Must You Pay Liquidated Damages to Terminate Your Contract?
Does your employment contract stipulate that you have to pay $X amount in compensation if you terminate your contract before a certain period of time?
A clause that provides for a sum of compensation if a term of the employment contract is breached is known as a liquidated damages clause. Liquidated damages clauses can pose concerns to employees who wish to quit their job before their employment term is up.
Additionally, it can place job-seekers in a dilemma when they have signed an employment contract with Company A, only to receive a more attractive offer from Company B – will they be liable to pay Company A $X if they choose to break their contract before their first day of work?
This article will provide an overview of liquidated damages clauses in Singapore with examples of situations when such a clause may be unenforceable, in particular:
What is a Liquidated Damages Clause?
As mentioned above, a liquidated damages clause is a clause in your employment contract which provides for a fixed amount of compensation in the event that you breach the contract.
For example, when you sign an employment contract that states that you are bonded to your company for a period of time (e.g. 2 years), or that you are to commence work for the company on a particular date, these are legally binding contractual terms.
If you then fail to show up for work on that start date, or choose to terminate your contract before your bond period is over, you will be in breach of contract. This entitles your employer to damages that compensate them for the loss suffered by your early termination.
LDCs may require the payment of a:
- Lump sum, e.g. “In the event of default by X, X shall pay Y as liquidated damages $__ amount”; or
- Periodic payments, e.g. “In the event of default by X, X shall pay Y as liquidated damages $__ amount for each day of default”.
In the context of early termination, a liquidated damages clause could require you to pay a:
- Lump-sum worded as a flat fee (e.g. $5,000);
- Lump sum consisting of several months of salary; or a
- Fixed amount for each calendar day from the time you serve notice to the end of the bond period.
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Am I Liable to Pay Liquidated Damages If I Terminate the Contract Early?
LDCs can be beneficial to both parties because it provides certainty as to the amount of compensation recoverable. Parties will also not have to expend additional effort and legal costs to prove the amount of compensation that the breaching party is liable for.
However, employers may take advantage of employees by drafting LDCs that impose highly onerous terms, in order to deter employees from terminating their employment contract early.
If you are an employee, it is important to note that even if you have willingly signed an employment contract that includes a liquidated damages clause, the liquidated damages clause cannot be enforced against you if it is essentially imposing a penalty to punish you for the breach. If your employer tries to enforce the penalty and sues you for compensation, the liquidated damages clause will have no effect.
When is a clause likely to be a penalty clause?
- If the clause stipulates an amount that is not a genuine pre-estimate of the damage your employer will suffer as a result of your early termination, it is likely to be a penalty.
- If the amount stipulated is extravagant or unconscionable, such that there is a large discrepancy between it and the likely loss suffered by your employer.
- If the sum is so disproportionate to the losses your employer may suffer, that its main function is to deter a breach rather than to compensate your employer.
- The fact that the clause states that it is a “liquidated damages clause” does not prevent it from being a penalty.
Possible examples of penalty clauses
- A clause that requires an employee on a monthly salary of $2,000 to pay $50 per calendar day from the date of terminating his employment until the 1-year term contract is up. For example, if the employee quits after 3 months, he would be liable for a sum exceeding $9,000. This sum appears to be very high, given that it amounts to 4.5 months’ worth of salary. It is unlikely to be a genuine estimate of losses if the employer cannot provide evidence that the costs of recruiting and training a replacement employee will amount to the sum stipulated.
- A clause that requires the employee to serve a bond of 2 years and to pay a lump sum of $10,000 if he breaks the bond, regardless of the amount of time left on the bond period. The sum is unlikely to be a genuine estimate of losses because it is for a fixed sum that does not take into account the severity of the breach. For example, an employee who quits on the first day of work is likely to cause greater losses to his employer than one who quits towards the end of the bond period.
Examples of clauses that may be valid liquidated damages clauses
- Employment contracts: Where an employee has contracted to serve a bond of 2 years to the company in exchange for the company sponsoring the employee’s tuition fees, it is likely to be a genuine pre-estimate of the employer’s loss if the liquidated damages clause requires the employee to pay a sum equivalent to the course fees incurred, pro-rated based on the remaining duration of the employee’s bond.
- Recruitment contracts: Where a job-seeker has contracted with a recruitment agency to broker an employment opportunity for him, the recruitment agency typically requires the job-seeker to remain employed for a period of time. If the job-seeker later changes his mind and chooses to terminate his employment contract prior to the start date, the recruitment agency may require him to pay 1 month’s salary. This is likely to be a genuine pre-estimate of the recruitment agency’s loss if the early termination resulted in the loss of commission that it could have earned from the employer for assisting the employer with filling a job vacancy.
What Other Compensation Might I Need to Pay If I Terminate a Contract Without Notice?
You should note that apart from making payment under a valid liquidated damages clause for early termination, you may also have to make additional payment if you choose not to serve your notice period.
For example, where your employment contract stipulates that you must provide X number of months of notice, you are liable to pay compensation in lieu of notice if you wish to terminate the contract without fully serving out your notice.
The only exception to having to pay compensation in lieu of notice is if you are terminating your employment contract without notice because your employer has breached the terms of the employment contract.
For example, where your employer fails to pay your salary within 7 days of the due date.
What Options are Available to Me?
If your employment contract contains a liquidated damages clause and you are considering whether to breach your contract, the following options are open to you:
1. Fulfil the terms of your employment contract
You may wish to continue working for your employer until you can terminate the contract without being in breach. If you do so, you will not be liable to pay your employer compensation.
However, this may not be an attractive option if you are dissatisfied with your job, or have secured a better employment opportunity elsewhere.
2. Terminate the contract early and pay your employer the compensation under the liquidated damages clause
This will allow you to pursue other job opportunities sooner. However, this option may not be appropriate if you cannot afford the sum stipulated in the liquidated damages clause and/or it is disproportionate to the benefit you may gain from early termination.
3. Negotiate with your employer for a lower liquidated damages sum
In persuading your employer to negotiate, it might be helpful to remind them that the alternative of resolving the matter in court (see next point) will likely be a lot more costly and time-consuming for them.
In addition, during the negotiations, you should request that your employer provide proof that the sum stipulated in the contract is a genuine estimate of his loss. For example, the employer could provide evidence of the cost of training and recruiting a new employee, or the cost of the fees that the employer has incurred in training you.
However, there is no guarantee that your employer will accept your proposed sum during the negotiations, or agree to negotiate the matter in the first place.
4. Dispute the liquidated damages clause in court
It should be noted that LDCs are not covered by the Employment Act. This means that the Ministry of Manpower will not be able to help you with any dispute concerning the validity of a liquidated damages clause, and it must be settled by the Singapore courts instead.
For example, if you terminate your contract early, your employer may bring a claim for liquidated damages against you in court. You can then dispute the liquidated damages clause and argue that it should be struck down because it is an unenforceable penalty clause.
The courts will then examine the liquidated damages clause, and the other terms of your employment contract, to decide if the liquidated damages clause is enforceable. If the court agrees with you that the liquidated damages clause is unenforceable, it will determine the amount of damages you should actually pay instead (after all, you have still breached your contract).
In making this determination, the court will take into account the loss suffered by your employer as a result of your early termination. This amount will likely be less than the sum stipulated in the liquidated damages clause.
However, this course of action comes with risks. If you lose the lawsuit (for example, the court decides that the liquidated damages clause is enforceable), you are liable for the amount stipulated in the liquidated damages clause. Additionally, you may have to bear the legal fees incurred by your employer, which can amount to a hefty sum. This is not including the legal fees that you will have to pay your own lawyers (if you have hired any).
Before proceeding with any of the above options, it is recommended that you seek legal advice from a lawyer who specialises in Singapore employment disputes.
An employment disputes lawyer can provide you with an assessment of the likelihood that the liquidated damages clause is enforceable against you, and therefore assist you in making an informed choice on whether you should terminate your contract early.
After all, whether a liquidated damages clause amounts to a penalty clause is highly contextual. As the law surrounding this area can be complicated, you will strongly benefit from a professional assessment.
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