SE13070 - Termination payments and benefits: damages: the "Gourley" principle

The concept of "damages" can apply to any contract, including an employment contract. Whenever one party to a contract acts contrary to its terms (that is, breaches the contract), and by doing so inflicts a loss on the other party, the latter can sue for damages. So rules that apply to calculating damages generally also apply where an employer breaches an employment contract. Probably the most common breach is where an employer fails to give proper notice of termination.

A payment of damages falls within Section 148 ICTA 1988 (see SE13005). Whether a payment is "damages" can be a difficult issue and close attention to facts is essential.

When an Industrial Tribunal, a Court or parties to a termination settlement calculate damages they will often follow the “Gourley principle”. This principle is a rule of non-tax law that derives from British Transport Commission v Gourley (1955). There is an example at SE13995.

The principle is that a person must not be placed in a better or worse position than if the contract had actually been carried out. For example, say an employer fails to give proper notice of termination to an employee, and there is no contractual provision or expectation relating to payments in lieu of notice (see SE12976 onwards). The employer has breached the contract and the employee can claim damages (see SE12978).

The damages are first calculated by reference to the pay and benefits that the employee would have received during the notice period if proper notice had been given - say gross pay of £2,000. Note that this is not in fact “pay” but is merely part of the calculation of the appropriate level of damages.

But £2,000 would place the employee in a better position than if the contract had been carried out. If the employee had received pay during notice, it would have been taxed, leaving (say) £1,500 in hand. As the damages payment itself is exempt from tax (see SE12978) the employee would keep the whole £2,000. So to satisfy the “Gourley principle”, the damages payment is adjusted to £1,500.

It is important to recognise that this £500 adjustment to the sum of damages is not a deduction of tax and must not be repaid as such. The actual payment made to the employee - £1,500 above - must be considered under the normal taxation rules for that termination payment (in this case, SE12978).

If mistakes are made during this process then what is actually paid is taxed, under the appropriate tax law. If doing so leaves the individual “out of pocket”, that is a matter for the parties to remedy between themselves.

It is a rule of law that anyone suffering loss as a result of a breach of contract must "mitigate" the loss. This means that a dismissed employee must seek suitable alternative employment. An employer is entitled to reduce damages if the employee fails to do so. The amount of damages can be reduced to take into account earnings in a new employment during what would have been the notice period. It can also be reduced to take into account what could have been earned if the employee had not failed to seek alternative suitable employment.

Note also that these adjustments and calculations represent an "ideal". In practice, negotiations may have regard only to some of them, or even ignore them. If that happens, that does not necessarily mean that the payment is not "damages". It may only mean that the employee has in strictness been overcompensated or undercompensated according to law. However, if a payment reflects none of the adjustments associated with a damages payment in law, then it is open to question whether it is in fact a payment of "damages". Whether the payment is in fact damages for breach of contract depends on the facts of the case. That is, did the employer act contrary to the provisions of the employment contract?