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Understanding employment contracts: The importance of an effective set-off clause (Part 3)

01 February 2024

5 min read

#Workplace Relations & Safety

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Understanding employment contracts: The importance of an effective set-off clause (Part 3)

In part one (bonus clauses) and part two (policy clauses) of this series on employment contracts, we outlined common pitfalls that employers face within standard clauses of employment contracts.

A well-drafted employment contract will set out the terms and conditions of employment in a concise way with clearly defined protections for the employer.

However, issues can arise where an employer adopts a ‘set and forget’ strategy where one employment contract template is used for all employees regardless of their employment status or position, both of which could impact how their employment contract should be drafted e.g., an employee’s modern award coverage.

This next instalment examines ‘set-off’ clauses within the employment contract (sometimes referred to as a “common law set off clause”, which is distinct from the annualised wage arrangements as applicable under various modern awards and/or enterprise agreements).

Purpose of set-off clauses

A common law set-off clause within an employment contract allows payments made to an employee that are greater than the minimum rate of pay for that employee to be able to satisfy different payment obligations that typically arise from an applicable modern award or enterprise agreement. These obligations may include, for example, payments for overtime, penalty rates, allowances and leave loading.

Set-off clauses are generally used by employers seeking to pay a fixed annual remuneration to employees covered by modern awards or enterprise agreements. In this arrangement, the set-off clause allows all payment-based obligations under an award or enterprise agreement to be satisfied by the fixed annual remuneration (i.e. an ‘all-in’ figure). This approach is appealing to many employers as it eliminates the need to calculate all payment-based obligations amounts accrued by each covered employee during every pay period.

Employers relying on set-off clauses must ensure that their employee’s fixed annual remuneration exceeds the minimum rate of pay under any modern award/enterprise agreement and all additional payment-based obligations that the employee is entitled to under the applicable modern award/enterprise agreement. If the ‘all-in’ annual rate falls below the sum of all payments that the employee is otherwise entitled to, the employer will be in breach of the Fair Work Act (FW Act), the applicable modern award/enterprise agreement and be at risk of prosecution by the Fair Work Ombudsman or the relevant union.

It is crucial for employers to include a well-drafted and enforceable set-off clause in employment contracts for employees if the employer seeks to rely on fixed annual remuneration to satisfy all payment obligations under a modern award/enterprise agreement. Failure to expressly state within the employment contract that the fixed annual remuneration is paid to satisfy these obligations may leave an employer open to a finding from a court or tribunal that the fixed annual remuneration does not satisfy all payment obligations arising from the applicable modern award/enterprise agreement, and that these must be paid separately to employees in addition to the fixed annual remuneration (even if the fixed annual remuneration exceeds all payment obligations that an employee is entitled to).

In the case example below, we illustrate where an employer’s failure to include a set-off clause in a modern award covered employee’s contract contributed to a Federal Court finding that they had breached the FW Act, with the Federal Court ordering the employer to backpay the employee and pay civil penalties for the breach.

Case example – Australasian Meat Industry Employees Union v Dick Stone Pty Ltd [2022] FCA 512

The Australasian Meat Industry Employees Union (Union) took action on behalf of an immigrant employee (employee) who worked as a labourer at Dick Stone, a meat wholesaler (employer).

The employee commenced employment on 22 March 2016 and was required under a written contract to work 50 “ordinary work hours” a week plus reasonable additional hours as requested. The employee often worked a 50-hour week and occasionally worked extra hours for which he was paid overtime rates. 

The employee was covered by the Meat Industry Award (Award) and the employer was obligated to pay the employee overtime rates for hours worked over 38 hours a week and outside of the ordinary hours stipulated by the Award, along with certain allowances.  

At all times the employee was paid an hourly rate which was higher than the minimum pay rate under the Award. This rate, which it referred to in the proceedings as “blended rate”, reflected the Award entitlements. However, the employment contract did not explicitly mention the “blended rate” and did not include a set-off clause.

The employer submitted that all amounts paid over the minimum rate of pay should set-off (or be applied to) any allowances or entitlement the employee had for overtime. The Union’s position was that the employer could not be considered to have paid the employee any amounts for overtime as there was no agreement or mutual understanding that the payment for working any portion of a 50-hour week would include an overtime rate, nor was it designated as overtime.

In finding in favour of the employee, the Federal Court relied upon earlier caselaw which provided that: “…an employer cannot later reallocate an amount agreed to be paid to an employee in respect of subject A (for example, ordinary hours of work) to meet a claim in respect of subject B (for example, overtime)”.

The Federal Court concluded that because of the employer’s failure to communicate its intention to fulfil its obligations to pay overtime rates as per the Award by absorbing them in over-award payments, it was not open to them to set-off part of those payments to discharge its obligation to pay overtime to the employee. The employer was therefore found to have contravened the FW Act and was ordered to pay various penalties and rectify the underpayment to the employee.

How we can help
If you have any questions on employment contracts or set-off clauses, please get in touch with a member of our team below.

The information in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this newsletter is accurate at the date it is received or that it will continue to be accurate in the future.

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