When Can NZ Employers Pay In Lieu Of Notice (PILON)?

If you’re running a small business, ending an employment relationship is one of those “high-stakes” moments where a simple administrative decision can quickly become a legal problem.

One of the biggest practical questions we hear is: can you pay the employee out and have them finish up immediately?

In many cases, the answer can be yes - but only if you handle pay in lieu of notice (PILON) properly. The detail matters, because notice and pay obligations in New Zealand are heavily tied to your employment agreement, good faith obligations, and a fair process.

Below, we’ll break down when you can use pay in lieu of notice, when you shouldn’t, and the key steps to reduce risk when you’re terminating employment.

What Is Pay In Lieu Of Notice (PILON) In New Zealand?

Pay in lieu of notice (PILON) is where employment ends immediately (or earlier than the notice period), and instead of having the employee work out their notice, you pay them what they would have earned during that notice period (as required by the employment agreement or an agreed exit arrangement).

From a small business perspective, PILON can be useful when:

• you need to protect client relationships or confidential information;
• the workplace relationship has broken down and keeping the employee on site creates risk;
• the employee would otherwise be disengaged, disruptive, or unsafe;
• you need a clean operational handover quickly.

But it’s important to understand what PILON isn’t:

• It’s not a shortcut to avoid a proper dismissal process.
• It doesn’t remove your obligation to act fairly and in good faith.
• It doesn’t override what the employment agreement says about notice (or other entitlements).

If you’re setting up (or updating) your Employment Contract, it’s worth thinking about whether you want the flexibility to use PILON and how it should be worded - because your ability to pay in lieu often comes down to what you agreed to in writing.

When Can An Employer Pay In Lieu Of Notice?

There isn’t a single rule that applies to every business and every termination. In practice, whether you can use pay in lieu of notice depends on a few key factors - especially your employment agreement, whether you have the employee’s agreement, and the circumstances of the termination.

1) When The Employment Agreement Allows It

The cleanest situation is where the employment agreement includes a clause saying you can terminate by either:

• giving the required notice, or
• paying in lieu of some or all of that notice.

If the clause is drafted properly, it generally lets you end employment immediately and pay out the notice period, without needing the employee’s further agreement at the time of termination.

If your agreement doesn’t have a PILON clause, you may still be able to agree an exit arrangement - but you should be careful not to assume you can do it unilaterally.

2) When You And The Employee Agree To It At The Time

Even if your agreement is silent, PILON may be possible if the employee genuinely agrees (without pressure) to finish earlier in exchange for a payment covering the notice period.

To reduce disputes later, you’ll usually want the agreement recorded in writing (for example, in the termination letter, or as part of a settlement/departure arrangement). In higher-risk situations, it can also be sensible to give the employee a chance to get independent advice before signing anything.

In a small business, a practical approach can be to clearly offer two options:

• work the notice period (with clear expectations and handover requirements), or
• finish up earlier and receive an agreed payment covering the balance of notice.

Be mindful that employment relationships in New Zealand are governed by “good faith” obligations under the Employment Relations Act 2000. That means the way you communicate, consult (where required), and document the decision matters.

3) When You’re Ending Employment For Redundancy (But Still Following A Fair Process)

Redundancy is a common context where employers consider PILON - particularly if the role is ending and you don’t need the employee to keep working for operational reasons.

You still need to run a proper redundancy process (including consultation) and comply with the notice provisions in the employment agreement. But once you’re at the point of ending employment, paying in lieu can be a practical option if the agreement allows it (or if you and the employee agree to an earlier finish date and payment covering notice).

If redundancy is on the table, getting specific advice early can save a lot of stress - Redundancy Advice can help you check your proposed process, documentation, and payments before you press “send” on anything.

4) When There’s A Serious Relationship Breakdown Or Workplace Risk

Sometimes there’s nothing “wrong” with the employee’s performance, but the relationship has deteriorated to the point where keeping them at work during notice is risky.

In these cases, paying in lieu of notice (where you have the contractual right or agreement) can be used to:

• reduce the chance of conflict in the workplace;
• protect staff wellbeing;
• protect your customers and brand;
• avoid disruption to operations.

Just keep in mind: PILON doesn’t fix an unfair process. If the termination itself is unjustified (or the process is procedurally unfair), paying out notice won’t prevent a personal grievance risk.

When Should You Avoid Paying In Lieu Of Notice?

Pay in lieu of notice is common, but it’s not always the right move. The biggest “watch-outs” for business owners tend to fall into a few categories.

1) When Your Employment Agreement Doesn’t Allow It (And The Employee Doesn’t Agree)

If the contract requires notice to be worked (and doesn’t give you a PILON option), terminating immediately can amount to a breach of contract.

Even if you pay the notice period anyway, the employee might argue they were entitled to remain employed during that period (for example, to access benefits, commissions, or to avoid reputational harm). This can get complicated quickly, particularly if there are contractual incentives or conditions tied to being “employed” on certain dates.

2) When You’re Using PILON To “Rush” A Performance Or Misconduct Process

If you’re terminating for performance or misconduct reasons, your biggest legal risk is usually not the notice period - it’s whether the dismissal is justified and whether you followed a fair process.

So if you’re thinking “we’ll just pay in lieu of notice and it’ll be fine,” it’s worth pausing. A payment doesn’t replace proper steps like:

• raising concerns clearly;
• giving the employee a genuine opportunity to respond;
• considering alternatives to dismissal;
• carrying out a reasonable investigation (if misconduct is alleged).

For many small businesses, it’s helpful to have a structured approach before you reach termination - a Performance Management Process can help you manage issues early and keep your documentation and decision-making consistent.

3) When The Employee’s Pay Structure Is Complex (Commissions, Allowances, Bonuses)

PILON isn’t always as simple as “base salary x notice period”. If your employee’s normal earnings include variable elements (like commission), there can be disputes about what should be included in the payout, especially if the contract is unclear about how those amounts are treated during notice.

That doesn’t mean you can’t use PILON - it just means you should calculate carefully, check the contract wording, and document your approach.

4) When You’re Considering “Summary Dismissal”

In cases of serious misconduct, employers sometimes consider summary dismissal (termination without notice). That is a separate concept from pay in lieu of notice.

In other words:

• PILON = you don’t have the employee work notice, but you pay the notice period (where you’re entitled to do so).
• Summary dismissal = you terminate without notice and typically without notice pay (only in limited circumstances, and only if the dismissal is justified and the process is fair).

If you’re in serious misconduct territory, it’s usually worth getting tailored advice before deciding which path to take - because the downside of getting it wrong can be significant.

How Much Pay In Lieu Of Notice Should You Pay?

Once you’ve confirmed you can use pay in lieu of notice, the next question is: what exactly needs to be paid?

As a starting point, the amount is usually tied to the employee’s:

• contractual notice period (e.g. 2 weeks, 4 weeks, 1 month); and
• what they would have earned if they worked those hours during the notice period (as determined by the employment agreement and how the employee is ordinarily paid).

In practice, a PILON payment often includes:

• base wages/salary for the notice period;
• regular allowances (if they would have been paid during that time, depending on the contract wording);
• tax and KiwiSaver treatment (these payments are commonly processed through payroll and may be treated as taxable earnings - but the correct treatment can depend on the payment type and your payroll setup);
• any other contractual entitlements that would have applied if they remained employed during the notice period (depending on the wording and the nature of the entitlement).

Where businesses sometimes get caught out is assuming benefits automatically end the moment employment ends. If an employee would have had (for example) a vehicle allowance, accommodation allowance, or commission entitlement during the notice period, you may need to consider whether it forms part of what they “would have earned” - and whether your contract wording changes that outcome.

Note: This is general information only and isn’t tax advice. If you’re unsure about PAYE, KiwiSaver, or payroll treatment for a particular payment, consider checking with your payroll provider, accountant, or IRD guidance.

Don’t Forget Final Pay Items

PILON is often only one part of “final pay”. Depending on the situation, final pay may also include:

• payment for any annual holidays owed (in line with the Holidays Act 2003);
• payment for any alternative holidays (if applicable);
• any outstanding wages up to the termination date;
• reimbursements the employee is entitled to claim;
• deductions (only if lawful and properly agreed).

If you’re unsure about what can and can’t be deducted, be careful - employers can’t simply “take it out of final pay” without a lawful basis (and, in many cases, proper written authorisation).

Practical Steps To Use PILON Safely (And Reduce Dispute Risk)

Even when you’re legally entitled to pay in lieu of notice, how you implement it matters. Here’s a practical framework many small businesses follow to keep things clean and defensible.

1) Check The Notice Clause (And Any PILON Wording) First

Before you have the final termination meeting, check:

• how much notice the contract requires;
• whether you can elect to pay in lieu;
• any wording around benefits, commissions, and allowances during notice;
• any specific termination provisions (including process steps, if any).

If you don’t have up-to-date agreements in place, it’s worth fixing this before issues arise - your Employment Contract is usually your first line of protection.

2) Make Sure The Termination Decision Is Substantively And Procedurally Fair

In New Zealand, an employee can challenge a dismissal if it’s unjustified. Even where you pay notice (or pay in lieu), the process still needs to be fair and reasonable in the circumstances.

That usually means you’ve:

• clearly identified the reason for termination (performance, misconduct, redundancy, etc.);
• followed a reasonable process for that type of termination;
• given the employee a real opportunity to respond;
• genuinely considered their response before deciding.

If you’re not confident your process is sound, it’s often better to pause and get advice than to rush to a quick exit and hope a PILON payment will “cover” it.

3) Put The PILON Terms In The Termination Letter

Your termination letter should usually spell out (in plain language):

• the notice period under the employment agreement;
• that you’re ending employment immediately (or on a specific earlier date);
• that you will provide pay in lieu of notice for x weeks (and what it is intended to cover);
• what will be included in the final pay (and when it will be paid);
• practical exit items (return of property, handover, confidentiality reminders).

Having the right paperwork makes a huge difference if there’s ever a dispute. Many businesses choose to use a structured set of documents rather than drafting “from scratch” each time - an Employee Termination Documents Suite can help keep your approach consistent and reduce missed steps.

4) Consider Whether “Garden Leave” (Or Suspension) Is A Better Fit

Sometimes you want the employee to remain employed during the notice period (so they’re still bound by duties as an employee), but you don’t want them actively working.

That’s often where “garden leave” comes in - it can allow you to keep the employee away from work while still employed, rather than terminating immediately and paying out the notice period.

Separately, in some misconduct situations you may be considering suspension while you investigate. Suspension is different again and can carry its own legal risks and obligations (including around process and pay), so it’s worth checking your contract and getting advice before using it.

Whether you can use garden leave depends on the contract wording and the scenario. If you’re deciding between garden leave and pay in lieu of notice, it’s worth checking your agreement and getting advice on the risks and benefits.

5) Plan The Operational Details (Access, Comms, Customers)

From a business-owner perspective, the legal side and the practical side need to move together.

If you’re finishing employment immediately, think through:

• IT access removal (email, systems, passwords);
• client communications (who tells clients, and what will be said);
• return of business property;
• handover of work in progress;
• internal messaging to staff (keeping it factual and respectful).

This is also a good time to remind the employee (in writing) of confidentiality obligations and any post-employment restraints, if applicable.

Common Small Business Scenarios (And How PILON Typically Works)

To make this more concrete, here are a few scenarios where pay in lieu of notice commonly comes up for NZ small businesses.

Scenario 1: “They’ve Resigned, But We Don’t Want Them Here For Four More Weeks”

If an employee resigns with notice, you might prefer they leave earlier. Whether you can end earlier (and what payments are required) depends on your agreement and the circumstances.

In some cases, you can agree an earlier finish date and pay in lieu of the remainder of the notice period - but you should document it clearly to avoid confusion about what was agreed and what will be paid.

If you’re dealing with a resignation issue, this can also intersect with questions about whether someone can leave without notice at all - resigning without notice is a situation where getting the legal framing right early can really help.

Scenario 2: “We’re Dismissing For Performance - Can We Just Pay Them Out?”

Sometimes you can use pay in lieu of notice at the end of a performance process - but the core risk is whether your performance management and dismissal process was fair.

If you’re not sure your steps were sufficient (warnings, support, time to improve, consultation, documentation), paying in lieu doesn’t remove that risk.

Scenario 3: “We Need To Make The Role Redundant And Cut Costs Quickly”

Redundancy can be lawful, but it needs to be handled carefully - including consultation and considering alternatives. Once you reach the notice stage, pay in lieu of notice can be a practical way to finalise the exit quickly (if allowed by contract or agreed with the employee).

If you’re considering this path, it’s worth reading up on redundancy obligations and then getting tailored advice for your specific workforce and financial situation.

Scenario 4: “There’s Been Misconduct And We Want Them Gone Today”

If the alleged misconduct is serious, you might be considering suspension while you investigate, a disciplinary meeting, or summary dismissal. Pay in lieu of notice might still come into the conversation - but you’ll want to be extra careful here, because serious misconduct dismissals can be challenged if the investigation and process aren’t fair.

This is one of those moments where a quick call for advice can save you a long and expensive dispute later.

Key Takeaways

• Pay in lieu of notice (PILON) is where you end employment earlier than the notice period and pay the employee what they would have earned during that time (where the contract allows it or it’s agreed).
• The safest basis for PILON is a clear employment agreement clause allowing you to pay in lieu, or a written agreement with the employee at the time (ideally documented clearly and reached in good faith).
• PILON doesn’t replace a fair process - if the dismissal is unjustified or procedurally unfair, paying out notice won’t “cancel out” your legal risk.
• When calculating PILON, consider not just base wages, but also any regular allowances/entitlements the employee would have received during the notice period (depending on the contract and the entitlement).
• Final pay usually includes other items (like annual leave owing), so make sure your termination letter clearly lists what will be paid and when.
• If you’re terminating for performance, misconduct, or redundancy, get the process right first - then decide whether working notice, garden leave, or PILON is the best practical option.

If you’d like help handling a termination properly (including whether pay in lieu of notice is appropriate in your situation), you can reach us at 0800 002 184 or team@sprintlaw.co.nz for a free, no-obligations chat.