An offer you can’t refuse

Discretionary bonuses continue to cause problems, with the latest case
reported to have cost investment bank Lehman Brothers more than £5m. Jonathan
Maude and Richard Yeomans give advice on how to avoid the pitfalls of such

Fettered Discretion

Anna Lyst applies for a position at Bucks Bank and, during her
interview, is informed that as well as a basic salary, Bucks also rewards
employees through the use of a ‘discretionary’ bonus scheme. She is told that,
although the bonus scheme is referred to as being discretionary, it is more or
less guaranteed that she will receive approximately 50 per cent of her basic
salary. Can Anna count on getting this bonus?

Jonathan Maude and Richard Yeomans comment: Many employers (and
particularly financial institutions in the City) choose not to have clear bonus
rules with a set formula linking bonus to, say, revenue or profit. This is
because they do not want their hands to be tied when slicing up the often vast
bonus cake. Instead, they operate discretionary bonus schemes, designed to give
them maximum flexibility when rewarding staff.

However, the very nature of ‘discretion’ means it often leads to disputes
with disgruntled employees, and recent cases have shown that the exercise of
discretion is restricted. As a result a number of successful bonus-related
claims have been brought to employment tribunals and the High Court. Potential
claims can be wide-ranging and include breach of contract, unlawful deduction
from wages, constructive dismissal, unfair dismissal and sex, race and
disability discrimination. One recent, much publicised case brought by Kerim
Derhalli in the High Court against investment bank Lehman Brothers resulted in
a settlement reported to be at least £5m.

It is now well established that there is no such thing as absolute
discretion when it comes to bonuses. Take the case brought by Stephen Clark
against Nomura International in 2000. Clark was a senior trader with Nomura,
who was dismissed in February 1997. Nomura had a written discretionary bonus
scheme which stated that a bonus was "not guaranteed in any way",
"dependent on individual performance" and was conditional upon the
employee remaining in employment on the bonus payment date. Clark was given
three months’ notice in February 2001 and was placed on garden leave. The bonus
payment date arose during this time. Clark therefore satisfied the requirement
that he remain employed throughout the relevant bonus year, even though he was
not actively working during the last three months.

Nomura decided to award Clark a nil bonus, even though he had achieved
profits for Nomura over the relevant period of £6.4m and Nomura knew he had
been responsible for another transaction which would bring in another £16m over
the following two years. Nomura unsuccessfully tried to argue that Clark’s
performance was merely one condition for the bonus and that in exercising its
discretion it was entitled to take into account other factors such as Nomura’s
"legitimate business needs" and the need to "retain and
motivate" staff.

The High Court found that Nomura’s discretion was ‘fettered’ in two ways.
First, it accepted Clark’s argument that under the terms of the scheme, performance
was the only factor to be taken into account when exercising discretion. In
deciding bonuses, Nomura was not therefore entitled to reduce Clark’s bonus on
the basis that he was leaving. Second, it held Nomura could not exercise
discretion "irrationally or perversely". The Court concluded that no
reasonable employer would have awarded a nil bonus to someone who had performed
as well as Clark, and therefore he was entitled to a bonus of £1.35m.

The fettering of discretion means it is increasingly important for employers
to have carefully drafted bonus schemes in place. For example, a common ploy is
to state in the bonus scheme that bonuses are "non-contractual" and
that an employee must be employed and not be under notice on the bonus payment
date. It is likely that such a provision would have defeated Clark’s claim,
because he was under notice on the bonus payment date. It is also advisable to
spell out in the scheme the factors the employer can take into account when
exercising discretion such as wanting to retain and motivate staff in the
future. Given that such provisions could help deprive an employee of a bonus
even if he had worked for the full bonus year and had fantastic results, it is
all the more surprising that so many employers fail to implement these types of

Sex discrimination

Anna has been working for Bucks Bank for approximately two years and
has received notification that her bonus is a great deal less than she was
expecting. She understands that some of her male colleagues have received
significantly more than she has, although they are performing the same job
function. She took maternity leave during the second year of her employment and
thinks this may have affected the amount of her bonus. Does she have any legal
recourse in these circumstances?

JM and RY comment: A well-drafted bonus scheme can prevent
discrimination claims by introducing an element of objectivity into the
decision-making process. There have been a number of recent discrimination
cases where women have successfully argued that discretionary bonuses have
favoured their male colleagues. Last year, Julie Bower took Schroder Securities
to an employment tribunal and complained that she was awarded a bonus of only
£25,000 compared to the £650,000 and £440,000 given to two male colleagues. The
employment tribunal was persuaded that given her performance, her comparatively
low bonus could only be explained by the fact that she was a woman and she was
therefore awarded £1.4m in compensation.

Employers should take particular care when determining bonuses for women who
are on maternity leave. If a woman has completed the bonus year before her
maternity leave starts, she will have earned that bonus and it will be payable.
Also, if she has only completed part of the bonus year at the time she goes on
maternity leave, she is likely to be entitled to a pro rata bonus. These were
the conclusions reached by the European Court of Justice (Lewen v Denda 2000
IRLR 67) when it held that it would be discriminatory to withhold bonuses in
respect of work done before a woman went on maternity leave.

In another case (GUS Home Shopping Limited v Green 2001 IRLR 75), two women
participated in a bonus scheme where the bonus was essentially a loyalty bonus,
conditional on them not having left employment by a certain date. They
persuaded the employment tribunal that they had satisfied this condition and
the fact that they were on maternity leave on the relevant date should not
deprive them of the bonus. However, it is likely that a different decision
would have been reached if the bonus had been made conditional upon their
"active" employment or the achievement of personal targets, since the
women would not have been able to satisfy those criteria. This case again
highlights the advantages of a carefully drafted bonus scheme.

Protecting against claims

It appears that Anna has taken advice in connection with her concerns over
the level of bonus received and Bucks Bank has decided that, in view of recent
case law, it will settle the claims she has raised. This has been fairly
expensive, and caused some concern within the Bank. It has sought advice as to
steps it can take to avoid this problem arising again.

JM and RY comment: Employers should consider including the following
provisions as part of any bonus scheme:

– State that participation in a bonus scheme and the level of award are at
the company’s absolute discretion

– Specify that receiving a bonus in one year is no guarantee of receiving
one in future years

– Provide that entitlement to any bonus is conditional on the employee remaining
employed and not being under notice (whether notice is given by the employee or
the employer) until the bonus payment date

– Specify the factors to be taken into account when determining bonuses. For
example, if retention and motivation of staff are factors, this should be spelt
out in the rules

– Give details of any trigger conditions which apply to a bonus; such as the
achievement of specified individual, departmental or company targets

– Clarify the bonus entitlement of women on maternity leave and, if you are
introducing a "loyalty bonus", consider making "active"
employment a requirement.

Jonathan Maude and Richard Yeomans are partners at Manches Solicitors

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