In McMahon v AXA ICAS Ltd the Court of Session considered whether payments due to an employee under a permanent health insurance scheme set out in her contract of employment continued to be due and payable as ‘wages’ after she was dismissed because illness prevented her from working. The court concluded that they did, leaving the employer potentially liable for more than 15 years of payments.
Ms McMahon began employment with AXA ICAS Ltd (AXA) in 2000. In September 2013 she was dismissed because a long- term illness was preventing her from working.
Ms McMahon’s contract of employment provided that if she remained unable to work after 26 weeks of absence caused by illness or injury, she would be paid 75% of her normal earnings less state benefit, increasing by 5% each year until she either recovered or reached 65 years old. The benefits were supposed to be secured by a policy with an insurance company effected by and paid for by her employer. The promised benefits were not in fact secured by an insurance policy.
Ms McMahon initially made a claim for unpaid wages for the period May 2011 to June 2013. AXA argued that its only obligation was to arrange and pay for a suitable permanent health insurance policy; failure to do so could not trigger a deduction from wages claim. However, the court held that so long as Ms McMahon was an employee and unable to work, AXA itself was contractually obliged to meet the scheme payments. Furthermore, failure to make the PHI payments amounted to an illegitimate deduction from her wages. In January 2025, AXA’s appeal against these decisions was refused by the EAT.
While the unpaid wages claim was pending, in March 2022, the ET was asked to allow an amendment which would introduce a continuing unauthorised deduction from wages claim for each month from May 2011 up to the present day. Ms McMahon claimed that, notwithstanding the termination of her employment in September 2013, she remained entitled to wages as per the permanent health insurance scheme benefits set out in her contract of employment. This was based on a submission that her dismissal was in breach of an implied term in the contract of employment to the effect that, while entitled to these benefits, she would not be dismissed because of an inability to work. The application was refused and the EAT refused an appeal.
Ms McMahon appealed to the Court of Session. The key issue before the court was whether AXA could rely on the dismissal as terminating the obligation to pay the PHI benefits. The court upheld the appeal. It noted that section 27 Employment Rights Act (ERA)defines ‘wages’ broadly to include sums payable in connection with employment, which could include PHI payments. As for how the entitlement to PHI benefits could survive the dismissal, the court considered that AXA had placed itself in the position of an insurer promising to pay certain benefits for so long as Ms McMahon met the eligibility conditions, and that since incapacity for work was one of those conditions, it made little sense if that alone allowed the payments to stop.
The Court noted that a number of potential legal analyses could justify this outcome. The PHI benefits could be viewed as collateral obligations under the contract of employment. Alternatively, applying the Supreme Court’s decision in Tesco Stores Ltd v USDAW an implied term to the effect that AXA could not terminate the contract for the purpose of depriving Ms McMahon of the PHI benefits would mean that the dismissal was a nullity and had no impact on AXA’s contractual obligation to honour the PHI payments. The Court saw force in the ‘collateral obligation’ analysis, primarily because it reflected the purpose of what is in effect an insurance scheme designed to operate when the employment relationship is ruptured, or at least interrupted, by illness or injury. It was also in line with Lord Sumption’s analysis in the Supreme Court in Geys v Société Générale, London Branch, where he distinguished between ‘core’ obligations, such as the payment of wages in return for work, and ‘collateral’ obligations that do not depend on the continuation of the employment relationship. However, the approach based on an implied term might be more in tune with the language of section 13 ERA, which refers to the wages of a worker ‘employed by an employer’. The court noted that the two approaches were not, in any event, mutually exclusive. The court also raised a further possible analysis under which Ms McMahon never accepted the wrongful dismissal, meaning that the contract continued unaffected. However, that approach raised issues of fact that would be difficult to resolve in the context of the appeal. The Court accordingly remitted the case to the employment tribunal with a direction that the amendment was to be allowed.
Action for employers
In this case, the employment contract imposed a freestanding obligation on the employer to pay PHI benefits. Where PHI cover forms part of the employee benefits package, the employer will usually fund it by taking out an insurance policy with a third-party insurer. In that case, it is important to ensure that the employment contract does not give the employee greater rights than are covered by the insurance policy. The employment contract should state that the employee’s eligibility for PHI benefits is subject to the rules or policy of the relevant insurance provider as amended from time to time, and that the employer is obliged to make payments to the employee only if, and to the extent that, it has received payment from the insurer for that purpose, and that it is not obliged to provide replacement cover or compensation if the insurer refuses cover or rejects a claim. Unfunded PHI liabilities are extremely expensive; it is not clear what Ms McMahon earned, but as an example 75% of the median UK salary of GBP32,890 would give rise to a potential liability of over GBP370,000 to date.
In a long line of cases, it has been held that there is an implied term prohibiting an employer from dismissing an employee without good cause where the effect would be to deprive the individual of their rights under a PHI or long-term sickness scheme. Employers are advised to include very clear wording in their contracts permitting them to dismiss in the event of long-term sickness absence, notwithstanding any entitlement to PHI benefits.
Ahead of the provisions of the Employment Rights Act 2025 which will significantly limit employers’ ability to make changes to contracts of employment and remove the cap on compensation for unfair dismissal, employers would be advised to audit whether they have employees with contractual entitlements to PHI benefits for which they could be liable in future, and take steps to limit their financial risk.
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