Federal Court ruling limits use of set-off clauses for annual salaries of award-covered employees

The Federal Court of Australia recently delivered a significant decision in legal proceedings brought by the Fair Work Ombudsman (FWO) against Woolworths and Coles[1]. The Court found the retailers failed to keep accurate records of overtime, hours of work and entitlements and cannot rely on annualised salaries to discharge award-based liabilities over different pay periods.

Background

The FWO alleged that Woolworths and Coles underpaid tens of thousands of employees covered by the General Retail Industry Award 2010 (Award) during 2015 to 2019 (Woolworths) and 2017 to 2020 (Coles). Class action representatives have also brought claims alleging underpayments by the retailers, with some underpayments alleged to have occurred as far back as 2013.

The Award-based employees were paid annualised salaries under employment agreements containing ‘set-off’ clauses, which is a common practice in numerous industries. Like many employers using annualised salaries, the retailers did not keep track of Award entitlements (including overtime, penalties and allowances) or hours of work. This, combined with a failure to reconcile amounts paid to employees against their entitlements under the Award, resulted in massive underpayments.

Woolworths and Coles have already made significant remediation payments (more than $300 million and $7 million, respectively) and have informed the market they are setting aside further amounts for remediation. The FWO and class action representatives are pursuing even more compensation for employees, alleging remediation efforts to date are insufficient.

Contractual wording

In defending the proceedings, Woolworths and Coles relied on having paid annual salaries that were higher than the minimum amounts required under the Award. The retailers said these overall above-Award payments could be applied to offset liabilities in any pay period within a 26-week period. To do so, they relied on ‘set-off’ or ‘offset’ clauses in the relevant employment agreements.

This practice is standard in numerous industries and is often coupled with a failure to adequately make and keep records of hours of work, given that employers assume, incorrectly, that the annual salary means they do not need to worry about tracking entitlements such as overtime and penalty rates. Employers paying annualised salaries often fail to reconcile award-based entitlements against annualised salary amounts paid.

Woolworths relied on the following clause in its employment agreements:

If at any time you are entitled to any payment or other benefit as a consequence of the Employment (whether under legislation, an industrial instrument, the National Employment Standards or otherwise) including, without limitation, minimum hourly rates, penalties, overtime, allowances such as meal allowances and loadings such as annual leave loading (Minimum Entitlements), you agree that:

(a) as far as possible, the Remuneration and other benefits under this Agreement will be in satisfaction of the Minimum Entitlements over a 26 week period calculated at the applicable minimum rate: and

(b) the Minimum Entitlements do not form part of this Agreement.

As part of this, your Base Salary and any allowance outlined in your Letter of Offer includes payment for:

(a) all hours you work over a 26 week period (whether part of your ordinary working hours or not): and

(b) public holidays and suitable public holidays (whether you work on those days or not).

Coles relied on examples of similar clauses in its employment agreements.

Like countless Australian employers, the intention of Coles and Woolworths was to discharge their obligations to pay Award entitlements owing for a given pay period, such as overtime and penalty rates, by making above-Award payments in other pay periods.

Decision

The Federal Court held employers can only set-off award entitlements against amounts paid within the same pay period, no matter what the employment agreement says. In other words, if an employer underpays an employee in a particular pay period by not paying sufficient overtime or penalty rates for that pay period, the employer cannot make up for the underpayment by paying above-Award amounts in a later pay period. This is the case even where an annual salary means the employee would have been paid, overall, sufficient amounts across the year.

The Court cautioned that even careful drafting is unlikely to permit employers to apply past or future over-award payments in satisfaction of payments owing for a particular pay period.

Implications for employers and insurers

Although it may be appealed, this decision makes clear that an obligation to pay entitlements owing under an award can only be satisfied by paying the relevant amount within the relevant pay period.

Employers should immediately review use of annualised salaries and set-off clauses for award-covered employees, to ensure they are meeting their pay and record-keeping obligations under the Fair Work Act 2009 (Cth) (FWA) and industrial instruments. Subject to the drafting of relevant enterprise agreements, the same logic (being an inability to use annualised salaries to meet underpayments in pay periods) is likely to apply.

Employers can run into problems when using payroll systems that do not record start and finish times, overtime worked and/or penalty rates. An employer failing to keep such records will not only find it difficult to remedy underpayments, but will also be exposed to civil penalties for breach of record-keeping obligations under the FWA and Fair Work Regulations 2009 (Cth).

Employers paying annualised salaries to award or enterprise-agreement covered employees should:

• ensure they reconcile payments made in each pay period against employee entitlements to overtime, penalties, allowances, loadings and minimum rates of pay for the pay period;
• consider whether they may be exposed to underpayment claims for failing to pay award or enterprise agreement-based entitlements in particular pay periods;
• ensure they are making and keeping employee records as required by legislation;
• implement payroll systems that record employees’ start and finish times, overtime and penalty rates within their corresponding pay period; and
• seek legal advice from employment lawyers if unsure about any of the above.

This decision represents a pivotal moment in the employment law landscape, with broad implications for use of annual salaries, remediation projects and payroll compliance.

Further, EPL, statutory liability and D&O insurers are likely to see more such claims coming across their desks. Australian employment class actions pursuing significant underpayment claims and statutory penalties may increase in frequency and claim quantum. The trend is likely to affect the retail, construction, hospitality and finance sectors, amongst others. The potentially huge sums of back payments may affect stock prices and could even result in shareholder class actions.