McMahon v AXA ICAS Ltd: Practical Considerations for Employers and HR Professionals

The decision in McMahon v AXA ICAS Ltd is one of the most significant recent UK employment law cases concerning permanent health insurance (PHI) benefits, unlawful deductions from wages, and the limits on an employer’s ability to dismiss employees on long-term sick leave.

This case progressed through the Employment Tribunal, the Employment Appeal Tribunal (EAT), and ultimately the Inner House of the Court of Session in Scotland.

Whilst a decision of the Scottish Courts, the case highlights the legal risks that arise when employers operate PHI or income protection schemes without fully considering the contractual obligations attached to them.

Background

AXA ICAS Ltd employed Carol McMahon from 2000 until her dismissal in 2013. Her contract included entitlement to a PHI scheme providing 75% of salary during long-term incapacity, with annual increases until recovery or retirement age. Ms McMahon became unable to work due to illness in 2010 and later became eligible for PHI benefits.

However, her employer, AXA ICAS Ltd had failed to secure the insurance policy intended to fund those benefits.

Ms McMahon argued that:

1. she remained contractually entitled to PHI payments;
2. there was an implied contractual term preventing dismissal where dismissal would deprive her of PHI benefits; and
3. non-payment of those benefits constituted an ongoing unlawful deduction from wages under the Employment Rights Act 1996 (ERA).

Earlier tribunal decisions rejected the argument that post-dismissal PHI payments could amount to “wages,” but the Court of Session ultimately disagreed.

The Court of Session’s Ruling

1. Whether PHI Benefits Constitute “Wages”

The central legal issue concerned sections 13 and 27 of the Employment Rights Act 1996, particularly the definition of “wages.”

Section 27 ERA defines wages broadly to include sums payable “in connection with employment.” The question before the court was whether PHI benefits payable after dismissal could still fall within that definition.

The Court of Session held that PHI benefits were capable of qualifying as wages even after termination because:

• the entitlement arose from the employment contract;
• the scheme was specifically intended to operate when the employee was incapable of working; and
• the employer could not rely on dismissal to extinguish rights the scheme was designed to protect.

This was a significant development because unlawful deduction claims in the Employment Tribunal are uncapped, whereas a breach of contract claim in the Employment Tribunal is subject to a cap of £25,000 of damages.

2. The Implied Term Restricting Dismissal

The court accepted that there may be an implied contractual term preventing an employer from dismissing an employee for incapacity where the effect would be to deprive them of PHI benefits.

The reasoning included the finding that:-

• the PHI scheme existed specifically to protect employees who became unable to work;
• allowing dismissal solely because of incapacity would undermine the purpose of the scheme; and
• employers should not benefit from their own wrongdoing by terminating employment to avoid liability.

This implied term has potentially wide implications for employers managing long-term sickness absence.

3. Post-Termination Liability

Another important issue was whether liability for PHI benefits could survive termination of employment.

The employer argued that any post-dismissal losses should only be recoverable as damages for breach of contract. That distinction mattered because breach of contract claims in the Employment Tribunal are subject to a £25,000 cap.

The Court of Session rejected this narrow approach and concluded that the obligation to make PHI payments could continue beyond dismissal where the dismissal itself breached the implied contractual protection.

As a result, Ms McMahon was allowed to pursue ongoing unlawful deduction claims potentially extending over many years, and in excess of £25,000.

4. Administrative Failures and Employer Responsibility

A striking feature of the case was that the employer had apparently failed to secure the insurance policy intended to fund the benefit scheme. The contractual entitlement nevertheless remained enforceable against the employer itself.

The case therefore demonstrates that:

• insurance arrangements do not necessarily limit employer liability;
• employers remain contractually responsible for benefits promised to employees; and
• failures in scheme administration can create substantial direct financial exposure.

So what does this decision mean for employers, and what are the Key Takeaways?

For employees, the case strengthens their protections when on long-term sick leave.

For employers, it creates increased litigation risk where PHI or income protection schemes are poorly drafted, inconsistently administered, or disconnected from sickness dismissal procedures.

Employers should therefore:-

1. urgently review employment contracts, staff handbooks, PHI policy wording and insurance arrangements. Any mismatch between contractual promises and insurance cover may expose the employer to direct liability.
2. exercise extreme caution before dismissing employees on long-term sick leave – dismissal for incapacity may breach an implied contractual term if the employee has entitlement to PHI benefits.
3. ensure insurance policies are actually in place, as one of the most damaging facts in the case was the alleged failure to secure the insurance cover at all. HR and legal teams should therefore check policy renewal dates and employee eligibility for insurance policy cover.
4. Be alive to the fact that liability may continue after termination of the employment relationship, as this decision suggests that PHI-related liabilities may survive dismissal and continue for years. This significantly increases the financial exposure of sickness management decisions, particularly for senior or long-serving employees.
5. align sickness absence procedures with contractual benefits – this will likely require a policy audit to ensure contractual benefits are considered as part of capability procedures, and training where necessary to ensure managers understand PHI implications.

It is also highly advisable that you seek legal advice before taking the decision to dismiss an employee in these circumstances.