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How to Manage a Payroll Error: Overpayments and Underpayments of Wages

Australian employers must manage a payroll error in accordance with the law, or face legal consequences. Payroll errors can be corrected with the agreement of the employee and where doing so is consistent with the law.

Payroll is one of the least appreciated but most important functions in a business. When payroll is done well, it keeps employees happy and saves a company from legal consequences. On the other hand, payroll mistakes can even have an impact on the entire company.

Many employers are unaware of what they can and cannot do in the event of a payroll error, and how to manage a payroll error to protect themselves from legal consequences.

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In this article, Farrah Motley, Director of Prosper Law and an employment lawyer, explains how to manage a payroll error.

Can an employer rely on a contract to correct payroll errors?

It is not uncommon for employment contracts to include a clause allowing the employer to deduct amounts from the employee’s wages.

A common clause in standard employment contracts often states that:

In the event an error has been made in the payment of an employee’s salary, overtime payment or leave accruals, balances or usages, the employer shall, for purposes of future compensation, adjust such compensation to the correct amount, giving written notice to the employee.

On this basis, the employer could simply deduct the amount owed from the next payment. However, the law does not allow for this to happen.

Authorisation to deductions by agreement

Under section 324(1)(a) of the Fair Work Act, an employer can only make authorised deductions from an employee’s wages, incentive-based payments, bonuses or allowances if both:

  • the deduction is authorised in writing by the employee; and
  • the deduction is principally for the employee’s benefit.
payroll error

In addition to the above, section 324(1) of the Fair Work Act also permits the employer to make deductions where:

  • the employee authorises the deduction in accordance with an enterprise agreement;
  • the deduction is authorised by or under a modern award or an order of the Fair Work Commission; or
  • the deduction is authorised by or under a law of the Commonwealth, a State, a territory, or an order of a court.

An employer must be careful before relying on a contract to correct payroll errors. Indeed, the Fair Work Act provides that the employee’s written authorisation must:

  1. specify the amount of the deduction; and
  2. the employee can withdraw the authorisation at any time.

It is rare for an employment contract to specify the amount of the deduction. For this reason, these clauses are generally invalid. And even if the clause were effective, the employee has the right under the law to withdraw their consent at any time. This is regardless of the term of the employment contract.

There is no express provision in section 324 of the FW Act that permits an employment agreement to “authorise” payroll deductions generally unless the authorization falls within section 324(1)(a) of the Act and specifies the amount of the deduction.

In the event, that an employer relies on such a contractual clause and the employee later disputes the deduction, the employer may:

  1. have to repay the amount to the employee; and/or
  2. be subject to a civil penalty.

Therefore, employers should be cautious about relying on a general deduction clause in their employment contracts. An employee’s express written consent to a specific amount is required despite the language used in the contract. That is, unless the deduction is properly authorised by an industrial instrument, statute, or court order.

Can an employer correct a payroll error in a later payment?

Sometimes a payroll error or misjudgment can lead to an overpayment of wages. Overpayment of wages generally occurs in two cases. The first is a clerical error or the entry of incorrect data into a payroll system without the employer’s intent to make such payments. The second scenario is a misinterpretation of the applicable industrial instrument, such as a contract, award, enterprise agreement, or National Employment Standards.

Managing overpayments

An employer can only deduct money from payments to an employee to recover an overpayment if permitted by an industrial instrument (e.g., an enterprise agreement or modern award), legislation or court order.

In the absence of an express provision authorising deductions, and in the case of an overpayment, the law does not permit an employer to automatically deduct the overpayment from an employee’s future wage payments without the employee’s written authorisation.

However, it is likely that recovery of an overpayment of wages with the employee’s consent will be considered an appropriate deduction in the employer’s favour. This is especially true if the reason for the overpayment was merely an error in the payroll.

payroll error

The High Court dealt with the right to recover incorrect payments in David Securities Pty Ltd v Commonwealth Bank of Australia. This case dealt with the issue of the right to recover monies paid as a result of a mistake of law. The Court held that payments made by mistake should not result in unjust enrichment and ordered that reimbursement be made.

How can employers recover an overpayment of wages?

An employer may seek recovery of an overpayment by negotiating and recording a written agreement between the employer and the employee. The employee generally must choose how the money will be repaid and the amount and frequency of each payroll deduction. The amount and frequency of the deductions must be reasonable.

For example: Jason was overpaid $2,000 over three years due to a payroll error. Under his award, it is not permissible to take a deduction when an employee is overpaid.

Jason and his employer, Amelia, meet to discuss the overpayment. Jason agrees to repay the money, and they work out a solution. Amelia says that Jason can decide how the money will be repaid and the amount and frequency of the payments. Jason tells Amelia he would prefer $20 be deducted from his weekly pay until the $2,000 is repaid in full. The agreement is put in writing and both sign.

This repayment is reasonable because Jason could choose the method of repayment and the amount and frequency of each payment.

However, suppose an employee refuses to agree to repayment. In this case, the employer must take independent action to recover the overpayment, such as through civil action and recovery action. An employer should seek advice from a workplace lawyer if an agreement on repayment cannot be reached.

Can an employer deduct money owed from an employee’s wages?

Sometimes employees owe money to their employers at the end of their employment. There are various reasons for this, such as repayment for the purchase of products, cash loans, cash shortfalls, rent or benefits with payment plan, overused holidays, overpaid wages, errors etc.

The employer can ask for their money back if the employee quits work. The easiest way to recover money is to deduct the amount the employee owes the employer from their final wages.

Employers often ask workplace lawyers if it’s possible to deduct the money they believe the employee owes them. Employers need to understand that what looks easy may not be easy.

payroll error

The law does not allow an employer to take the easy option of recovering money owing by deducting the employee’s wages. In most cases, the employer is no better off than any other creditor unless the employee consents in writing.

While there should be accountability for things like cash shortfalls, the law states that it cannot take the form of a deduction from wages. The employer will need to take independent action with help of an employment lawyer to recover amounts overpaid, (e.g. through a civil claim in the courts).

Employers must not make the mistake of entering into unlawful deductions. Unlawful deductions can result in steep civil penalties, up to $630,000 for companies and $126,000 for individuals, for “serious contraventions” of the Fair Work Act.

Notice periods and reductions in pay

As a rule, the employer and the employee must inform each other in advance when they intend to terminate the employment relationship. If an employee terminates his employment, he may have to do so in writing by letter (or email) to his employer. Similarly, when an employer gives notice to an employee, the employer must give the employee a period of notice.

In both cases, the notice period:

  • begins on the day after the employee has given notice that he wishes to terminate his employment;
  • ends on the last day of employment.

An employer must observe the following minimum notice periods when dismissing an employee:

Work ExperienceMinimum Notice Period
1 year or less1 week
More than 1 year – 3 years2 weeks
More than 3 years – 5 years3 weeks
More than 5 years4 weeks

Employees that are not covered by an Award or employment contract do not needto give notice when they resign. However, the employee’s employment contract, applicable Award or registered agreement, will usually specify the notice period required. An employment contract cannot provide for less than the legal minimum specified by the National Employment Standards.

For example, an Award, employment contract, enterprise agreement or other registered agreement may specify longer minimum notice periods (e.g. 1 month instead of 1 week).

Payment in lieu of notice

Generally, the employee will observe the notice period. However, sometimes the employer will not require the employee to work the notice period. If this happens, the employer and the employee may agree that the employer will pay out the notice period instead. If the employee does not work the notice period when the employment relationship ends, this is notice-not-worked.

In case, an employee has been dismissed and wishes to leave during the notice period, the employer may agree to shorten the notice period. If the employer does not agree to a reduction of the notice period, the employee may resign himself and comply with the minimum notice period. The time the employee has already worked during the original notice period is not counted.

Minimum notice periods

The minimum notice period that an employer must observe depends on the length of service of the employee. Continuous service is defined as the period during which the employee has been employed by the enterprise. Service includes authorised unpaid leave (e.g. unpaid parental leave). Service will not include periods of unauthorised leave or absence.

payroll error

For example, Hannah has been employed for 5 years and 3 months. This includes 12 months of unpaid parental leave. Hannah’s manager has to terminate her employment because her job is being made redundant and is trying to work out how long the notice period should be. Hannah’s award refers to the National Employment Standards for notice periods.

The employee’s continuous service for the purposes of notice would include the time she has taken 12 months of unpaid parental leave. Hannah is therefore entitled to 4 weeks’ notice from her employer.

Where an employer provides for a longer notice period than provided for in the award, registered agreement or employment contract, the employee only has to work out the minimum notice period. He can work out the additional notice period if he so wishes. If the employee only works the minimum notice period, the employer doesn’t have to pay the additional notice period.

Taking leave during a notice period

An employee can also take annual leave during the notice period if the employer agrees to the leave. However, the employer cannot force an employee to take leave during the notice period.

An employee may take sick leave during a notice period if he or she:

  1. gives notice of the leave as soon as possible
  2. provides proof if the employer requires it (e.g. a medical certificate).

An employee who has used up all his sick leave may take unpaid sick leave. He must notify the employer of this and evidence.

There are some situations where a notice period does not apply to an employee. According to the National Employment Standards, notice periods do not apply to employees who:

  • are casual workers
  • are employed under a fixed term contract for a specific period or task
  • are doing seasonal work
  • are dismissed for serious misconduct (e.g. theft, fraud, assault or sexual harassment)
  • have a training arrangement and are employed for a fixed period or for the duration of the training arrangement (with the exception of apprentices)
  • work as daily hire labourers in the construction industry or in the meat industry in connection with the slaughter of livestock
  • work as weekly hire workers in the meat industry and whose dismissal depends on seasonal factors (but not if the dismissal is for other reasons).

In the case of apprentices, the employer must provide notice to the apprentice unless they are:

  1. employed for a specified period or task; or
  2. dismissed for serious misconduct.

How can Prosper Law help?

Prosper Law is an employment law firm with experience in providing legal advice to employees and employers. We have extensive experience in dealing with employment matters.

If you are an employer facing difficulty to recover monies from employees, contact our employment lawyer for help who can assist you by providing tailored advice, and by reviewing and updating your policies, procedures and contracts.

If you need to talk to an employment lawyer, get in touch today.

Contact the team at Prosper Law today to discuss how we can provide you with workplace legal advice for a fixed fee or at affordable hourly rates.

Farrah Motley | Director

PROSPER LAW – Australia’s Online Law Firm

M: 1300 003 077

E: farrah@prosperlaw.com.au

W: www.prosperlaw.com.au

A: Suite No. 99, Level 18, 324 Queen Street, Brisbane, Queensland Australia 4000

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