The Bonus Question

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04 December 2009

Bonus schemes come in all shapes and sizes and the nature of a bonus scheme will fundamentally affect the freedom an employer has to reduce, defer or withhold a bonus. The scheme may reserve full discretion to the employer, so the employer retains complete freedom as to when and how much to pay, or whether to pay at all.

Alternatively, the scheme may be fully contractual, so that an employee has a contractual entitlement to a bonus if he or she hits applicable targets.

More commonly, the scheme will be a mix of the two, with a discretionary element built into a contractual right to participate in a bonus scheme. It is worth employers spending time getting the bonus documentation right paying particular attention as to which elements of the scheme should be contractual and which should be subject to the employer's discretion.

For example, a scheme may include a contractual entitlement for the employee to have his performance appraised but any consequent decision to pay the bonus and how to calculate any bonus might be discretionary. Careful drafting can also reap dividends on the termination of the employee's employment when battle lines on this issue are most commonly drawn.

Reducing, deferring and withholding bonuses

Where an employee has a contractual right to a bonus, then seeking to withdraw or defer that bonus would, in most circumstances, require the employee's consent to vary that element of his contract. The contract itself may reserve a right to the employer to make amendments to the scheme, but that will generally only permit the employer a degree of wriggle room rather than the ability to make wholesale changes.

Where the scheme has a discretionary element, the employer should be able to rely on the exercise of that discretion to limit payments under the scheme, or in some circumstances, to defer or even withdraw them altogether. This does not mean, however, that an employer has a completely free hand.

Capricious, perverse and irrational…

Not a premiership manager holding forth on the standard of officiating in the Premier League, but the court setting out how an employer must not behave when exercising its discretion. The court does not go so far as to say that an employer has to act reasonably, simply that it must not act in a way that no reasonable employer would have done.

So, an employee who has achieved maximum bonuses in the past and has hit his targets will have good grounds to argue he should receive a bonus. Equally, where the employee can show that his performance matches or exceeds that of comparable colleagues who have been paid, the employee may well be similarly entitled.

A similar restriction on an employer's free hand is found in the implied duties of mutual trust and confidence and good faith, which are characteristics of all employment relationships. These are sometimes described as obligations of fair dealing on the part of the employer, and would prevent the employer from behaving in such a way as to destroy mutual trust. This might arise, for example, where an employer terminates an employee's employment immediately before he becomes entitled to a substantial bonus.

Even where the scheme itself looks non-contractual, in some circumstances, a contractual entitlement to a bonus may have become implied through custom and practice. This is a particular problem where, having regularly paid bonuses year-on-year, an employer then seeks to withdraw a bonus altogether and to pay nothing. It is usually easier in those circumstances to pay a reduced rather than a nil bonus.

Equality issues

If, rather than reducing bonuses across the board, an employer seeks to pick and choose, the risk of challenges in the field of discrimination looms.

If the decision to award a bonus is in part linked to, for example, length of service or a requirement for full-time working, then there may be grounds for complaint based on indirect sex discrimination - it is generally accepted by employment tribunals that women with child care responsibilities are more likely to work part-time and have shorter periods of continuous employment with one employer.

Awards based on length of service can also bring age discrimination issues into play whilst schemes that use attendance levels as a criterion may need to be adjusted for particular employees to prevent disability discrimination.

What are the risks of seeking to reduce, defer or withhold?

Where an employer denies an employee a bonus to which he or she is contractually entitled, the employee may be able to bring a claim for breach of contract.

If still in employment, this would have to be brought in the County Court or High Court, usually an unattractive venue for most employees because of the expense and risk of an award of costs against the losing party (although unsurprisingly the High Court has seen a number of high value banker bonus cases in recent years).

The employee may also have a claim for unlawful deduction from wages, which can be brought in the employment tribunal, a costs-free jurisdiction (more or less). However, this claim may only be brought where the employee can identify the precise sum that the employer has failed to pay and cannot, therefore, be used to challenge the employer's exercise of discretion.

Where an employer has behaved particularly poorly, an employee may seek to resign and claim constructive unfair dismissal.

Balancing interests

The key to successfully implementing changes to a bonus scheme is to understand precisely the nature of the scheme that you are operating.

In the current climate, however, if bad news on the bonus front is looming, good communication and engagement with the affected employees should help people to appreciate that sacrifices have to be made into order to maintain the goodwill of shareholders and customers.

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