By Henry Ea -
A recent Federal Court judgment has delivered a significant blow to a common payroll practice, ruling that Australian employers cannot use an annualised salary to "pool" payments and offset underpayments in one pay cycle with overpayments in another.
The decision, stemming from legal action brought by the Fair Work Ombudsman (FWO) against Coles and Woolworths, has redefined the rules around contractual set-off and record-keeping, leaving many companies at risk of underpayment claims and substantial penalties.
The FWO first launched legal action against Woolworths in 2021, alleging the supermarket giant had underpaid thousands of salaried managers by over a million dollars. This was followed by similar action against Coles, with the FWO claiming that annualised salaries were insufficient to cover entitlements for significant overtime, weekend and public holiday penalty rates, and other allowances. At the time, then Fair Work Ombudsman Sandra Parker stated that the action was a warning to all employers to prioritise compliance.
The core of the case centred on the “set-off” clauses in the retailers’ contracts. Woolworths’ clause, in particular, was designed to satisfy all award entitlements over 26 weeks, allowing the company to use excess payments from some fortnights to cover shortfalls in others.
However, Justice Nye Perram of the Federal Court rejected this approach. He ruled that for a set-off clause to be lawful, each fortnightly payment must discharge the award obligations due in that specific fortnight. Pooling overpayments over a six-month period was described as an “accounting abstraction” that did not constitute a valid payment under the Fair Work Act. Perram applied this same principle to the various clauses used by Coles, concluding that a company’s obligations could only be met by a payment made within the same pay period.
In a critical observation that will have far-reaching consequences, Perram commented that it was doubtful that any level of careful drafting could have achieved the set-off sought by the retailers through six-monthly pooling. This finding casts a long shadow over similar arrangements in countless Australian workplaces, forcing employers to reassess their payroll systems urgently.
Key findings that are changing the game
According to Christopher Leong, Special Counsel, Employee Relations & Safety at King & Wood Mallesons, the most critical findings are poised to disrupt current payroll and compliance practices.
The first key finding is that contractual set-off is pay period specific. Leong explains that contractual remuneration can only offset an employer’s award obligations within the same pay period (weekly or fortnightly). A contractual “overpayment” in one period cannot be used to cover a shortfall in a previous or subsequent one. This directly challenges a common practice used to manage fluctuating hours, such as those worked during weekends or public holidays. Furthermore, overpayments can’t reduce compensation. If an employer’s reliance on set-off provisions leads to payment frequency contraventions, any overpayments from one period cannot be used to reduce the amount of compensation awarded for underpayments in other periods.
Leong says the judgment “significantly re-frame[s] the baseline position on the availability of contractual set-off between pay periods.”
The decision also establishes a strict burden of record-keeping for employers. Even when an employee’s salary exceeds the award minimum, employers must maintain a single, self-contained, easily accessible record of daily overtime hours and other allowances.
“It is not sufficient for an employer to just rely on a combination of data sets (i.e. clock-in/out data and rosters) to satisfy the overtime record-keeping obligation,” Leong says.
Finally, in cases where employers fail to keep proper records, they bear the onus of proof, facing the burden of disproving the employee’s account of hours worked.
“The fact the employer may have directed the employee to record their hours and the employee failed to do so, will not provide a ‘reasonable excuse’ to relieve the employer from that burden,” Leong warns.
What employers must do now
Leong advises that businesses take immediate and decisive action. “Employers will now need to revisit their forms of contract, and also the bases on which they have set their remuneration packages,” he says. He recommends a two-pronged approach. First is a forward-looking analysis to review and revise existing contracts and audit current compensation packages to ensure they can meet all award obligations in every pay period. Second is a retrospective analysis to review ongoing or recently concluded underpayment remediation activities, as the methodology used may no longer comply with the latest case law.
“[E]mployers who have not taken pro-active and swift corrective action … will leave themselves highly exposed to both meritorious and speculative underpayment claims.”
The risks of inaction
Leong warns that failure to act could expose employers to significant risks. The most immediate risk is direct liability for breaching awards and the Fair Work Act, which could lead to substantial compensation and penalty awards.
Under recent legislative changes, the bar for a “serious contravention” is now lower. The court’s unequivocal findings on set-off and record-keeping make it harder for an employer to claim they were not aware or reckless, potentially exposing them to criminal “wage theft” laws, which carry significant penalties.
Senior managers and decision-makers could also be personally responsible for the company’s actions under civil and criminal provisions. “[I]t is critical that senior managers and other decision-makers take appropriate steps to ensure their organisation has adopted sound and defensible positions in their oversight and implementation of payroll governance activities,” Leong warns.
Could this decision lead to a significant increase in underpayment claims, particularly class actions against employers who have relied on a “set-and-forget” approach to annualised salaries?
“[W]e have already seen a marked uptick in employment-related class action activity,” Leong says.
“[E]mployers who have not taken pro-active and swift corrective action … will leave themselves highly exposed to both meritorious and speculative underpayment claims.”
Leong notes that this is particularly true in the class-action space, where lucrative penalty awards and compensation are now a significant incentive. This was highlighted in the recent TWU v Qantas Airways Limited case, which resulted in a record penalty, a portion of which was directed to the prosecuting union.
How will this affect employment lawyers?
Leong says the most significant takeaway for employment lawyers is the court’s definitive position that set-off is not available between pay periods, regardless of how well a contract is drafted.
He explains that previous legal strategies, such as explicitly stating the intention to set off between pay periods or framing over-award components as a prepayment of future entitlements, have been rendered ineffective by the court’s ruling.
Consequently, lawyers must now fundamentally reevaluate how they draft set-off clauses in new contracts. This decision will also influence how they advise their clients—including management and stakeholders—on both historical and prospective compliance.
“Previously available approaches will now need to be viewed through a heightened risk-based lens,” Leong concludes.
A case management hearing is scheduled for late October.
