What is pay in lieu of notice (PILON)?

Pay in lieu of notice, or PILON, is when an employee is dismissed and receives a compensation payment instead of working their notice period. The payment is designed to reimburse the individual for the portion of salary or wages lost due to not working their notice.

PILON is different from garden leave as the employee is dismissed immediately instead of still being employed by the company for the duration of the notice period.

With garden leave, the individual will not be performing their duties for the company, but they will not be allowed to gain employment anywhere else during the notice period either.

PILON means the employee can immediately start looking for another role elsewhere.

The reasons for paying an employee in lieu of notice include:

• preventing the individual’s access to sensitive company information
• concern about the effect their continued employment will have on the company and other team members
• it being a part of a negotiated agreement between you and your employee if they choose to resign.

If you dismiss an employee for gross misconduct, they are not normally entitled to receive pay in lieu of notice.

How does pay in lieu of notice work?

Pay in lieu of notice usually comes into play if it has been included in an individual’s employment contract, and we would recommend that you include it in your contracts. If you try to make a PILON payment without first having created a contractual clause, you will then be in breach of contract by preventing the employee from working.

The PILON clause must state that a dismissal can be made immediately by making a payment in lieu of basic salary for the notice period. It should detail how, when and what will be paid to the individual in the instance that you choose to invoke it.

In this way, you can limit the amount paid to just the employee’s basic salary, and exclude extras such as commission, bonuses or reimbursement for loss of company perks. This will minimise the amount of money paid out by your company.

Within the clause, make clear that the termination of contract is immediately effective even if the payment is made at a later date. There have been cases where having a vague PILON clause has proved costly to employers, so it’s important to be specific!

Even if the PILON clause is detailed in the employee’s contract, it’s essential to clearly communicate your intentions to pay them in lieu of notice.

What if there’s no PILON clause in the contract?

If you did not include a PILON clause in the employee’s contract, making a payment in lieu of notice upon dismissal will likely be a breach of contract.

Often the employee will see the value in receiving payment in lieu of notice rather than working their notice period, so you could try and get them to agree to this even if you don’t have a PILON clause in the contract.

If you think they’re unlikely to agree and you don’t want them to work their notice, you can try to mitigate any potential claims by including in the payment any bonuses or benefits the person would’ve been entitled to within their notice period.

These benefits could span:

• commission
• bonuses
• compensation for loss of benefits, i.e. healthcare or company vehicle

However, if the employee thinks that the offer of payment does not match what they believe they have earned, they still may want to make a breach of contract claim. It’s a good idea to seek professional HR advice before going ahead with a PILON payment where you do not have a clause in the contract to check if you’re at risk of a tribunal claim.

If you don’t have a PILON clause in your contract and you can’t get the employee’s agreement at the termination stage, you should be aware that proceeding with the PILON may be a breach of contract. This could put the enforcement of any post-termination restrictive covenants in your contract at risk.

If you find yourself in this situation and enforcing restrictive covenants are a concern, it would be a good idea to seek professional HR advice before you decide how to proceed.

How is PILON calculated?

If there is a payment in lieu of notice contract clause, the payment should follow what is set out in the contract. Otherwise, PILON is calculated by working out what the employee would have earned during their notice period. This method could vary according to whether the person earns a salary (paid a fixed amount monthly) or a wage (paid according to hours worked).

From April 2018, new legislation has dictated that PILON should be treated as taxable earnings, whether it was mentioned in the employment contract or not. This means that you’ll have to deduct the usual Income Tax and National Insurance contributions from the payments in the same way you would’ve done if the employee had continued to work.

You’ll also need to calculate whether the employee has either taken too much or is owed any holiday at the date you are making the PILON, and either make a payment in lieu of this or make a deduction in respect of any overtaken holiday from their final pay.