It is not uncommon for employers to include a clause in their employment agreements that requires staff to forfeit a specified amount of salary or wages if they fail to work out their notice period upon resignation.  Typically, this clause is intended to compensate the employer for potential losses or disruptions caused to their business by the employee’s early departure.

The enforceability of such a clause was considered recently in Caleys Ltd v Deadman [2024] NZEmpC 200.

Case Background

On 21 November 2022, Ms Deadman – an employee at Caleys – resigned from her position for health reasons.  She advised Caleys that her last day would be the following day – 22 November 2022.  

Ms Deadman’s employment agreement provided that, if Ms Deadman did not give one month’s notice as required, she was to forfeit one month’s salary, that is, she would have to pay Caleys one month’s salary.

As Ms Deadman had not given one month’s notice, Caleys demanded payment from Ms Deadman payment of one month’s salary.  Ms Deadman did not pay, so Caleys took the matter to the Employment Relations Authority, which refused to enforce the clause on the basis that it was a penalty rather than a genuine pre-estimate of the loss Caleys would suffer if Ms Deadman failed to give one month’s notice.  Caleys then appealed to the Employment Court.

Court’s Decision

The Court applied the test in 127 Hobson Street Ltd v Honey Bees Preschool Ltd, which held that penalty clauses are unenforceable if the penalty is out of all proportion to the legitimate interest of the innocent party in enforcing the provision in the contract.  In the case of Ms Deadman and Caleys, the Court considered:

1. Timing: The enforceability of the clause was judged at the time the contract was signed, not when the breach occurred.
2. Losses: Caleys failed to prove any tangible financial loss, such as lost customers or additional costs from understaffing.
3. Proportionality: The clause was deemed excessive in relation to any legitimate interest Caleys was trying to protect.

What This Means for Employers

Employers should ensure their contracts clearly define their right to recover damages for unfulfilled notice periods.  The clause must, however, be aimed at protecting genuine business interests and be proportional to any actual losses that the business may suffer.  Without evidence of real financial harm, a forfeiture clause is likely to be unenforceable.

Without a forfeiture clause, employers can still sue the employee for any actual losses they have suffered.  Practically, however, the cost and effort involved in doing this is likely to outweigh the benefits. 

If you have any questions arising from this article, or have any employment issues, please don’t hesitate to call Cathy Fisher, Fortune Manning, (09) 915 2412, or email cathy.fisher@fortunemanning.co.nz.