is not lawful for an employer to deduct or require payment from an employee simply as punishment for failing to provide notice.

The Supreme Court has clarified that the test for determining whether a clause with a non-performance consequence is an unenforceable penalty provision is whether the consequence is proportionate to the legitimate interests of the innocent party in performance of the provision. A consequence will be out of proportion if the consequence is exorbitant when compared with the legitimate interest protected. This assessment must take place notionally at the time the provision was agreed, not at the time of the breach.

Caleys Ltd v Deadman [2024] NZEmpC 200

This test was applied by the Employment Court in Caleys Ltd v Deadman to determine whether the company was entitled to a payment, in accordance with a forfeiture clause, for Ms Deadman’s failure to provide notice.

Ms Deadman’s employment agreement contained a forfeiture clause requiring one month’s notice of termination or payment to the equivalent. Ms Deadman was reminded of the requirement to provide one months’ notice or payment to the equivalent. Ms Deadman resigned with one days’ notice.

Caleys Ltd deducted $1,303 from Ms Deadman’s pay and requested payment of $3,157, being the outstanding sum for one month’s wages in accordance with the forfeiture clause.

Legitimate Interest

The Court accepted that employers have a legitimate interest in ensuring employees provide notice of termination to avoid incurring losses and to protect its commercial interest in having a reasonable opportunity to recruit a replacement staff member.

This legitimate interest includes ensuring that:

• Workflow handover is efficient, and business continuity is preserved;
• Business opportunities are not restricted;
• Service to customers is not undermined therefore protecting future growth prospects; and
• Strain on the remaining workforce is limited, particularly in a small business which doesn’t have the resources to cover empty roles.

Proportionate

When balancing the Caleys Ltd’s interests in business continuity against the employee’s interest in receiving her pay, the Court considered the following factors:

a)    Handover and Workflow

Ms Deadman did not work independently, her work was monitored by one of the owners who she did a handover to on her last day. There was no indication that a more extensive handover was required therefore there was not a significant impact on business continuity.

b)   Growth Prospects and Workforce Strain

Ms Deadman’s notice period was only one month, there her responsibility for any impacts on Caleys Ltd’s growth prospects and/or workforce strain were limited to that period only.

c)    Opportunity to Recruit

Caleys Ltd chose not to replace Ms Deadman until after the Christmas break. Therefore, it was apparent that the claims related to the timing of Ms Deadman’s resignation rather than the lack of notice. 

There was no evidence of actual financial loss to the Company, nor any way to estimate the cost of potential customers or business opportunities that may have been lost. The Court considered that any potential losses were limited and were negligible in the circumstances.

When compared to the Company’s legitimate interest in performance, the forfeiture of one month’s salary was exorbitant. Therefore, the purpose of the clause was to compel performance by threatening punishment for non-performance which is an unenforceable penalty provision.

Had the clause referred to the forfeiture of one month’s salary or the cost of damages incurred by the company as a result of the failure to provide notice, whichever is lesser, it may have been enforceable. However, even then Caleys Ltd’s claim would have been unsuccessful due to the lack of evidence and inability to prove actual loss.

How Does This Impact Employers?

 The enforceability of forfeiture provisions relies on the wording of the provision, the legitimate interest the employer is seeking to protect, the proportionality of the consequence to the losses incurred and the supporting evidence.

The Employment Court will not readily accept a claim that undermines an employee’s right to remuneration in circumstances where the employer’s interest in performance is vague or limited in scope and where the losses incurred are not calculable, provable or a direct result of the employee’s breach.

Our Recommendations:

• If an employee resigns without notice, seek further information to understand why no notice was provided. There may be an opportunity to negotiate a mutually beneficial exit arrangement that minimises disruption to the business and prevents any losses from being incurred – prevention is always better than a cure.
• Given the tension between forfeiture clauses and an employee’s rights to remuneration, the careful drafting of these clauses is imperative to enforceability. If there is a forfeiture clause in your employment agreement, we recommend seeking legal advice for guidance on whether or not the provision is enforceable.
• Where losses are suffered as a result of an employee failing to provide notice, consider whether enforcing a forfeiture clause or making a claim for penalties and damages is the most appropriate course of action in the circumstances. 

The specialist employment law team at DTI Lawyers can assist with all employment matters including drafting effective terms of employment, dispute resolution and enforcement of employment obligations. You can contact us by email at [email protected] or phone 07 2820174.