EM Law | Commercial Lawyers in Central London
Bonus disputes solicitors
Paying staff bonuses enables employers to attract and retain talented workers and increase motivation. However, there are many legal issues with the implementation and operation of bonus schemes, many of which arise from the fact that bonuses are often outside the express terms of the contract of employment, or if they are referred to in the contract, it is in terms that involve discretion. This is where bonus disputes can arise.
A bonus may be expressly provided for in a contract and calculated according to a stated formula, or it may not be referred to in the contract and paid as and when the employer feels it is merited. In practice, the distinction between a contractual and non-contractual bonus is not clear-cut.
The courts have been willing to place certain limits on the exercise of discretion by employers in bonus schemes, importing public law concepts of reasonableness and making use of implied terms (particularly the duty of mutual trust and confidence). In this way, bonus schemes expressed to be non-contractual or discretionary can give rise to contractual or quasi-contractual rights. In addition, cases on the exercise of discretion in other contexts (for example, in relation to the operation of share option schemes or pay rises) may also be relevant when considering issues relating to bonus disputes.
A bonus which is stated to be contractual may be expressed as:
- An entitlement to participate in a bonus scheme; and/or
- An entitlement to a certain amount of bonus, often in accordance with a specific bonus formula.
Contractual bonuses with performance criteria
Where a bonus scheme is contractual with defined performance criteria, the question of liability or entitlement is usually relatively straightforward.
Sometimes the amount is calculated by reference to objective performance criteria, either of the individual employee or of the business as a whole, or a combination of both. Some performance targets are easy to measure, such as sales achieved, others are more subjective, such as where they are based on a general assessment of the employee’s performance.
In Mihlenstedt v Barclays Bank International Ltd  IRLR 522, the Court of Appeal held that where an employer is required to form an opinion as part of a contractual obligation, it must do so reasonably and in good faith.
A contractual scheme may guarantee that the employee is entitled to a certain level of bonus in a given period. Even though a precise figure may not be given, such arrangements are nevertheless contractual because a binding promise to pay has been made and the amount is capable of precise calculation.
Establishing contractual status
In bonus disputes, the line between contractual and discretionary entitlements is often blurred. However, if an employee can establish that a particular bonus entitlement is contractual (that is, made pursuant to a binding promise, sufficiently certain and quantifiable) then they will be able to enforce it without having to enter into arguments about whether the employer was acting irrationally or perversely.
A non-contractual bonus scheme will typically provide that there is no right to a bonus, but that payments may be made entirely at the employer’s discretion and on the employer’s own terms.
Where an employer has absolute discretion as to whether to consider an employee for a bonus, and as to the amount of any bonus awarded, this is often referred to as absolute discretion.
Case law in this area of bonus disputes is complex but if an employer genuinely reserves an absolute discretion, and operates the scheme accordingly, a disappointed employee cannot easily claim a right to any bonus.
Many bonus schemes say that employees will be considered for a bonus, and so fall into the category of schemes which are partially discretionary. In such cases of bonus dispute, the employee will have the right to a rational and non-perverse exercise of discretion by the employer as to the amount of the bonus.
Even if a bonus scheme is stated to be discretionary, the employee may argue that they have an implied contractual right by reason of custom and practice, if bonuses have been paid on a regular basis.
Limits on exercise of employer’s discretion
It is clear from case law on bonus disputes that there are limits placed on the exercise of the employer’s discretion with regard to bonuses. The duties overlap and can be summarised as:
- The duty to exercise discretion honestly and in good faith.
- The duty not to exercise discretion in an arbitrary, capricious or irrational way.
- The duty not to breach the implied term of trust and confidence.
The general approach to the exercise of discretion in contracts is that a power conferred on one party to make decisions that affect both parties must be exercised honestly and in good faith, for the purposes for which it was conferred, and must not be exercised arbitrarily, capriciously or unreasonably.
Termination: implications for bonuses
Bonus entitlements often become a central issue in severance negotiations.
An employee dismissed in breach of their notice entitlement is entitled to damages, which may include an entitlement for loss of any bonus that would have been payable if they had still been in employment. However, depending on the circumstances, those damages may not include a bonus that is conditional on the employee being in employment and not under notice.
An employee who resigns may be entitled to a bonus, depending on the terms of the bonus scheme. Typically an employer will provide that, in order to be eligible for payment of a bonus, the employee must remain in employment on the payment date and also not be under notice of termination. While the situation might seem straightforward, in practice a court or tribunal may wish to be convinced that the employee was made fully aware of such provisions before tendering their resignation. It is then clearly for the employee to time his resignation sensibly.
Another issue which frequently arises is whether a resignation is “voluntary” or “involuntary”. The employee may argue that they were forced to resign, in circumstances where they have a claim for constructive dismissal, and so they should not forfeit any bonus due to the resignation. Bonus schemes are sometimes drafted in such a way that bonus is not forfeited if there has been such an “involuntary” resignation. However, the parties may still become embroiled in a dispute about whether, on the facts, the resignation was truly involuntary.
Following Midland Bank plc v McCann, denying a discretionary bonus to a redundant employee will not normally be regarded as capricious or irrational, where the employer can establish that the redundancy is genuine. The stated policy objective behind the scheme in that case was to attract and retain key staff. There was clearly no point in applying such a policy to leavers. However, it is a different matter if the employer has made or purported to make an employee redundant expressly to avoid paying a bonus.
Employees may claim in respect of unpaid or underpaid bonuses in various ways:
- A claim under section 13 of the Employment Rights Act 1996 (ERA 1996) for unlawful deduction from wages.
- A breach of contract or wrongful dismissal claim in the High Court or a county court.
- A claim that the bonus scheme has been operated in breach of discrimination legislation.
- An unfair dismissal claim in the employment tribunal.
Calculation of bonuses on termination
The court will consider all the terms of the bonus scheme and the surrounding circumstances. Relevant issues may include the following:
- Is the scheme stated to be contractual or discretionary? Is the language used consistent on this point? If there is discretion, does this apply to the scheme itself, or merely to the level of bonus?
- In a discretionary scheme, what has been the past practice in relation to bonuses? Is there any argument that the employee has a reasonable expectation of a specific amount based on previous years?
- Does the employee have to meet certain conditions?
- How is the level of bonus payment to be determined? Is there a single figure, a formula or a maximum level, a reference to a particular percentage, for example of salary or revenues generated? Are there other relevant factors besides performance and, if so, are the factors weighted?
- How is performance assessed and is this an objective (for example, by reference to revenue) or a more subjective appraisal? If relevant factors are listed, has the employer made its decision in accordance with those factors?
- What is the purpose of the discretionary scheme: is it for past performance, or for future incentivisation, or both?
- Are there “good leaver” and “bad leaver” provisions?
- What is said to the employee during the bonus year?
- What guidelines or explanatory booklets exist?
Discrimination, pregnancy and maternity leave: bonus disputes and issues
A failure by an employer to pay a bonus, or the amount of bonus paid, may (depending on the circumstances) give rise to an equal pay claim, or a claim for discrimination on the grounds of any of the “protected characteristics” in section 4 of the Equality Act 2010, or a claim of less favourable treatment under other legislation.