The Court of Appeal has confirmed, in the case of Cavanagh v Williams Evans Ltd, that when an employer terminates an employee’s contract making a payment in lieu of notice (PILON), it cannot avoid payment if it subsequently discovers that the employee is guilty of gross misconduct, which would have otherwise entitled the employer to dismiss summarily.

Mr Cavanagh was made redundant from his position as managing director of Williams Evans Ltd.  The company exercised their contractual right to terminate his contract immediately by making a payment in lieu of his six month notice period.  However, before payment had actually been made, the company discovered that, two months earlier, Mr Cavanagh had fraudulently transferred £10,000 of company money into his pension fund.  The company refused to pay Mr Cavanagh his notice pay on account of this misconduct.  Mr Cavanagh brought a claim for this sum.

In defending the claim, the company sought to rely upon the principle that an employer can justify an otherwise wrongful dismissal by reliance on facts discovered after the dismissal itself.  Therefore, if an employer terminates an employee’s employment in breach of contract (i.e. by not making a PILON), they can justify this on the basis of the employee’s misconduct, even if that misconduct was not known to them at the point they terminated in breach (“the Boston principle”). 

The Court of Appeal, however, rejected this argument, and awarded Mr Cavanagh his notice pay.  In doing so they held that by exercising their contractual right to terminate by paying in lieu of notice, the company had terminated the contract properly.  This therefore gave rise to a debt to Mr Cavanagh.  This could be contrasted with the situation where an employer terminates in breach of contract, which would give rise to an action for damages on the part of the employee.  The Court of Appeal held that the Boston principle only applied to an action for damages, not a contractual debt.  Mr Cavanagh’s employment had been lawfully terminated, and the lawful termination had triggered the liability for pay in lieu.  The company could not subsequently avoid this contractual obligation.

Impact for employers

  • Despite the outcome, the Court of Appeal clearly had some sympathy for the employer in this case.  The Court noted that there were other arguments that the employer could have run in this case, which it didn’t.  For example, it could have counterclaimed for Mr Cavanagh’s breach of fiduciary duty.
  • The ruling that the Boston principle only applies to claims for damages rather than for a debt creates the situation where the employer in this case would have been better off had they ignored the PILON clause and terminated in breach.  However, there are steps employers can take to mitigate the risks of such a situation arising.  PILON clauses can be drafted to provide what will happen if misconduct comes to light after the contract has been terminated (either the PILON isn’t payable, or is repayable).  Further, if a compromise agreement is being signed, it can provide for a warranty on the part of the employee that they have not committed any act of misconduct that would entitle the employer to dismiss summarily.