Where an employer has made an accidental overpayment of wages or expenses to an employee, it is possible to legally recover those overpayments by making deductions from future wages.
This how to guide sets out the key legal and practical issues for employers to be aware of.
What is an overpayment?
An overpayment is a payment made which the worker is not entitled to at the time the payment is made. This could be a result of an administrative error, payroll delay or fraud by the worker. It does not include payment of a loan or bonus that is subject to clawback or where the mistake is in the contract itself and the payment has been made in accordance with that contract.
Are you able to recover the overpayment?
Firstly, check if there is a clause in the relevant employment contract which expressly states that deductions can be made from wages in the event of an overpayment. Employers can rely on this to recover an overpayment where the worker is still employed.
If there is no contractual right to make deductions from wages, employers should seek written consent from the worker to recover this payment. Employers should try to act quickly as the longer the delay in acting the less likely the employer will be able to reclaim the overpayment.
Recovering the overpayment by making deductions from wages
It is generally unlawful for an employer to make a deduction from a worker’s wages unless there is either a specific contractual clause or the worker has given their express written consent. So long as the purpose of the deduction is the reimbursement of an overpayment of wages or expenses, employers are permitted to make deductions from wages without it being unlawful.
This does not apply to overpayments resulting from mistakes in the worker’s contract where the employer has paid the worker in accordance with that contract.
The deduction must be made from wages and not from a payment of expenses. The purpose of the deduction must be to recover the overpayment and not for some other reason.
What are wages?
The term “wages” is widely defined and includes any sum payable to the worker in connection with their employment, including:
- Any fee, bonus, commission or holiday pay relating to the worker’s employment;
- Statutory sick pay or statutory family pay (in whatever form); and
- Other statutory payments paid in lieu of wages.
Wages does not include an advance under a loan agreement, payments of expenses or payments by way of pension or as compensation for loss of office. Benefits are also not wages unless they are money or can be exchanged for money, goods or services.
Deductions from particular types of payments
Redundancy payments: You cannot make a deduction from a statutory redundancy payment unless this is arranged under a settlement agreement. However, you may be able to make a deduction from an enhanced redundancy payment depending on the terms of the employee’s contract.
Statutory maternity pay (and other statutory family pay): Statutory maternity pay (SMP) is included in the definition of wages so if there has been an overpayment of SMP, employers can correct the situation by deducting the overpayment from a later payment of SMP. Note that it is not possible to contract out of SMP entirely or to limit SMP payments but an employee can enter into an agreement for the employer to make deductions from SMP in order to recover an overpayment. Overpayments of statutory sick pay can also be recovered in the same way.
Conditional payments: These include commission payments or bonuses that can be clawed back at a later date. These are not classed as overpayments of wages and therefore cannot be recovered in this way. They cannot later be redefined as overpayments and any attempt to recover such payments through wages will be unlawful.
Important points to consider
- It is a requirement of the Employment Rights Act 1996 that each element of a deduction is identified in the worker’s pay statement so make sure that all deductions are properly set out in the worker’s payslip.
- Make any necessary adjustments to payments due to HMRC to reflect the correct position once the money has been recovered from the worker. The worker’s PAYE and national insurance contributions can then be adjusted so that the worker pays the correct PAYE and national insurance contributions on any wages, taking into account the overpayment.
- Deductions for overpayments are ignored when calculating whether the worker has received the correct national minimum wage.
Our employment team can help you with:
- Reviewing contractual documentation
- Communicating and agreeing recovery of overpayments
- Drafting and negotiating settlement agreements