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Employers seeking to recover damages from an employee failing to work their notice period, now have case law dictating a range of conditions for enforcement.

The Employment Court in Caleys Ltd v Deadman [2024] NZEmpC 200 determined that a clause requiring an employee to give one months’ notice of termination, or in the alternative, forfeit a month’s salary or wages was unenforceable.

In this case, Ms. Deadman resigned on 22 November 2022 for health reasons. Caleys then demanded payment of $3,157.67 for her failure to complete her notice period. Ms. Deadman did not respond to demands or make payment, prompting Caleys to initiate legal proceedings in the Employment Relations Authority (ERA). The ERA ruled that the forfeiture clause was a penalty clause and not a legitimate pre-estimate of damages, so was unenforceable.

Caleys then appealed this decision to the Employment Court.

The key question before the Court was whether Caleys was entitled to the $3,157.67 under the forfeiture clause. To determine this, the Court applied the test from the Supreme Court’s ruling in 127 Hobson Street Ltd v Honey Bees Preschool Ltd [2020] 1 NZLR 179, which states that a penalty clause is unenforceable if the consequence is disproportionate to the legitimate interests of the party seeking enforcement. Specifically, a clause will be seen as a penalty if the consequence is excessive when compared to the interests it seeks to protect.

In applying this test, the Court considered several factors:

1. Timing of the Agreement
   The Court emphasised that the enforceability of the clause should be assessed at the time the contract was entered into, not when the breach occurred. The timing of the breach (which happened during the Christmas rush) was not a relevant consideration.
2. Loss Caused by the Breach
   The Court looked at whether the breach caused tangible losses. Caleys argued that the breach affected its ability to recruit a replacement and caused business disruption. The Court acknowledged that the forfeiture provision could be aimed at protecting such interests but must remain proportionate to those interests.
3. Proportionality
   The Court also considered whether the forfeiture provision was proportional to Caleys’ legitimate interests. This included evaluating the power dynamics in the employment relationship, as outlined in Section 3(a)(ii) of the Employment Relations Act 2000, which recognizes the inherent imbalance of power between employers and employees.

Caleys further argued that while there was no explicit financial loss, there were opportunity costs from losing potential customers and having its Directors cover Ms Deadman’s duties. However, the Court found no evidence that the Directors worked additional hours or were compensated for doing so. Nor was there evidence that potential customers were lost due to understaffing.  So, there was no proof to substantiate the financial losses claimed.

Ultimately, the Court ruled that the forfeiture provision was neither a valid pre-estimate of damages nor reflective of the actual losses suffered. The amount sought by Caleys was deemed disproportionate to any losses that could be reasonably attributed to the breach. Therefore, the Court upheld the ERA’s decision, ruling the forfeiture clause to be unenforceable.

What Does This Mean for Employers?

For employers hoping to recover damages from an employee who fails to work their notice period, this ruling highlights the following key points:

1. Is it in your IEA? Employers must ensure that their employment agreements clearly outline their right to recover damages.
2. Protect Legitimate Interests: Employers must be able to demonstrate that the clause is aimed at protecting legitimate commercial or operational interests.
3. Proportionality and Proof of loss is Key: Employers must show that the damages they are seeking to recover are proportionate to the actual losses incurred due to the breach.

The Court’s decision suggests that the language of such clauses is critical. For example, a clause that refers to the forfeiture of one month’s salary or the actual damages incurred by the employer—whichever is lesser—could be enforceable, as long as the employer can provide evidence of real financial loss. However, in this case, Caleys was unable to prove such loss, rendering the clause unenforceable.

If you have a forfeiture clause in an existing employment agreement, contact us to ensure it is legitimate and seek guidance on how it could be enforced in light of this decision.

Disclaimer: We remind you that while this article provides commentary on employment law, health and safety and immigration topics, it should not be used as a substitute for legal or professional advice for specific situations. Please seek legal advice from your lawyer for any questions specific to your workplace.