Underpayment alert as Federal Court rules on contractual set-off clauses

On 5 September 2025, the Federal Court reshaped the law on a practice many employers have relied on for decades: using contractual set-off clauses to balance out overpayments in one pay period against shortfalls in another.

The Court's ruling in Fair Work Ombudsman v Woolworths Group Limited; Coles Supermarkets Australia Pty Ltd [1] was unequivocal. Employers relying on this contractual practice can only offset within a single pay period and cannot “carry forward” payments to cover entitlements arising in another pay period.

The ruling does not abolish set-off clauses altogether, but it sharply limits their utility – both practically and from a compliance perspective. They now have a far narrower function than employers have historically assumed to consolidate different award entitlements within the same period.

The decision contributes to the tension at the heart of its industrial relations system between highly regulated compliance obligations and the need to deliver the flexibility and dynamism required for a modern economy to remain globally competitive. While the decision is certainly a hurdle for employers, options remain available for employers willing to invest in strategic workforce planning.

This shift has major implications for payroll design, contract drafting, and remuneration strategy. While an appeal is possible, the Fair Work Ombudsman (FWO) and plaintiff firms will rely on the decision immediately, making it essential for employers to act now.

This shift has major implications for payroll design, contract drafting, and remuneration strategy. The decision also risks stifling flexibility in how employers structure remuneration, as it narrows the scope for innovative salary models and increases reliance on rigid ‘per period’ compliance.

For now, unless and until a superior court says otherwise, this represents the current state of the law. This means employers must act now to review – and potentially address - their approach to remuneration, payroll and record-keeping compliance, to protect against exposure to claims.

Contractual set-off clauses cannot operate across pay periods. Employers cannot use overpayments in one month to cover underpayments in another month. The requirement in s 323 of the Fair Work Act 2009 (Cth) (FW Act) is that entitlements be paid “in full” for each prescribed pay period.

Set off clauses in contracts operate differently to annualised salaries which are expressly provided for in modern awards and/or enterprise agreements. The Court reaffirmed that offsetting pay across pay periods is still allowed but only when a modern award or enterprise agreement expressly allows for an employee to be covered by an ‘annualised salary’.

Set off clauses in employment contracts can only discharge award entitlements where there is a clear “coincidence of purpose” — a direct link between the salary and the entitlements it is intended to cover.

Vague or generalised clauses are unlikely to withstand scrutiny. This will mean that employment contracts must list in detail the exact modern award or enterprise agreement penalty, allowance or other rate which is being ‘offset’ to be effective.

The decision effectively requires employers to introduce per pay period reconciliations and top-up payments. Annual or retrospective reconciliations will not avoid liability. This is likely to be one of the most expensive and complex implications of the ruling.

Where a modern award requires agreement, the employer bears the onus of proving the employee knowingly consented. Implied or informal arrangements will not suffice.

A contractual clause authorising “reasonable overtime” is evidence of standing authorisation. But if an employee adjusts their hours for their own convenience, that is not employer-directed overtime. The Court also confirmed that “reasonable additional hours” and “overtime” are distinct concepts.

Employers seeking to rely on set-off clauses or annualised salary arrangements must still comply with detailed record keeping requirements. This includes detailed records kept of overtime and penalty rates, even where the employee is not receiving additional payments for those entitlements because of the ‘rolled-up’ rate.

The decision confirmed that simply keeping clocking data and roster information is not enough. Further, partial or reconstructed records are not valid. Records must be detailed, accessible and contemporaneous. This is critical, because the burden of proof under s 557C of the FW Act shifts to employers where records are incomplete.

This ruling will force employers to confront strategic questions:

With their utility confined to a single pay period, some employers may find that set-off clauses now deliver very little compliance value. Those employers seeking to smooth payments across time may wish to consider negotiating annualised salary arrangements as part of their enterprise agreements or to make better use of existing ‘Individual Flexibility Agreements’ under modern awards.

The practical answer is – most likely, yes (at least to some extent). Employers should anticipate the need for live reconciliation within each pay cycle, and processes for automatic top-up payments when shortfalls arise.

Policies and procedures should also be considered which seek to more strictly monitor and approve the working of overtime.

Even with the potential of an appeal on the horizon, employers cannot afford to wait until then. The decision is likely to see an increase in claims from unions and employees, in addition to greater regulatory interest by the FWO, for those employers relying on contractual off-sets and annualised salaries.

At Kingston Reid, we see this decision as a turning point, as well as an opportunity to redesign future-focussed remuneration strategies that will offer protection and certainty. While this decision is a hurdle for employers, efficiency and flexibility is still possible for those employers willing to invest in strategic workforce planning.

The views expressed in this article are general in nature only and do not constitute legal advice. Please contact us if you require specific advice tailored to the needs of your organisation.

References

[1] Fair Work Ombudsman v Woolworths Group Limited; Coles Supermarkets Australia Pty Ltd [2025] FCA 1092