Enforceability of forfeiture clause address in recent Employment Court decision
Employers seeking to recover damages from an employee who fails to work out their notice period need to meet a range of conditions for it to be enforceable.
The Employment Court has recently determined that a clause requiring an employee to give one month’s notice of termination or, in the alternative, forfeit a month’s salary/wages (forfeiture provision) was unenforceable.
Ms Deadman resigned on 21 November 2022, with an effective date of 22 November, due to her health (one day’s notice).
The plaintiff employer, Caleys Limited, a window furnishings business, wrote to Deadman, stating she owed the company under the forfeiture provision in her individual employment agreement. Caleys requested payment of the outstanding sum, $3,157.67. Deadman did not respond or make the payment sought.
Caleys initiated proceeding against Deadman in the Employment Relations Authority, seeking to recover this sum. In the Employment Relations Authority, Deadman was successful in her claim because the forfeiture clause was considered to be a penalty clause and not a genuine assessment of liquidated damages. Caleys then challenged this determination in the Employment Court.
On the challenge from the Employment Relations Authority, the court had to consider whether Caleys was entitled to the amount of $3,157.67 from Deadman under the forfeiture provision. This required the court to determine whether the forfeiture provision was enforceable, or whether it was an “unenforceable penalty.” The court applied the test set down by the Supreme Court in 127 Hobson Street Ltd v. Honey Bees Preschool Ltd [2020] NZSC 53, [2020] 1 NZLR 179:
“A clause stipulating a consequence for breach of a term of the contract will be an unenforceable penalty if the consequence is out of all proportion to the legitimate interests of the innocent party in performance of the primary obligation. A consequence will be out of all proportion if the consequence can fairly be described as exorbitant when compared with the legitimate interests protected.”
Applying that test, the court considered the following:
Time the contract was entered into: The assessment takes place at the time the contract was entered into, rather than the time of the breach. The court therefore did not accept Caleys’ comments about the inconvenient time that Deadman resigned (so close to Christmas).
Loss caused by breach: This assessment includes consideration of the loss caused by the breach (contractual damages), which may also extend to the impact of non-performance on the broader commercial interests the parties seek to achieve or protect through the contract.
Caleys explained that its legitimate interest in performance was to (a) avoid losses that it would incur as a direct result of Deadman failing to give the required notice, and (b) protect its commercial interest in having a reasonable opportunity to recruit a new staff member to replace Deadman before she finished. The court accepted that the forfeiture provision was designed to protect these interests. However, it determined the forfeiture provision was not proportionate to those interests (see below for more detail).
Proportionality: The court considered whether the forfeiture provision was proportional to Caleys’ interests in performance. This includes considering whether there was an imbalance of bargaining power, in which case claims would be scrutinised more closely. This was particularly relevant due to the “inherent inequality of power in employment relationships.”
Among other things, Caleys said that although there was no express financial cost to the company, there were opportunity costs as a result of losing potential customers, and loss to the company as a result of the directors having to cover her duties.
The court rejected this, finding that there was no evidence the directors worked additional hours as alleged, or that they were paid extra for covering her role. Further, even if the company may have lost potential customers due to understaffing, the court could not estimate the financial cost to the company.
These difficulties indicated that the forfeiture provision was not a genuine pre-estimate of damage, nor did it represent readily calculable monetary losses flowing directly from the failure to provide notice.
Therefore, for these and other reasons, the court did not consider that the amount Caleys was seeking from Deadman was proportionate to the losses suffered, or that could have been suffered, by Caleys. Rather, it was exorbitant when comparing the amount to the legitimate interests the company had. Consequently, it was a penalty provision, which was unenforceable.
Because both parties were self-represented, there was no issue as to costs.
Employers seeking to recover damages from an employee who fails to work out their notice period will need to demonstrate:
Elisabeth Giles is a Senior Solicitor at Lane Leave in Christchurch. Andrew Shaw is a Partner and head of the Employment Law team at Lane Neave in Christchurch. Fiona McMillan is a Partner at Lane Neave in Auckland. Andy Bell is a Partner at Lane Neave in Wellington.
