Australia: Contract of Employment v Relationship of Employment – A Double Edged Sword?

Enterprise - April 2010

The Fair Work Act 2009 (the Act) introduced many changes to the law affecting employers and employees. The Act introduced a new system of Modern Awards, a new suite of universal minimum conditions of employment (the National Employment Standards) and a new regime for compulsory bargaining in good faith for the purpose of creating collective workplace agreements (enterprise agreements).

In spite of this, at the core of the employment of every employee in Australia is a contract of employment. The contract may be written or it may be unwritten. The terms of the contract may be overridden by more favourable terms in an applicable Modern Award or enterprise agreement – but nevertheless the contract is still there.

The common law of Australia deals with the formation, content, enforcement and termination of contracts. From one perspective, it might be thought anomalous that employment in Australia is regulated by a combination of 21st Century statute law (i.e. the Act) and "horse and buggy" common law. Some may think that the Act ought to have gone further and codified the rules that apply to the contract of employment, rather than focusing more or less exclusively on regulating the collective interaction between employers and employees. That is an issue for another discussion.

The common law of contract is an omnibus collection of legal principles that apply to all types of contract. The uniform application of these rules can lead to a certain measure of artificiality in the employment context.

Under the common law of contract if a party commits a fundamental breach of the agreement, then that is said to give rise to a "repudiation". In response to the repudiation, the innocent party can elect to either keep the contract on foot, thereby hoping to obtain the fruits of that contract or to "accept the repudiation" and bring the contract to an immediate end. In the second scenario, the innocent party would then claim damages for the loss flowing from the premature termination of the contract.

It is thus a central feature of the common law that repudiation operates on an "elective" and not "automatic" basis.

But the application of this principle to a contract of employment is problematic. If an employer repudiates a contract of employment by dismissing an employee in circumstances not permitted by the contract, and in response the employee elect to keep the contract "on foot", what will be the outcome? In a commercial contract, the wronged party taking this action can look to obtain an order from the court requiring actual performance of the contract. But such relief is not available in the context of employment, because of longstanding legal principles based on the court's aversion to making orders that might require continual supervision. The relationship between employer and employee is deemed to be personal, founded on trust and confidence, something which cannot magically be brought back into existence by a court order.

To get around this the courts draw a distinction between the contract of employment and the "relationship of employment". A repudiation of a contract, occurring in the circumstances previously outlined, will bring about an end to the employment relationship, with the consequence that the person cannot obtain a reinstatement of the ability to work and receive remuneration. But the contract of employment can live on if the wronged party elects accordingly.

The continuation of a contract of employment in these circumstances is not merely a matter of legal metaphysics – real consequences can follow.

This has recently been illustrated in a decision of the Supreme Court of New South Wales - Tullett Prebon (Australia) Pty Limited v Purcell [2009] NSWSC 1079.

The background circumstances were as follows:

  1. Mr Purcell was employed by Tullett Prebon as a stockbroker. The contract of employment stated that the employment would endure for a fixed term of two years. Neither party could terminate the agreement prior to the expiration of this term, other than in circumstances of serious breach of contract.
  2. The contract obliged Mr Purcell to render his services exclusively to Tullett Prebon during the term of the employment. After the employment ceased Mr Purcell was restrained from, among other things, working in a competing business for a period of 12 months.
  3. The contract allowed the company to send Mr Purcell on "garden leave" at any time – during the course of which he would continue to receive his normal remuneration but would not perform any duties
  4. The contract also contained a clause under which Mr Purcell was required to pay an amount of money as a "genuine pre-estimate of liquidated damages" if the contract was terminated prior to the expiration of the fixed term.
  5. Mr Purcell purported to resign his employment approximately 15 months before the end of the fixed term. He then commenced employment with a competitor. This amounted to a repudiation of the contract of employment by Mr Purcell. In response, Tullett Prebon elected to send Mr Purcell on garden leave and to keep the contract on foot, Mr Purcell continued to be paid his normal remuneration.
  6. Tullett Prebon then applied to the Supreme Court of New South Wales for an injunction to enforce the exclusive service provision of the contract. The purpose of the injunction was to prevent Mr Purcell from working for the competitor. Tullett Prebon did not seek orders that Mr Purcell be required to come back to work - for the reasons explained earlier, the court would not entertain such relief in any event.
  7. The judge concluded that although the contract of employment had been kept on foot as a result of the election issued by Tullett Prebon, the relationship of employment was over. As a consequence of the demise of the relationship of employment, the Court was not prepared to grant an injunction enforcing the exclusive service obligation. However, the demise of the relationship of employment brought into play the restraint of trade clause in the contract – under which Mr Purcell was restrained from working for a competing business for 12 months after the employment was over. The Court concluded that in the circumstances Mr Purcell should be prevented by injunction from working for the competitor for a period of six months.
  8. Two days before the expiry of the injunction, Tullett Prebon wrote to Mr Purcell informing him that his garden leave was at an end and that he should return to work the following week. He was warned that if he did not return to work it would be construed as a breach of contract and the company would then take steps to terminate the contract. It needs to be remembered that although the injunction lasted for six months, there was still several more months left of the term of the contract – the contract that had been kept on foot as a result of Tullett Prebon's earlier election.
  9. Mr Purcell did not respond to the notification and did not return to work. He instead went to work for the competitor as soon as the injunction lapsed.
  10. Tullett Prebon commenced proceedings in the Supreme Court in order to enforce the "liquidated damages" provision of the contract.

The Court had to determine the following issues:

  • whether the direction to return to work was a lawful direction, the failure of Mr Purcell to comply with which entitled the company to then terminate the contract
  • whether by reason of its conduct the company was precluded from relying on the direction and thence terminating the contract
  • whether the "liquidated damages" clause was unenforceable as a penalty.

The Court concluded that the direction was lawful and Mr Purcell's failure to comply with it was a fresh repudiation of the contract. In response to that repudiation Tullett Prebon could elect to terminate the contract – which it had done. The effect of that termination was then to bring into play the "liquidated damages" clause.

The Court further concluded that there was nothing about the company's conduct, or the circumstances of the prior litigation, that precluded reliance on the direction.

On one view, it might be thought somewhat peculiar that an employer can successfully obtain an injunction against an employee on the basis that monetary damages would not be a sufficient remedy and then seek to terminate the contract once the injunction was over so as to then claim damages on the basis that the employee did not show up for work. The situation might seem even more peculiar when it is remembered that the Court had earlier found that the relationship of employment (which underpins the performance of work) had long since been terminated.

The Court said that reservations of the type illustrated in the previous paragraph could not stand in the way of the application of settled principles of contract law. As a result of High Court decisions in cases such as Automatic Fire Sprinklers v Watson (1946) 72 CLR 435 and Visscher v the Honourable President Justice Giudice (2009) 258 ALR 651 the contract remains on foot as a result of the wronged party's election - it is not merely a shell. In those circumstances, the possibility exists that conduct by the employee may amount to a repudiatory breach of contract attracting fresh legal consequences. The fact that the company would never have been able to enforce the continued contract to the point of actually requiring Mr Purcell to perform duties does not make any difference. If it did, then this would represent the elevation of an issue dealing with the availability of legal remedy to the level of a legal principle regulating the formation and existence of contract. This would be contrary to accepted legal doctrine.

In relation to the "liquidated damages" clause, the Court found that it was not a penalty. The amount derived by the formula was not so extreme or unreasonable to cast doubt on the acknowledgement contained in the clause – which was that both parties agreed that the relevant amount was a genuine pre estimate of the damages that the company would suffer in the event of premature termination of the contract.

In the final result, Mr Purcell was ordered to pay $503,100 plus interest and costs.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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