In the first of a two-part guide to overpayments, HRM covers the basics of the law, and how to best engage an overpaid employee.

When it comes to payroll, underpayments may carry the most significant regulatory and public relations risks, but there are few things as awkward as overpayments. Not only has a mistake or oversight caused your business to be out of pocket, to rectify the issue you have to talk to your employees and, in a reversal of the typical power dynamic, ask them for your money back.

“Ask them” is the right way to express it. The Fair Work Act is very strict about the ability of an employer to reduce pay. What’s more, while the employer is legally entitled to the money, they risk significant damage to the employment relationship if things go poorly. 

In fact, in the very worst cases, an overpayment can be more damaging than an underpayment.

HRM spoke to Michael Byrnes, employment law expert and partner at Swaab, about overpayments, and covered the following topics (the first four are covered in this post, the last three are covered in part 2 of the guide).

1. Why overpayments occur
2. The law
3. How to engage an overpaid employee
4. Recovering the money
5. “Blood from a stone”: an employee’s personal situation
6. “Changed position”: when an employee can keep the money
7. Suing the employee: the last resort

1. Why overpayments occur

Generally, overpayments occur due to one of two errors:

1. Incorrect payroll entry, either due to a miscommunication or a clerical error.
2. A contract, enterprise agreement or Award is misinterpreted so that the employee is paid more. This more frequently happens with regards to the payment of penalty rates, overtime pay, and so on, rather than the payment of the base salary. Just like systemic underpayments, over many years these can lead to substantial amounts owing.

Less typical is when an overpayment occurs because an employee is permitted to take paid leave before they’ve accrued it and then they leave the company before it has been accrued. These cases are generally easier to negotiate, as the employee tends to have more oversight (and responsibility) for the overpayment.

Also possible during the pandemic is an overpayment caused by a mistake regarding JobKeeper eligibility. The most likely scenario here is an employer that thought an employee was eligible and so paid the requisite money during the period in April when the government was yet to send out money, and later found the employee was not eligible.

2. The law

Often the first instinct of an employer when they notice an overpayment is to authorise reduced pay for a period until the amount owing is returned. 

“That’s wrong,” says Byrnes. “There are very strict rules about when a deduction can be made in pay, and it needs to be in writing and it needs to be principally for the employee’s benefit.”

 This is the principle outlined in section 324 of the Fair Work Act, which refers to when deductions from pay are permissible (section 326 outlines what counts as an unreasonable deduction).

Byrnes notes there are exceptions in section 324. An Award, law or enterprise agreement can contain a provision for deducting pay, but these are quite specific and still subject to strict conditions.

So what about having contractual provisions that deal with overpayment? These can be helpful, but they are not silver bullets. They normally only set out the collaborative process that will take place should an overpayment occur.

“A contractual provision will not prevail over the requirements of the Fair Work Act. The contractual terms are usually just a basis or foundation for setting up repayments, rather than a be-all and end-all of themselves,” says Byrnes. 

Another element of the law employers should be aware of when it comes to overpayments is the possibility of committing a breach with an overly aggressive attempt at recovery.

“Let’s assume an employer says, ‘We’ve overpaid you. We want you to repay in seven or 14 days’ and the employee responds, ‘I can’t do that, it’s unreasonable’,” says Byrnes.

“If an employer then treats the employee adversely for them having raised that objection [demotes them, changes their role, gives them fewer hours, etc.] that could arguably be adverse action. If the claim was successful it’s a breach of the Fair Work Act itself, which gives rise to compensation and penalties.

 “Employers need to tread very carefully and have adverse action and general protection provisions in mind when they are seeking repayment from employees.”

3. How to engage an overpaid employee

Given the above, when an overpayment occurs in most cases you will want to:

• Inform the employee of the overpayment.
• Outline in writing why it occurred (eg: clerical error) and the amount owing.
• Have a discussion about how it should be paid back. This should address the total amount, the frequency of installments, the amount of each installment and so on.
• Establish the agreed upon method of repayment in writing.

Crucial to any discussion and agreement is the personal financial situation of the employee (for more detail, see section five in the next instalment).

4. Recovering the money

The simplest way to recover the money is to reach a written agreement about a salary reduction over a set amount of time. The size of the deduction should be reasonable and not interfere with the employee’s ability to pay rent, bills and so on.

But deductions are not the only option. In certain circumstances it is also possible to recover the money through a repayment scheme, where the employee’s salary remains the same and they separately pay back the money over time. 

The advantage of this method over deducting salary over a period is that the legal restrictions are less severe – the Fair Work Act sections on deducting wage is no longer applicable. That being said, the overarching principles are similar, says Byrnes.

“There should be an agreement in writing, it should be treated as a debt to the employer, and it should be structured in such a way that the repayments don’t disadvantage or create a real detriment to the employee’s capacity to pay their bills and to have enough money to live on.”

Regardless of the method, the repayment should be well documented. If pay is being deducted, each payslip should outline the amount being withheld and the reason why.

If the overpayment is being returned as a debt, each instalment should be documented. If the employee misses a payment, just as you would with a debt, you should inform them of the amount owing and request it gets paid promptly. The awkwardness that can occur around debt recollection is one of the reasons why pay reductions are often favoured, even though they are subject to stricter legal requirements.

That’s the basic way to recover an overpayment. However, there are a few extra principles to keep in mind, and a legal defence called “change of position” that can mean the employee gets to keep the money they were overpaid. There is also the matter of what to do if an employee refuses to negotiate. To read about these, see part two of HRM’s guide.

Understanding the legal landscape is crucial for all HR professionals. AHRI’s short course provides participants with an overview of the most important aspects of HR law.