Annualised salaries and set-off clauses: are they worth the trouble?

Recent high profile cases involving alleged underpayment of employee entitlements have focused attention on whether employers can rely on set-off clauses in common law contracts, and other forms of annualised salary arrangements, in order to meet their award obligations. In addition, the Fair Work Commission has recently published new ‘annualised salary clauses’, intended to be adopted in a wide range of modern awards.

These developments come at a time when employers are relying less and less on enterprise agreements as a means of regulating terms and conditions, and are instead focusing more on awards for this purpose.

Awards can, however, be complex instruments, and may not be particularly well-adapted to the circumstances of a particular enterprise. This leads many employers to seek to rely on flat ‘salary arrangements’, or ‘all-in rates’ in order to avoid having to manage the complexities of hourly rates, overtime, allowances and other obligations that can arise under the award system or under some enterprise agreements. Under such arrangements, employees receive a rate of pay that is equal, or superior, to the rate required by the relevant industrial instrument, but without the shift-to-shift or week-to-week variations that can arise under the award/agreement model. This may appear to be a win-win option for both employer and employee: for the employer it is administratively less complex, whilst for the employee it means that there is greater predictability in income flow.

Below, we explore some of the ways in which such arrangements can be put in place, and identify some potential compliance risks associated with their use. The options that are most commonly adopted are:

• common law contracts of employment containing a ‘set-off’ clause; or
  
  
• an annualised salary arrangement such as those provided for in some awards.

This article is framed in terms of set-off of award entitlements, but it is important to appreciate that it is also possible to adopt similar contractual arrangements for employees whose terms and conditions are regulated by an enterprise agreement, and to include annualised salary provisions in enterprise agreements.

Set-off clauses

It is well established that an employer and employee can lawfully agree in a common law contract to an arrangement where the employee is paid a rate of pay (typically expressed as a salary) that is higher than the base rate required by the relevant award, and expressly agree that the ‘over award’ component of that pay arrangement will be treated as having met the employer’s obligations to make other forms of payment that may arise under an award, such as overtime, weekend penalty rates, leave loading, and allowances.

It is of the utmost importance, however, to ensure that any contractual provision of this kind is carefully drafted to achieve this lawful outcome.

The lawfulness of such arrangements was most recently re-affirmed by a Full Court of the Federal Court in Linkhill Pty Ltd v Director, Office of the Fair Work Building Industry Inspectorate.[1] In this case, the Full Court explored in detail the history of decisions of various courts and tribunals, (dating back to the decision in Ray v Radano in 1967),[2] testing whether or not set-off clauses were valid and/or could be relied on in practice.

The Full Court was of the clear view that such clauses were valid and could be relied upon so long as they were appropriately drafted, and that the amount of money being paid was sufficient to fully meet the employer’s award obligations. In particular, the Court found that where the employer and employee have agreed that the salary payment can be applied against specific award payment obligations, then the clause should be given effect.

By way of illustration, where an employer and employee have agreed that the salary rate of pay was to be applied to cover and offset against all obligations arising in relation to overtime, weekend and night penalty rates, then the salary rate of pay can be applied to meet those award obligations.

What can and cannot be offset?

The pay rate can only be applied to offset or meet the obligations that have been identified in the contract. It is not, for example, possible to lawfully provide that the rate serves to meet one specific award obligation, and then later try to argue that it meets a different award obligation.

Therefore, if a contract designated that part of the salary was to cover leave loading and overtime obligations, and made no reference to some other entitlement such as weekend penalty rates, the employer could not offset that part of the salary against weekend penalty rates.[3]

What level of specificity is required?

It is not necessary that the parties use precisely the same language in the contract to match every single award obligation that the payment is intended to cover. There should be a ‘close correlation between the nature of the contractual obligation and the nature of the award obligations. But it is not necessary that the same label be used…’.[4] As long as the concepts are broadly the same (e.g. payment for hours of work performed, or for work performed on weekends etc.) then generally this will be sufficient.

It is common practice for set-off clauses to list a range of specific award obligations in detail, but provide that the salary can also be used to set off any other payment obligations or entitlements. Sometimes this can be done by listing specific award clauses by number and title. This has the attraction of clarity and certainty, but can become problematic if/when the award itself is amended, or more than one clause is (or becomes) relevant to the particular entitlement.

It is also possible, and could provide more certainty, for a contract to nominate a specific monetary or percentage allocation of the salary to specific award entitlements (e.g. ‘$1.50 of the hourly rate is allocated to meet the obligation to pay the remote site work allowance under clause X of the ….award’). This is, however, notoriously difficult to achieve in practice, as it is often very hard to be clear about exactly what value can be attached to a particular award entitlement for every pay period. Furthermore, some award entitlements are calculated by reference to other award entitlements, and of course the value assigned to a particular entitlement within the award may vary as and when the award is varied.

Payment within a pay period, and time and record keeping

Awards will generally require certain payments to be made within a nominated pay period or roster cycle (which can often range from one week to four weeks in duration).

Therefore, the employer must satisfy the award payment obligation for each and every pay period or roster cycle. It cannot rely on a ‘over award’ payment in another pay period/roster cycle to satisfy the obligation from an earlier pay period/roster cycle.[5]

This is an issue that causes many set-off arrangements to come unstuck, particularly if there are substantial fluctuations in award pay entitlements from one pay period to another. The salary level must be sufficient to cover the employee’s award entitlements for every period. If the salary falls below the award entitlement in a given period, then the employer will be in breach of the award in respect of that period. The fact that the shortfall was ‘made up’ in another period will be of no avail to the employer.

Furthermore, if the employer has limited or no records of time actually worked, it becomes more difficult to show that the award obligations were in fact satisfied for each pay period.

In addition, under the Fair Work Act 2009 (Cth) (FW Act) and the Fair Work Regulations 2009 (Cth)[6] employers are obliged to keep various records (and to provide detailed payslips to employees). This can include an obligation to record and/or show the number of overtime hours worked, any averaging of hours agreements, the number of ordinary hours worked, and similar matters. Failure to observe these requirements is one of the most common forms of employer breach of the FW Act.

Further, as a result of 2017 amendments to the FW Act, where the employer was required to keep such records but failed to do so, in circumstances where there is an alleged breach of provisions such as those relating to the National Employment Standards or an award or an enterprise agreement, a reverse onus applies such that the employer is obliged to disprove such the allegation.[7]

Appropriation argument

In some instances, the courts have determined that where an over-award rate of pay is paid, but the contract does not specifically allocate the over-award component to a particular award obligation, it is open to the employer to ‘appropriate’ part of that component to meet a particular debt under the award, simply by asserting that the money paid is now relied on to meet that particular obligation.[8] This approach arises from general common law principles of creditor obligations: the creditor can choose to attribute the over-award payment to a particular part of a debt or obligation (assuming that the over-award component has not already been assigned elsewhere).

Suppose, for example, a salary of $1000 per week is paid. The base rate for the employee under the award is, say, $800 per week, and the employee should also have received $100 in penalty rates and $50 for allowances for that week (under the award). The contract is silent on whether the extra $200 was intended to meet or be set off against any particular award obligation. If a claim was made alleging underpayment and/or breach of award obligations, the employer may be able to appropriate $100 out of that extra payment towards meeting the obligation to pay penalty rates, and similarly, $50 towards the allowances obligation.

It is important to note that this defence relies on the employer being able to appropriate the amounts to the relevant debt arising under the award, and that the amounts have not already been appropriated (by conduct of the parties, or by a declaration by either employer or employee, or in some other way) for some other purpose. It is not, therefore, a particularly reliable defence to rely upon in the face of alleged failure to meet award obligations.

This issue is presently the subject of consideration by the Full Federal Court in the ‘casual employee test case’ of Workpac Pty Limited v Rossato.[9] These proceedings concern a claim by a nominally casual employee, Mr Rossato, for entitlements payable to continuing employees (e.g. annual leave and notice of termination). Workpac contends that the casual loading that was paid to Mr Rossato may be set-off against the entitlements claimed by him in the event that he is found to be a continuing employee. This is despite the fact that, as was the case with Mr Rossato, the parties could not have intended to provide for the entitlements payable to a permanent employee since they did not regard him as such! The case was heard in May 2019 and a decision is expected within the next few months.

Unjust enrichment claims?

A further option that may be available in underpayment cases is the argument that an over-award payment constituted an ‘unjust enrichment’ of the employee such that (s)he should be required to repay the employer. In Rossato for example, the employer argued that the casual loading payment to Mr Rossato was paid on the mistaken belief that it would satisfy the legal obligations of the employer to provide for permanent employment entitlements.

The ‘unjust enrichment’ principle is well established. It is, however, subject to an exception where the person who has been unjustly enriched is able to demonstrate that paying the money back would be unjust.[10] It remains to be seen whether the Full Court in Rossato will accede to the employer’s argument. In the meantime, employers should treat this line of defence with caution.

Award annualised salary arrangements

As noted earlier, some awards contain provisions or mechanisms that allow for some form of annualised salary to be paid to an employee instead of the more traditional award approach of paying a flat wage, plus various additional amounts such as overtime, penalties, allowances etc.

Awards with these provisions include commonly applied awards such as the Clerks – Private Sector Award 2010, the Banking, Finance and Insurance Award and the Mining Industry Award 2010. Many of these clauses were reviewed recently, and proposed or ‘model’ new clauses were published by the Fair Work Commission in the 2019 ‘Annualised Wage Arrangements’ decision, published on 4 July 2019.[11]

The new clauses are yet to be included in the awards that presently have annualised salary provisions, but it is anticipated that that will occur in March 2020. The precise terms of the proposed new terms vary, but in some instances they will be highly prescriptive and difficult to administer in practice. For example, some of the more prescriptive terms include requirements that:

• employees be advised in writing of the details of the annualised wage, including how it has been calculated (specifying which award obligations are included in this calculation), and the ‘outer limit’ of how many ordinary and overtime hours can be worked without requiring a payment higher than the annualised wage;
  
  
• an annual review be undertaken to ensure the employee was paid at least as much under the salaried arrangement as if they had simply been paid according to the standard award terms; and
  
  
• a written record be kept of all start and finish times, and of unpaid breaks, which is signed or acknowledged in writing in some way by the employee ‘each pay period or roster cycle’.[12]

These requirements are potentially so onerous that many employers may question the utility of reliance upon annualised salary provisions in awards in the first place.

The Fair Work Commission itself has made clear that an employer and employee are not obliged to rely only on an award annualised salary arrangement – they can choose to apply the normal common law contract with a set-off clause, as described above. As the Commission stated: ‘the model clauses (in awards) do not seek to invalidate or regulate any such contractual arrangements’.[13] This view is consistent with the approach in many of the leading cases discussed above.

It should also be noted that the new clauses would not have to be included in an enterprise agreement provision dealing with set-off arrangements, although if the underpinning award for the agreement included such a term, then that requirement would constitute part of the award provision against which the BOOT would be applied.

Final thoughts

The use of annualised salaries and set-off arrangements under common law contracts remains a viable option. There are, however, many practical and technical challenges associated with their use.

These are often not well understood, and that is why many of these arrangements have failed. In particular, businesses should consider the drafting and record keeping requirements carefully before assuming any set-off arrangement will withstand scrutiny.

But with the exercise of reasonable care, both common law contracts and award/agreement set-off clauses are attractive from many perspectives.