The High Court decision of Tullett Prebon Group Ltd v Ghaleb El Hajjali will be of interest to all employers who recruit highly specialised senior employees. The decision considers the enforceability of a liquidated damages “no show” clause, and how damages should be calculated where an employee changes his mind about joining a prospective employer, after signing an employment contract containing such a clause.
What happened in this case?
Mr El-Hajjali, the Defendant, was a senior derivative broker and expert in highly specialised “variance swaps” at Link Asset and Securities. After 6 months of negotiations and with the advice of his solicitors, Mr El-Hajjali signed an employment contract with the Claimants, Tullett Prebon, a competitor of Link.
The employment contract entitled Mr El-Hajjali to a guaranteed income of £1.2 million in his first year and contained a no show clause providing that if Mr El-Hajjali failed to take up employment he would be liable “to pay the Company, by way of agreed liquidated and ascertained damages a sum equal to 50% of the net basic salary and (if any) 50% of your signing payment (if any)”. The clause provided that this was a “genuine pre-estimate of the Company’s loss, given the loss of profit it will suffer as a direct consequence of the loss of your anticipated revenue generation under this Employment Agreement”.
Immediately after signing the contract, Mr El-Hajjali resigned his position with Link but was then persuaded to change his mind and remain in his original employment. After Mr El-Hajjali secured an indemnity from Link to protect him from any claims Tullett might bring against him, he informed Tullett that he would not be joining them after all.
Tullett attempted to find a replacement for Mr El-Hajjali but could not do so. Tullett brought a claim against Mr El-Hajjali in the High Court for breach of contract. Tullett claimed £300,000 under the no show clause. Tullett contended that the damages they were likely to suffer from the breach were around £2.5 to £3.7 million.
The Court had to decide whether the no show clause was a penalty and so was void as such. A penalty clause is one which is intended to apply undue force the other party to perform its obligations under the contract, rather than genuinely compensate the wronged party for the breach. Previous case law has established that a clause will be construed as a penalty if the sum specified is “extravagant and unconscionable” in comparison with the greatest loss that could possible have been proved as a result of the breach.
The Court concluded that the no show clause was not a penalty. It was relevant that the parties had equality of bargaining power – Mr El-Hajjali was represented by a large firm of solicitors and was given specific advice about the effects of the no show clause.
Furthermore, the £300,000 payable under the no show clause was not “extravagant” nor “unconscionable” compared to the loss that could follow the breach. Several factors were relevant to this decision. Tullett had not estimated its losses before entering into the employment contract or discussed them with Mr El-Hajjali, but this was not fatal. It was relevant, however, that before employing Mr El-Hajjali, Tullett had prepared a Business Initiative Proposal (BIP) which compared the revenue Mr El-Hajjali would be likely to bring in (over £3 million per annum) compared to the cost of employing him – this provided the basis for later establishing what losses they might suffer. Further, the fact that Tullett had given consideration to whether the no show clause was a penalty was relevant.
Finally, as regards the correct assessment of damages, that would normally be the cost of recruiting a replacement, rather than the loss of profit. If this were the case, the payment under the no show clause would be more than the damages. However, where a replacement cannot be found immediately, an employer may choose to claim the loss resulting from the breach, namely the value of the work lost by reason of the employee’s failure to turn up, less the amount that would be paid to the employee under the contract. In this case, Tullett had tried its best to find a replacement but was not able to do so. It was therefore not in breach of its duty to mitigate its loss and the correct measure of damages was the loss resulting from the breach rather than the cost of finding a replacement.
What does this decision mean for employers?
A no show clause which provides for a genuine pre-estimate of loss should the employee fail to turn up for work can be a valid and useful tool for an employer wishing to secure the employment of a very senior employee. However, care should be taken that this clause does not constitute a penalty which will be void. Whilst every case will turn on its merits and its own particular facts, a number of practical pointers can be drawn from this case to assist employers wishing to include no show clauses in their contracts of employment. First, it will be important to ensure the senior employee is legally represented in the negotiations for the new contract of employment. Second, the amount set out in the clause should be a genuine pre-estimate of loss i.e. an amount which aims to compensate the employer, rather than deter the employee from breach. Thirdly, the employer should prepare a written pre-estimate of loss should the employee fail to show, and this should be discussed and agreed with the employee before signing the employment contract.