Terminating an employment contract without requiring the employee to work through their notice period, and instead making a payment in lieu of notice (PILON), can trigger significant legal implications for both employers and employees. The most recent judicial discussions confirm that PILON, in certain circumstances, can equate to termination without notice, thereby influencing post-termination entitlements, benefits, and contractual remedies. Critically, the recent decision in Lo Wai Keung v Hannover Ruck SE clarified that when an employer decides to end employment immediately and pay the employee in lieu of notice, the termination technically occurs “without notice,” even though the employee is compensated for the unworked notice period. This distinction, while seemingly narrow, can have financial, contractual, and statutory ramifications for both sides.
What follows is an in-depth review of how these implications arise, including how statutory notice periods must still be considered, tax considerations, best practices in drafting PILON clauses, and the general interplay with other forms of termination such as garden leave or summary dismissal.
PILON as “Termination Without Notice”
Court guidance and the “Lo Wai Keung” case
Recent case law has shown that courts approach a PILON scenario as a form of termination that effectively bypasses the notice period. In Lo Wai Keung v Hannover Ruck SE, the employer opted to end the employee’s contract immediately for alleged performance issues, but paid the employee’s salary for the remaining notice interval. The contractual dispute centred on whether immediate termination - despite a payment in lieu - should be treated as “termination without notice” for the purposes of share scheme entitlements. The Hong Kong Court of First Instance, informed by English law principles, concluded that PILON effectively amounts to a termination without working notice, because there is no ongoing employment relationship during the notional notice interval once termination is confirmed and the relevant sum is paid.
In the UK context, while no single unified statute spells out the identical principle, the reasoning from Gothard v Mirror Group Newspapers Ltd and Delaney v Staples has long recognised that a payment in lieu is treated as damages for the contract’s immediate ending, rather than wages for ongoing work. Consequently, from a contractual standpoint, the notice period is never actually served. This can have the effect of invalidating certain post-termination benefits or share entitlements that might require “working out” the notice fully. Therefore, it is vital for employers to carefully draft the relevant clauses in their employment contracts to ensure the correct interpretation and avoid unintended breaches or accelerated vesting controversies.
Distinguishing PILON from summary dismissal
Although the payments or lack thereof might appear similar, paying a lump sum on termination should not be confused with summary dismissal for gross misconduct, in which the employee is summarily removed without any wage payment for the unworked notice period. Summary dismissals arise when the employee commits a breach so severe that the employer is permitted to dismiss immediately without pay. PILON, by contrast, compensates the employee for not working their notice; an employer typically uses PILON when it wishes to end employment swiftly but still fulfil the financial obligations for that period.
Statutory notice periods and contractual frameworks
Statutory minimums
Under the Employment Rights Act 1996, employees are generally entitled to the following statutory notice length:
One week’s notice after one month to two years of service
Two weeks’ notice plus one extra week for every full year of service, up to twelve years
Maximum of twelve weeks’ statutory notice after twelve years or more
These minimums apply unless there is gross misconduct justifying summary dismissal. Employers must ensure that their contractual provisions do not provide any less than these statutory floors. If a contract’s stated notice period is shorter than the minimum, the statutory period automatically overrides the contract.
Enhanced and contractual notice
Employers often opt for extended notice periods to protect business continuity. Enhanced notice might be two or three months’ pay after a certain level of service or for more senior positions. In these circumstances, the specified notice cannot be shorter than the statutory minimum. When the employer wants maximum flexibility, many adopt a PILON clause in the contract so they can pay the employee out instead of having them remain in place for an extended (and potentially awkward) working period.
Regarding PILON clauses, it is imperative that the contract specify:
How the employer calculates the payment, including salary and possibly benefits.
Whether any additional compensation - like earned bonuses, commissions, or pro-rata holiday - should be included.
When the termination date is deemed to be, so the parties are clear that the relationship ends immediately once payment is made.
Without a contractual PILON provision, the employer might inadvertently breach contract if it dismisses with immediate effect. That breach may invalidate post-termination restrictive covenants and obligations, depending on how consistently English common law interprets the situation.
When and why employers choose PILON
Addressing conduct or protecting business interests
Occurrences that encourage immediate termination include:
Serious misconduct or poor performance that does not itself rise to the level of gross misconduct but undermines trust in letting the employee remain.
Protection of confidential or proprietary business information.
Minimising potential disruption or negativity in the workplace.
Ensuring a “clean break” in redundancies or negotiated settlement exits.
By opting for PILON, the employer swiftly severs the relationship while meeting the financial obligations. This can be less burdensome than placing the employee on garden leave, which typically requires the contract to remain fully in force until the expiry of the notice period. PILON can thus ease certain tensions, though it may be more expensive up front if benefits are included.
Resignation scenarios
Though often discussed in an employer-initiated context, PILON can also arise if an employee resigns but wishes to depart immediately. If the business is willing, the organization can confirm a mutual agreement that the employee will forfeit working the notice in exchange for immediate pay. However, if the employer does not agree, the employee is ordinarily expected to work the notice; otherwise, they risk breaching the contract. Even in a resignation scenario, the contract’s PILON provisions can govern whether the employee can request or demand an immediate payoff.
Tax and National Insurance consequences
The Post-Employment Notice Pay (PENP) Calculation
Since changes introduced by HMRC in recent years, all payments characterised as “in lieu of notice” must be subject to income tax and Class 1 NICs in the same way as normal wages. The key is the concept of Post-Employment Notice Pay (PENP), which seeks to tax amounts that reflect salary employees would have received had they worked their notice period [9, 10]. Under these rules:
Employers calculate the notice period in days or months.
The relevant portion of salary for that notice interval is considered PENP.
Any termination payment above that required sum might, depending on the circumstances, enjoy partial or full tax relief up to £30,000 if it qualifies as a genuine redundancy or compensation for loss of office.
Additionally, if the contract specifically references PILON as part of wages, or the employer’s practice is to pay employees each time, HMRC will likely consider that sum entirely taxable. It is advisable that employers maintain robust documentation to justify how they arrived at the final figure, to avoid the appearance of artificially inflating or deflating the non-taxable portion [9].
Complexities with salary sacrifice and benefits
Difficulties can arise if the employee has a salary sacrifice arrangement (for instance, contributing a portion of pay to a pension scheme or cycle-to-work arrangement). In such cases, the “pre-sacrifice” salary is typically used for the PENP calculation, ensuring that the full notional salary is taxed for the unworked period [9]. Benefits in kind like company cars, private medical, or phone allowances can also complicate the figure if the contract does not clearly state whether these benefits are included in the PILON sum.
Practical drafting and litigation considerations
Contract drafting best practices
Given the potential ramifications, employers should:
Insert express PILON clauses that state precisely what sums are included or excluded (salary alone, or salary plus pension, or salary plus benefits, etc.).
Clarify the date on which termination takes effect and confirm that no further wages or benefits accrue after that date.
Ensure that employees are aware of the immediate cessation of employment, saving the employer from confusion about ongoing entitlements or holiday accrual.
By articulating that PILON is at the employer’s discretion, the employer also retains the right to require the individual to work the notice or remain on garden leave if that is preferable.
Impact on restrictive covenants
Employers who rely on restrictive covenants (non-competition, non-solicitation, or confidentiality) must remember that a breach of the notice clauses can risk invalidating these covenants entirely. Where the PILON arrangement is not contractually spelled out, it can constitute a breach, freeing the employee from these obligations. Consequently, employers wanting to enforce post-termination restrictions must maintain alignment between the contractual PILON terms and the actual approach used when terminating.
Wrongful Dismissal vs. Unfair Dismissal
If an employer wrongly withholds notice pay or tries to effect an immediate dismissal without paying the sum due, it can face claims for wrongful dismissal, which differ from unfair dismissal claims. Wrongful dismissal typically hinges on breach of contract, including failing to honour the required notice. Meanwhile, an employee with sufficient continuous service may also claim unfair dismissal if the employer bypassed correct procedures or lacked a fair reason for dismissal. A failure to pay the correct notice sum or use PILON properly can escalate the compensation exposure in an Employment Tribunal.
Defending potential claims
To minimise risk:
Employers issuing PILON should specify in writing that the payment fully discharges any claims for notice pay.
The sum should match or exceed what the employee would have earned had the contract run during the notice period.
The letter or settlement documentation can confirm that, upon acceptance, the employee acknowledges the end date and final sums in full. This helps forestall disputes later over additional sums supposedly owed.
Garden Leave vs. Paying In Lieu
Though often conflated, garden leave is distinct from PILON. Where garden leave is imposed, the employment does not stop until the notice period expires. The employee remains on the payroll, with benefits intact, and is often barred from working for a competitor or engaging in certain activities. Conversely, with PILON, the entire employment relationship effectively ends the moment the employer notifies the employee of the payment decision. The employee can typically pursue other employment opportunities right away, unless separate restrictive covenants remain in effect.
Some contracts provide that the notice period spent on garden leave will be subtracted from any subsequent post-termination restriction periods, since otherwise the employee would be out of work for an excessively extensive time. Employers must weigh up these comparative advantages carefully. Garden leave can be beneficial if the employer wants to keep the individual contractually bound and away from the competition a bit longer, but it also can be more complicated and more costly if the employee remains on the books with all benefits for the entire notice.
Recent trends and the path forward
The 2025 perspective
In line with the overall evolution of employment law, 2025 has seen a continued emphasis on clarifying how PILON interacts with statutory minimum notice, contractual notice, and employee entitlements. The Lo Wai Keung ruling, although a Hong Kong decision, proves influential in the UK context because it references established English law precedents to determine that paying an employee a lump sum for an unworked period is functionally the same as dispensing with notice altogether. This underscores that “without notice” can be lawful provided the employee receives the correct sum in lieu.
Practical steps for employers
Review Existing Contracts: Ensure every employment contract has a PILON clause specifying precisely what will be included - basic wage only, or wage plus benefits. Also confirm that it states the immediate termination date and references continuity of service only up to that date.
Communicate Clearly: On deciding to exercise PILON, send a letter to the employee explaining:
- The employment ends immediately as of a specified date.
- The total PILON sum.
- Any additional entitlements (holiday pay, bonus, or similar) that are factored in or remain outstanding.Manage Restrictive Covenants: Check that no inadvertent breach has occurred. If you wish to rely on non-compete or non-solicitation clauses, confirm that the PILON arrangement is consistent with the contract’s wording or introduced by a well-drafted settlement agreement.
Calculate Tax Accurately: Undertake the PENP formula carefully and consult your finance or payroll team to ascertain the correct portion subject to tax and NICs. Overlooking any part of the statutory or contractual notice can cause a dispute with HMRC or the employee over net sums.
Document Redundancy Situations Separately: If the employee also qualifies for statutory or enhanced redundancy pay, keep that payment separate from the PILON portion for clarity. Typically, up to £30,000 of redundancy can be tax-free, whereas the portion representing unworked notice is not.
Additional considerations for employees
Individuals who receive a PILON should assess:
Share Scheme Vesting: As in Lo Wai Keung, share plans may require active employment or “good leaver” status. A “termination without notice” triggered by PILON could disqualify the employee, depending on scheme wording.
Benefits and Accruals: If the contract states that pension contributions, bonus accruals, or private healthcare are included in final pay, employees should verify that the lump sum accounts for these. If the contract is ambiguous, it may lead to disputes.
Tax Liabilities: Because PILON is taxed as earnings for the unserved notice, employees could see a higher-than-expected deduction once the employer applies PAYE. Employees should consult a tax advisor if uncertain.
When an employer opts to end an employment relationship early and provide a lump sum payment for the unworked notice period, the resulting scenario is functionally a termination without notice. The immediate termination date has particular implications for share schemes, accrued contractual benefits, and the enforceability of clauses that rely on the notice being worked. Both statutory and contractual frameworks require careful consideration of minimum notice entitlements, while HMRC expects a precise PENP calculation to ensure correct taxation. Recent court guidance, including Lo Wai Keung, reinforces these principles by clarifying that PILON is not simply “working notice remotely,” but is in fact an accelerated end of the contract.
All parties - employers drafting policy and employees negotiating exit terms - should remain vigilant about the ramifications of PILON. Contracts should be explicit, calculations precise, and communications transparent. By taking these steps, employers can avoid costly litigation and maintain lawful compliance, while employees can ensure they receive fair compensation and clarity on how termination affects their rights. This synergy of well-drafted documentation, proper HR practice, and awareness of legal precedents ensures that “termination without notice,” by way of payment in lieu, is both effective and equitable in 2025 and beyond.
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