Paying over the odds

Bonus schemes have for many years been an important tool in both performance
management and retention strategies. However, a rash of cases reported over the
past year or more dealing with the issues surrounding bonuses – and in
particular discretionary schemes – show that in legal terms, they may not be as
straightforward as you think. In two of the cases employees were found by the
courts to be contractually entitled to bonus payments even though their
employers thought they had absolute discretion; and in the third an employer
was found to have directly discriminated against two employees who were not
paid a bonus because they were on maternity leave.

In the light of these cases, employers would be well advised to think very
carefully about the type of scheme they wish to operate. Otherwise they may
find themselves forced to make payments where they did not expect to. Check and
review the terms of bonus schemes already in place to ensure there are no
hidden surprises. Even discretionary schemes should be applied using objective
commercial reasoning and with scrupulous fairness to avoid some potentially
very large claims.

The limits of discretion

In the case of Clark v Nomura International, 2000, IRLR 766, the High Court
awarded a senior trader damages of £1.35m after he was refused his bonus

Clark’s letter of appointment provided he would be paid a
"discretionary" bonus which was not guaranteed in any way and was
dependent upon his individual performance and on still being in employment on
the date of the payment. He was dismissed after two years for a variety of
alleged issues, which included his appearance and language, and setting an
inappropriate example to others. But he was still serving his three months’
notice when the bonus became payable.

In his first year of employment he had earned substantial profits and
received a substantial bonus. In the second year he had again made substantial
profits and although the bank had originally decided to award him a bonus it
changed its mind following the dismissal and gave him nothing. Clark claimed
the decision to pay a nil bonus was in breach of his contract and sued for

The High Court drew a distinction between bonus schemes designed as a reward
for past performance and those designed to keep employees. The scheme in this
case fell into the former category as it was linked to the generation of
profit. The court held that as the discretionary bonus was dependent on
individual performance, the factors that had led Nomura to dismiss Clark could
be taken into account only if they impacted on that performance. The court
considered they did not.

Though it could be a lawful exercise of the employer’s discretion to award a
nil award, the court continued, it was an implied term of Clark’s contract that
this discretion must be exercised "without irrationality or
perversity". Clark had continued to make large profits and the factors
which led to the decision to dismiss did not affect that. Taking them into
account was therefore an irrational exercise of discretion and a breach of
contract, the court decided. Clark should have been awarded a bonus and was
entitled to that sum as damages for breach of contract.

This case shows how important it is that an employer can demonstrate, when
making any decisions concerning discretionary bonus payments, that they have
been taken with sound and commercial reasoning.

Could they be attacked as being perverse or irrational? Employers still have
a wide margin in exercising their discretionary powers but the case illustrates
they cannot assume they can do what they like.

When discretionary becomes contractual

Where an employer introduces a discretionary bonus scheme and later notifies
the employee of the terms of the scheme, that notification makes the entitlement
contractual until the scheme is withdrawn or changed.

This was the decision in the case of Chequepoint (UK) v Radwan, 15.9.00.
Radwan’s contract contained the following clause: "The company may at its absolute
discretion, pay to all or any of its employees an annual bonus, the terms and
conditions of any such bonus scheme to be notified to employees from time to

In 1992, Chequepoint wrote to Radwan saying there would be a new bonus
structure, payable quarterly and based on net profits linked to Radwan’s
regional budget. The letter set out the amounts payable by way of bonus for the
subsequent four quarters and stated the total bonus achievable was £10,000.
Radwan brought a claim for breach of contract when he was not paid any bonuses
for 1994, 1995 and 1996.

The employer argued that the original clause in the contract meant bonus
payments were payable entirely at the company’s discretion. The 1992 letter
should have been treated as a completely separate document. But the Court of
Appeal disagreed: it said the two documents should be considered together,
along with the surrounding evidence. This meant that once employees had been
notified in the 1992 letter of the scheme’s new terms, they became contractually
entitled to the bonus until it was changed or withdrawn.

Employers should be very careful after setting up a
"discretionary" scheme to ensure any documentation they issue
subsequently does not conflict with the original terms and unintentionally
create binding agreements to make payments.

Avoiding discrimination claims

The other question that has arisen recently in relation to bonuses is: what
is an employer obliged to pay to employees who are on maternity leave? The
fundamental principle is that an employer must not treat someone less
favourably because they are pregnant or on maternity leave.

In the recent case of GUS Home Shopping v Green & McLaughlin, 2000, IRLR
75, the Employment Appeal Tribunal decided two women who had been denied bonus
payments because they were on maternity leave were directly discriminated
against on the grounds of sex.

This case does not mean an employee on maternity leave is entitled to a
bonus where someone else who is absent for other reasons is not, but it does
mean they should be treated equally. If a bonus is related to annual
performance then an employee who has gone on maternity leave should receive
payment pro rata for the time during which her performance could be measured.

The European Court of Justice confirmed this in the case of Lewen v Denda,
2000, IRLR 67, ECJ. It is sensible to include a provision in the terms of the
scheme stating that an employee is only entitled to a bonus pro rata for the
period of time he or she is at work and any absences of a month or more will be
taken into account.

Make bonus schemes watertight

– Make the terms of the scheme clear and unambiguous.  

– Make it clear from the terms what factors are to be taken into account –
conduct, performance, and so on.

– Make it clear whether the purpose of the bonus is to reward past
performance or retain employees – or a combination of the two.

– Ensure any decisions as to who should receive discretionary bonuses are
based on sound reasoning and that they cannot be called irrational or perverse.

– Make sure the same criteria and calculations are used in relation to all
the employees covered by the bonus in question. For example, if based on past
performance then this should be reflected in the size of bonus.

– Make sure any additional documentation you send to staff referring to
bonuses does not conflict with the terms of the original scheme and
inadvertently create new obligations, such as turning discretionary payments
into contractual ones.

– Make sure the terms of the bonus scheme are non-discriminatory so
employees on maternity leave are not treated differently from others.

– Make it clear the effect absences for any reason will have on the bonus
payable, for example, employees will receive bonus pro-rata for the proportion
of the year worked.

– Consider making the terms of your bonus scheme separate from the terms of
the main contract of employment. But bear in mind this has not been tested in
the courts and may still be judged discriminatory.

David Green is partner and head of the employment and pensions unit at
Charles Russell

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