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Employment Contract Set-off Clauses
Senior Associate Kimberly Jones and the Employment team discusses this important topic.
The Federal Court of Australia (FCA / Court) recently delivered reasons that materially changed the accepted approach to employment contract set-off clauses, a mechanism employers have long used to offset higher payments in one pay period against lower payments in another.
The Court issued these reasons in Fair Work Ombudsman’s (FWO’s) proceedings against Woolworths Group Limited (Woolworths) and Coles Supermarkets Australia Pty Ltd (Coles). The matter involved four separate actions concerning alleged breaches of the Fair Work Act 2009 (Cth) (FW Act) and the General Retail Industry Award 2010 (RI Award).
Heard together as Fair Work Ombudsman v Woolworths Group Ltd; Fair Work Ombudsman v Coles Supermarkets Australia Pty Ltd; Baker v Woolworths Group Ltd; Pabalan v Coles Supermarkets (FWO Cases), the decision provides guidance to employers in ensuring they are meeting their legal obligations with respect to:
- interpretation of ‘set-off’ clauses;
- compliant record-keeping; and
- how compensation should be calculated.
Set-Off Clauses
In the context of employment law, set-off clauses are provisions in employment contracts that allow employers to offset payments made to employees against their entitlements under applicable industrial instruments, such as modern awards or enterprise agreements.
These clauses are often used when employers pay an all-inclusive salary or a higher rate of pay to cover various entitlements, such as overtime, penalty rates, or leave loadings, instead of calculating and paying these entitlements separately in each pay period.
However, for these set-off clauses to be effective, they must be carefully drafted to ensure that the payments made under the employment contract are sufficient to meet or exceed the minimum entitlements under the applicable industrial instrument.
In this case, the Federal Court found that Woolworths’ and Coles’ set-off clauses did not operate as intended. The Court held that set-off can only occur within the same pay period, it cannot be averaged or reconciled across multiple pay periods.
This is significant because many employers currently reconcile entitlements quarterly, or even every 6 or 12 months.
The Court emphasised that section 323(1) of the FW Act requires employees to be paid their minimum award entitlements for each pay cycle, meaning overpayments in one period cannot simply be used to offset underpayments in another.
The court also found that the set-off clauses in contracts of employment could not discharge obligations under the RI Award beyond the same pay period, effectively reinforcing the principle that set-off clauses must operate within the confines of the relevant payment period to lawfully discharge award obligations.
Record-Keeping
The ruling in the FWO Cases also addressed several issues regarding employee record-keeping.
The FCA found that the record-keeping obligations under the Fair Work Regulations 2009 (Cth) (Regulations), specifically regulations 3.33 and 3.34, were not satisfied by the employers. The Regulations require employers to keep specific records about their employees’ pay and hours, including:
- the rate of remuneration paid;
- gross and net amounts paid;
- any deductions made from the gross amount paid to the employee; and
- overtime hours wroked.
Section 557C of the FW Act places the burden of proof on the employer to disprove certain contraventions, including alleged underpayments, where proper employment records have not been kept. In this case, the respondents’ record-keeping failures triggered the operation of section 557C, shifting the burden of proof to them to disprove the underpayment allegations.
The court rejected the argument that annualised salary arrangements exempted employers from these obligations. Furthermore, the FCA ruled that clocking and rostering data were insufficient to constitute records for the purposes of regulations 3.33 and 3.34, as they were not readily accessible nor specifically stated the details of entitlements, they were merely raw data that an inspector would have to interpret.
Compensation
The FCA also considered how employee compensation should be calculated under section 545 of the FW Act.
Section 545 provides courts with the authority to make any order they consider appropriate if they are satisfied that a person has contravened, or proposes to contravene, a civil remedy provision. Relevantly, this includes the power to award compensation for loss suffered as a result of the contravention.
Both Woolworths and Coles argued that they should be able to offset an employee’s underpayments in one period with over-Award payments made in other periods.
However, the FCA ruled that compensation under section 545 was required to be determined independently of any contractual overpayments made beyond the stipulated award entitlements. Discretionary bonus payments unrelated to award entitlements or work performed were excluded from compensation assessments.
The Takeaways
While the FCA’s decision in the FWO Cases is likely to be subject to an appeal, employers should ensure that:
- set-off clauses in their employment contracts are explicitly linked to relevant entitlements under corresponding awards.
- accurate records are maintained that comply with the requirements of the FW Act and Regulations; and
- systems of reconciliation are in place that accurately reflect employee’s actual hours and entitlements.
The Court’s reasoning does not prohibit set-off clauses, but substantially constrains how they may be used. Their effect is now confined to the pay period in which the entitlement arises, rather than being spread across quarterly or annual reconciliation cycles.
This shift is likely to prompt employers to reconsider how remuneration is structured. Efficiency and flexibility remain achievable, but employers will need to ensure they have suitable advice and systems in place to apply these principles correctly.
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*The information provided in this website serves as a general guide and does not constitute legal advice. It is based on our research and experience at the time of publication. Please consult our knowledgeable legal team for any specific inquiries or advice relevant to your circumstances, as the content may not have been updated subsequently.