It’s that time of year again, Christmas is over and many employees’ thoughts turn to what bonus they can expect to receive in respect of their performance over the past year. Despite efforts to manage employees’ expectations, the award of (or failure to award) bonuses can have both a detrimental effect on employee morale, and may lead to allegations of breach of contract and/or discrimination.

The recent Court of Appeal decision in the much publicised case Horkulak v Cantor Fitzgerald International [2004] IRLR 942, reiterates the now firmly established principle that employers should be extremely careful when deciding whether or not to award bonuses. An employer must remember that even if a bonus scheme is described as “discretionary” this does not provide it with an absolute and unfettered discretion as to whether or not to pay a bonus, and if so how much it should be.

So what are the top tips to bear in mind when awarding bonuses this year? What is your exposure if you don’t award bonuses fairly and how can you prevent future disputes arising?

Discretionary or contractual?

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.

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, as set out above, case law has developed to confirm that an employer does not have an absolute and unfettered discretion as to whether to make a bonus payment. Therefore an employer must consider what fetters is has upon it when exercising its contractual discretion whether or not to award a bonus.

Points to consider when exercising discretion

Firstly ensure you consider the express wording or conditions of the employment contract, any specific bonus scheme rules, provisions of a staff handbook or letters/circulars relating to bonus issues. If references to the discretionary nature of the bonus scheme are not drafted carefully, you may inadvertently be subject to specific parameters within which you can exercise your discretion (see further below).

Secondly, cases such as Clark v Nomura International plc [2000] IRLR 766, and most recently Horkulak above, have confirmed that even when a discretion appears to be unfettered, the courts are willing to imply a term into the bonus scheme that an employer will not exercise its discretion perversely or irrationally. The courts will consider whether or not a reasonable employer would have exercised its discretion in that way. According to the Court of Appeal in Horkulak “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”. In Clark v Nomura the High Court ruled that Nomura’s decision to award Mr Clark a nil bonus, in circumstances where he had earned the bank profits in excess of £13.75 million, was an irrational and perverse exercise of its contractual discretion.

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 £270 per week) and a compensatory award depending upon how long the employee is out of work (currently up to £55,000). Alternatively, the employee could remain in employment but protest at the level/lack of bonus and commence proceedings for an unlawful deduction from wages.

Finally the employee could claim that the discretion has been exercised in a discriminatory way. In Gus Home Shopping Ltd v (1) Green (2) McLaughlin [2001] IRLR 75, the EAT held that failure to pay employees’ bonuses because they were absent on maternity leave (when otherwise they would have been entitled to an award) amounted to sex discrimination. In Bower v Schroder Securities, The Times, 11 Jan 2002, an employment tribunal held that if an employer exercises its discretion to pay a female employee a lesser bonus than a male colleague (who undertakes the same role), this also amounts to sex discrimination. Damages awards for discrimination are uncapped.

How should bonus schemes be drafted?

The key to avoiding future disputes in relation to discretionary bonuses lays in the careful drafting of all bonus rules and documentation so as to ensure that you retain, as far as possible, the flexibility that you require. There are various issues which should be addressed when reviewing or drafting discretionary bonus schemes. To explain these is outside the scope of this article. However probably the most important consideration is to clearly define the parameters of discretion.

Care should be taken to draft bonus scheme criteria in order that they precisely set out those factors which will be taken into account by the company when assessing entitlement and level of any bonus under the scheme. If you choose to set out contractual parameters within which to exercise your discretion, this may avoid dispute in the future and reduce the risk of claims. For example, if a bonus is intended to be performance related, you should consider the basis upon which performance is measured. Does it include both company and individual performance? Does it relate only to profitability or does it include performance in any subsidiary functions of an employee’s role (such as client care/people management/increasing company profile?) On the other hand, such parameters may also restrict you when exercising your discretion, by preventing you from considering other factors which may have come to light at a later date and which are not expressly stipulated in the bonus scheme. For example, if a discretionary bonus scheme is stipulated as being performance related, you must exercise your discretion (both in relation to whether to pay a bonus, and if so, the amount) having regard only to performance issues. In such circumstances, if you were to take account of other considerations when exercising your discretion (such as the need to motivate the employee and/or conduct issues), it would be open for the employee to claim that such an assessment is in breach of contract.

If you would like further information on bonus drafting tips to reduce your exposure please contact a member of the employment team or your usual Fox Williams adviser.

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