Bonus claims often form a substantial part of compensation claims made by employees, particularly on termination of employment where an employee may feel aggrieved that they have been dismissed shortly before they were expecting to receive a bonus payment.

Contractual Schemes

Employee bonuses can be classified as either contractual or discretionary. A contractual bonus is one by which the amount of the bonus can be calculated according to a set formula or conditions in the contract, fulfilment of which is a binding contractual obligation upon the employer to pay the requisite sum.

When dealing with a contractual scheme, employers must be cautious to ensure that the rules of the scheme are sufficiently well drafted to enable them to cover most eventualities.  What is going to happen if the employee resigns before the end of the year?  What if the Company’s performance is poor?  What if the employee is dismissed for gross misconduct?  These are all important considerations.  For example, an employer is unlikely to want to pay out a contractual bonus payment where it already knows that an employee has resigned and is intending to join a competitor.  It is important that the wording of the contractual scheme enables the employer to withhold payment in those circumstances.

When paying out a contractual bonus, employers should be careful to ensure that they are making the award in accordance with the rules of the scheme, otherwise a claim for breach of contract is likely to ensue.

Discretionary Schemes

More frequently, bonus schemes are drafted as discretionary, which purportedly give the employer flexibility in considering whether or not to make a bonus payment either during employment or upon termination.  However, case law over recent years has established that an employer’s discretion is not unfettered.  When exercising a discretion in a discretionary bonus scheme, an employer must not exercise its discretion in an “irrational or perverse” way.  Other cases have suggested that the test may be even stricter than this, and that “it is presumed to be the reasonable expectation and therefore the common intention of the parties that there should be genuine and rational, as opposed to an empty or irrational, exercise of discretion”.  This means that, for example, a top sales person who has a discretionary bonus scheme and is expecting a bonus of £50,000 based on his performance could not generally be awarded a bonus of £2,000 simply because there has been a personality clash between him and his manager.

Points to consider when drafting discretionary schemes

When drafting discretionary bonus scheme rules, it is also important to consider in what circumstances you may not want to make a payment to the employee.  For example, it is common practice in the City to have a provision in the employee’s contract saying that any discretionary payment under the bonus scheme will only be made if the employee is in employment on the bonus payment date, and is not under notice (whether given or received).  This is intended to enable an employer to exercise its discretion not to award an employee a discretionary bonus payment in circumstances where the employee has resigned to go to a competitor, or has been dismissed part way through the year.

It is also worth considering whether you want to specify what factors will be taken into account in exercising the employer’s discretion.  Many employers prefer not to express this and to leave their discretion as wide as possible.  However, it may be helpful sometimes to express that both company and individual (and perhaps team) performance can be taken into account in assessing the discretionary payment which may be made to an employee.

What claims could an employee bring?

If discretion is exercised perversely or irrationally, or in breach of any express conditions detailed in the employee’s contract or bonus scheme rules, the employee could bring a claim for breach of contract. The damages sought would be the bonus monies the employee believes should have been paid.

As this breach would relate to the employee’s remuneration (which is considered a fundamental term of a contract of employment), it would be open for the employee to resign and claim constructive unfair dismissal. The employee would seek his notice monies, and unfair dismissal compensation constituting a basic award based on age, length of service and salary (currently capped at £290 per week) and a compensatory award depending upon how long the employee is out of work (capped at £58,500). Alternatively, the employee could remain in employment but protest at the level/lack of bonus and commence proceedings for an unlawful deduction from wages.

Other potential pitfalls

Finally, the employee could claim that the discretion has been exercised in a discriminatory way. A failure to pay employees’ bonuses because they were absent on maternity leave (when otherwise they would have been entitled to an award) is likely to amount to sex discrimination. An employer who  exercises its discretion to pay a female employee a lesser bonus than a male colleague (who undertakes the same role), is also likely to be exposed to a claim for sex discrimination. Damages awards for discrimination are uncapped.

When determining bonuses, employers should therefore be cautious not to forget about those who remain employees but are not currently working in the office, such as those who are on long term sickness absence or maternity leave.  Care should be taken to ensure that those employees are treated fairly and in accordance with the rules of the bonus scheme (which must not be discriminatory).

Given the complexities involved in drafting bonus schemes, it is often a good idea to seek advice at an early stage, before claims are brought as a result of employees not receiving what they had expected under the rules of the scheme.

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