Penalty Clauses in Employment Agency Contracts

Councils that recruit interim staff through employment agencies need to be aware of possible penalties payable if staff are taken on permanently.

With recruitment and retention of staff becoming increasingly challenging across the public sector, Councils are turning to employment agencies to fill vacant posts in the short term. Often, staff taken on an interim basis will be suitable for permanent employment by the Council directly. While this is a legitimate course of action to take in order to maintain front-line services, there are risks attached which could prove costly if the employing Council does not tread carefully.

Additional Fees

It is very common in employment agency standard terms and conditions for an additional fee to be payable if one of their agents is employed directly by the Council they are placed with. What Councils also need to be aware of is that employment agency terms often include a clause requiring payment of a fee if their agent is employed directly by the Council after the end of their placement with the Council.

The period during which the fee is payable can be quite significant, often 12 months or more, and so Councils run the risk of becoming liable for such payments long after the relationship with the employment agency has ended.

Case Study

  • Small Town Council employed a Planning Officer through the agency Planners R Us for three months ending on 15 January 2016.
  • The Contract between the Planning Officer and Planners R Us said that the Planning Officer could not work for one of the agency’s clients for a period of 3 months after the end of their placement.
  • The Contract between the Council and Planners R Us said that a fee (worth 3 months’ agency fees) would be due if the Council employed one of their agents within 12 months of the end of their placement.
  • The Planning Officer did a good job and in October 2016 Small Town Council asked the Planning Officer if he was able to work for them directly on a permanent basis. The Planning Officer confirmed that they were.

In this case study, the Planning Officer is correct that they are not restricted from working for the Council directly. The three-month period binding the Planning Officer has elapsed. However, even though the Planning Officer is not restricted, the Council will be liable for a fee until 16 January 2017.

Isn’t this a penalty clause?

Normally, a breach of contract gives rise to Damages which should put the innocent party in the position it would have been in if the breach had not occurred. The Planners R Us contract is different because it requires payment of a sum of money rather just compensation for Damage caused. Clauses such as this are permissible in some circumstances but in other circumstances can be unenforceable (“Penalty Clauses”).

Traditionally, a clause will be an unenforceable Penalty Clause if it is not a genuine pre-estimate of the innocent party’s loss i.e. if it is disproportionate to the maximum possible loss from the breach. The period of time to which a restriction applies (12 months in this case) must also be reasonable.

More recent cases have said that even if a penalty clause is not proportionate to the loss suffered, it may still be enforceable if there is a “commercial justification” for protecting the “legitimate interests” of the innocent party. For example, a legitimate interest might be the protection of an industry which would be threatened if certain behaviours were not discouraged through the threat of additional costs.

The parties’ positions

In this case, Small Town Council could argue that the fee is not proportionate to the loss suffered by Planners R Us and so the clause may be an unenforceable penalty. In particular this is because a lot of the revenue that missed out on by Planners R Us would have been paid straight to the Planning Officer. Their loss is only the loss of profit – maybe 5-15% of the revenue.

Planners R Us would certainly argue that the fee is not disproportionate. They would also argue that the recent cases on Penalty Clauses apply and that they have a legitimate interest in preventing their clients from poaching their operatives within 12 months otherwise their industry could not function. They would also argue that 12 months is a reasonable period for such a restriction and the Council could have gone to anyone else with the Planning Officer’s skillset. Lastly, they would say that these clauses are common in their industry and so a Court may be persuaded by this argument.


Given the arguable nature of penalty clauses, even after recent consideration by the Courts, both parties could spend a lot of money litigating the point with little certainty over the outcome. In addition, there are other commercial considerations to bear in mind such as whether the parties want to work together in future and reputational damage. As a result most penalty clause disputes tend to be settled by agreement.

Councils should nonetheless be aware that these clauses may exist in their contracts with employment agencies, check the terms carefully and avoid falling foul of such clauses if they do employ former agency staff permanently.