An HR guide to pay in lieu of notice

Navigating the end of an employment relationship requires a delicate balance of legal compliance, financial accuracy, and emotional intelligence. For many employers, the notice period can be the most challenging phase to manage. While most contracts assume an employee will work through their notice, there are many scenarios where it is in the best interest of the business for the individual to depart immediately.

This is where pay in lieu of notice (PILON) comes into play. Understanding how to implement PILON correctly is essential for protecting your business from breach of contract claims and ensuring a smooth and fair dismissal. In this guide, we will break down everything business owners need to know about PILON.

What is pay in lieu of notice?

Pay in lieu of notice (PILON) is a contractual mechanism that allows an employer to terminate an employment contract immediately by paying the employee the salary they would have earned during their notice period, rather than requiring them to work it. When PILON is exercised, the employment relationship ends on the day the notice is given (or the date specified by the employer) rather than at the end of the weeks or months specified in the contract.

Technically, unless an employment contract specifically contains a PILON clause, an employer does not have an automatic right to insist an employee takes pay instead of working. Without this clause, dismissing someone immediately and paying them off, could technically be viewed as a breach of contract, even if the employee receives the full money. This is because the employee is being deprived of certain benefits of employment, such as the continued accrual of holiday pay or the use of a company car during that time.

From a tax perspective, as of April 2018, the law changed to ensure that all PILON payments are treated as standard earnings. This means they are subject to Income Tax and Class 1 National Insurance contributions, regardless of whether there is a PILON clause in the contract or not.

Examples of when PILON might occur

There are multiple reasons why an employer may use pay in lieu of notice; it is a tool used based on the specific circumstances of an employee departure. Here are several common scenarios:

Redundancies

When a role is no longer required due to restructuring or financial shifts, keeping a redundant employee in the business for several months can be awkward and demotivating for the remaining team. PILON allows the employee to start their job search immediately with a lump sum of cash, while the business can move forward with its new structure.

Terminating senior executives

High-level employees often have access to sensitive strategic data, trade secrets, and client lists. If a senior leader is moving to a competitor or the relationship has soured, the risk of them staying in the building, even for a few weeks, might be too high. PILON ensures they lose access to company systems and physical premises immediately.

Performance or cultural misalignment

If an employee is being let go because they are not a good fit for the company culture or are consistently underperforming (but the situation hasn’t reached the level of gross misconduct), keeping them on-site during a notice period can negatively affect team morale. In these cases, a clean break via PILON is often the kindest and most efficient route for both parties.

Mutual agreement

Sometimes, an employee may request PILON because they have another job offer starting sooner than their current notice period allows. Alternatively, the employee may have accepted a voluntary redundancy offer, meaning that they are entitled to PILON if their redundancy goes ahead. If the employer is happy to let them go early in either of these situations, they may agree to a PILON arrangement to facilitate a quick transition.

Steps employers should take to make sure PILON is used correctly and fairly

To avoid legal pitfalls and maintain a reputation as a fair employer, following a structured process is vital.

1. Check the written contract

Before mentioning PILON to an employee, review their latest signed contract. Look for a specific pay in lieu of notice clause. This clause should outline the employer’s right to terminate with immediate effect and specify what the payment covers. This is usually just basic salary but sometimes covers benefits.

2. Calculate the payment accurately

A PILON payment should represent what the employee would have earned had they worked their full notice. This typically includes basic salary, statutory entitlements, any bonuses or commission they would have been guaranteed during that time, and pension contributions.

3. Formal communication

The decision to use PILON must be communicated in writing. The termination letter should clearly state:

• The last day of employment
• The exact amount of the PILON payment
• How the payment will be taxed
• When the payment will be made (this is usually in the next payroll cycle)
• Any requirements regarding the return of company property (laptops, keys, ID badges)

4. Consistency

PILON should be applied consistently across the workforce. If you offer PILON to one employee in a specific department but force another in a similar situation to work their notice, you may open the door to claims of discrimination or unfair treatment.

Pay in lieu of notice vs. garden leave

While pay in lieu of notice and garden leave both involve an employee being away from the workplace during a notice period, they are legally and operationally different.

In a PILON arrangement, the employment status ends immediately upon termination, the contract is severed, and the individual is typically paid their notice as a lump sum, leaving them free to start a new job or pursue other interests right away. Conversely, under garden leave, the individual remains an employee until the notice period expires, meaning the contract stays in force and they continue to receive salary and benefits on their normal pay dates.

During this time, the employee must remain available to the business to answer queries and, crucially, is restricted from starting work elsewhere. Overall, garden leave is often preferred by employers who wish to keep restrictive measures in place to prevent an employee from moving to a competitor immediately. Otherwise, PILON is utilised when a business simply wants a clean break and to remove the individual from the books as quickly as possible.

When PILON won’t be of benefit to an employer

The benefit of PILON is that it offers a quick and clean solution. However, it isn’t always the most strategic way of letting employees go.

If an employee holds critical or niche knowledge that hasn’t been documented, an immediate departure via PILON can leave gaps in the business. In these instances, requiring the employee to work their notice to train a successor or write handovers is much more valuable than a clean break.

As mentioned previously, if you terminate a contract via PILON without a specific clause allowing you to do so, you might inadvertently render restrictive covenants unenforceable. This could allow a salesperson to walk straight out of your office and into a competitor’s, free to call up your clients the very next day.

PILON requires a lump-sum payment, which can impact cash flow. If a business is struggling financially, it might be more manageable to have the employee work their notice and pay them through the standard monthly payroll.

In cases of gross misconduct (like theft, violence, or serious negligence), an employer is usually entitled to immediate termination of an employee contract, meaning there’s no notice or pay in lieu. Providing PILON in a gross misconduct situation is unnecessary and sends the wrong message to the rest of the staff.

The role that HR plays with PILON

HR manages a multi-faceted role when implementing pay in lieu of notice. From a risk management perspective, HR professionals must verify that employment contracts specifically permit pay in lieu of notice and ensure that the entire dismissal process adheres to Advisory, Conciliation and Arbitration Service (ACAS) guidelines. This diligence is vital to protect the organisation from potential unfair dismissal claims.

Beyond the technicalities of law and finance, HR handles the logistical and emotional aspects of the termination. They often facilitate the termination meeting itself, acting as a professional lead to deliver the message clearly while managing any immediate emotional fallout. During these discussions, HR provides clarity on important questions regarding final pay and benefits, ensuring the employee understands the transition. Simultaneously, HR coordinates with the IT department to maintain business security, ensuring that all system access is revoked the moment the PILON takes effect. This synchronised effort ensures that company data remains protected while the employee’s departure is handled with the necessary professionalism and speed.

Here to help

At Sapphire HR, we understand that while your people are your greatest asset, they can also become a significant source of stress when things don’t go to plan. Regardless of the industry you operate in, the fundamental principles of fair pay and legal compliance remain universal, and we choose to invest time in understanding your unique business culture and long-term goals.

When managing pay in lieu of notice, we provide bespoke support by auditing your current contracts to ensure the legal right to use PILON, calculating payments with precision to avoid HMRC penalties, and managing the entire exit process with the dignity and professionalism required to protect your employer brand.

Navigating the end of an employment journey doesn’t have to be a difficult journey. With the support of our friendly team, you can handle PILON and other complex HR processes with total confidence, ensuring your business is protected and your staff are treated fairly.