Beware of turning pay rises into a contractual right

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Can an employer's mistaken belief that employees were entitled to an RPI-linked pay rise turn into a contractual obligation? Potentially, yes. A recent case demonstrates how an employer's actions and communications, as understood by its employees, can create a contractual entitlement.

In this case, a number of staff had transferred from ITS to CSC Computer Sciences Ltd (CSC) under TUPE (the Transfer of Undertakings (Protection of Employment) Regulations 1981; now 2006). Their contracts provided for annual salary reviews and referred to "annual salary increases". It was CSC's understanding that the ex-ITS employees had received a pay rise of at least the increase in the Retail Prices Index (RPI) so regularly that it had become a contractual right. CSC therefore increased their pay by this amount each year from 2001 to 2007. However in 2008 it started giving pay rises of less than the RPI increase.

The ex-ITS employees brought Employment Tribunal (ET) claims alleging either that the RPI increase was an express term in their written contracts, or that it had become a contractual right by virtue of custom and practice. The ET ruled that it was not in their contracts, but that it had acquired contractual status because of the way the employer communicated the practice and the employees understood it. The Employment Appeal Tribunal (EAT) upheld this ruling.

CSC appealed to the Court of Appeal, but the Court agreed with the ET and EAT. Even though the employer had initially been mistaken about the RPI increase being contractual, the way it had behaved and communicated to employees had created a contractual right. This was because:

  • a CSC HR manager had stated in correspondence to ex-ITS employees, regarding potentially moving to a CSC contract, that "you would no longer receive a guaranteed RPI pay rise annually as per your current ITS contract"
  • CSC had issued a briefing document to managers in 2008 referring to "the ex-ITS group…for whom a guaranteed minimum increase is awarded"
  • these documents were supported by the evidence of the ex-ITS staff
  • CSC had consistently acted on that basis from 2001-2007, in contrast to the pay increases it gave its other employees, and despite it being disadvantageous to CSC
  • the ex-ITS staff refused to move to the CSC contracts, showing that they thought, and CSC believed, they had such a right.

The behaviour of the parties demonstrated the existence of the contractual term. The Court of Appeal concluded: "…what matters is the effect of [the employer's] communications, viewed objectively: the employer's subjective understanding is irrelevant".

Employment contracts should usually refer to "pay reviews" rather than "pay rises" and should specify that "a pay review does not confer any automatic right to an increase" unless there are specific reasons for departing from that in individual cases. It was clearly unfortunate for this employer to end up creating a contractual right through its mistaken belief. It is a salutary reminder that the way an employer behaves and communicates to its employees can create contractual rights which did not previously exist, often by operating the same practice year after year and by the way it is referred to in communications to staff.