Avoiding disputes over bonuses

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Love them or hate them, bonuses have been in the news recently and mostly for all the wrong reasons.

The controversial one-off super tax (brought in by the Labour Government) of 50% on bank bonuses in excess of £25,000 paid between 9 December 2009 and 5 April 2010 has been very expensive for banks, with tax bills for some banks reportedly being in excess of £350 million and an overall £2.5 billion expected to be collected for the Treasury. The recent six-figure bonuses for Network Rail management (including £641,000 for their chief executive), which only narrowly received internal approval, have confirmed the controversial status of bonuses in the current climate.

Key points

  • The coalition Government is to set out proposals for “robust action” for bonuses in the financial services sector.
  • Vince Cable’s Green Paper includes proposals for limiting bonuses to “pre-crisis” levels or risk the Government considering tax on gross profits in the financial services sector.
  • Bonuses remain an important incentive for many employees.
  • To avoid disputes, employers should have clear terms, document all discussion regarding bonuses and clearly state when bonuses are not being paid.

The coalition Government has kept bonuses in the news by promising “detailed proposals for robust action to tackle unacceptable bonuses in the financial services sector”. Proposals in the Conservative and Lib Dem manifestos differed, but a Green Paper published by Vince Cable’s Department for Business Innovation and Skills on 26 July confirms the coalition’s position. The Green Paper suggested that banks should limit bonuses to “pre-crisis” levels to allow additional funds for lending, primarily to small businesses. It is clear that the Business Secretary is keen to keep the pressure on banks to show “restraint on bonuses” or risk the Government considering “disincentives that could include a tax on their gross profits”.

Despite the potential controversy that bonuses can cause, in reality they are here to stay. While far from all bonuses will be at the levels paid in the city, bonuses will continue to be an important incentive for many employees. On this basis, bonuses at any level still have the potential to cause arguments between employers and employees and so it is no surprise that bonus issues regularly make case law as well as headlines.

As such, to avoid disputes over bonuses, employers should remind themselves of the following:

  • Clear terms – bonus terms should be clear, unambiguous and in writing. Crucial terms will include how the bonus is calculated (including clear targets and definitions of any relevant terms, for example “profit” or “turnover”), any upper limits or caps on the bonus and when and how the bonus will be paid.
  • Document discussions – ensure that any discussions regarding bonuses, for example in the recruitment phase, are accurately recorded to avoid subsequent arguments over what was discussed and agreed orally.
  • Withholding bonuses – bonus schemes should state when a bonus will not be paid. Termination of employment and/or the circumstances of that termination can determine whether or not a bonus is paid, for example bonuses may not be paid if the employee is not employed or is under notice on the bonus payment date, or if the employee commits misconduct before leaving.
  • Possible pro-rating – if bonuses are to be pro-rated in the years of arrival and/or termination then this should be made clear.
  • Crunch the numbers – when setting bonus targets be sure that the targets are not too low and that you are clear what level of bonus the employee could achieve and/or set upper limits on the potential bonus (or commission) at the start. Realising an employee will achieve too large a bonus and then seeking to change terms to reduce the bonus or retrospectively applying a cap to the bonus is unlikely to be popular or legal.
  • Beware discretion – discretionary bonuses (ie where there is discretion over the amount of the bonus or whether it will be paid at all) are common. Regular payment of discretionary bonuses may give rise to a contractual right to a bonus. In addition, always ensure that discretion is exercised reasonably.

Paul Gaff, partner, Thomas Eggar

Related info

Frequently asked questions

Is it ever permissible for an employer to withhold bonus payments?

If an employer lowers a disabled employee’s targets, should it also reduce his or her bonus and end-of-year rating?

What other payments might an employee be owed upon termination of employment other than his or her salary?

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