It’s easy to denounce banking executives for their apparent incompetence and greed, but keeping them from their bonuses is a far trickier proposition. Michael McCartney looks at some of the legal issues that employers may face if they try to curb bonus payments.
Recent pronouncements from the government and the G20, plus the Financial Services Authority (FSA) code on bankers’ remuneration, suggest that there will be tighter regulation of bonus payments in the near future. This may go some way towards satisfying the public anger resulting from the perception that the culture of excessive bonuses is still flourishing in banks recently replenished by public funding. However, this approach is likely to be fraught with danger for employers, prompting disaffected senior employees to turn to their employment lawyers to defend their interests.
Q If bonuses are linked to performance, what legal recourse will be open to those who are unhappy about their bonuses?
A Employees who perform particularly well will have a claim for breach of contract if their bonus award is significantly below par. Whether this claim will succeed or not will depend on factors such as the express wording of the bonus scheme, the overall performance of the employer, the relative bonuses awarded to other staff, and the justification relied upon by the employer for awarding a low bonus. If the scheme is discretionary, the employer is under an obligation not to act irrationally or perversely in the amount of bonus it awards.
Q What particular laws and regulations can claimants turn to?
A The burden of proving irrationality is not straightforward. Employers are likely, therefore, to face a combination of claims under discrimination laws, equal pay, unlawful deduction from wages and even quantum merit. It looks likely that direct and indirect discrimination laws and equal pay will pose the most significant threat. The FSA’s guidance on remuneration policies stipulates that banks must now consider their obligations under discrimination laws when awarding bonuses. The Equality Bill, which is due to come into force next year, is also expected to ban pay secrecy. This will undoubtedly pave the way for future litigation.
Q What are the legal pitfalls of implementing a deferred bonus scheme?
A Deferred bonuses are fairly typical in the financial sector, albeit as one element of the overall bonus package. The difficulty will be in replacing existing bonus schemes with one that is entirely deferred. First, employers will need to check their discretion to implement changes. If the scheme is long-established, it is likely to have become contractual by virtue of custom and practice. In most cases, the employer will need to implement a change to terms and conditions to amend the scheme. This will trigger an obligation to consult elected representatives under section 188 of the Trade Union and Labour Relations (Consolidation) Act 1992. The minimum period is 30 days, if 20 employees are affected, or, 90 days if 100 or more staff are affected. Employers that fail to consult properly will be liable for a protective award of 90 days’ pay per employee.
Q What if an unfair dismissal case arises?
A Employers will also be vulnerable to unfair dismissal claims from employees who refuse to consent to the change. They are, however, likely to have a strong defence if the change is a result of a legal requirement. Nevertheless, staff may try to argue that the manner in which the new scheme was implemented breached the implied terms of trust and confidence. Employers are advised to consult well in advance and to build support for the new scheme with generous stock incentives.
Q If an employee leaves an employer before a deferred bonus is paid, where would either party stand?
A This will depend on the wording of the scheme. Under most existing schemes, the deferred bonus includes good leaver/bad leaver provisions. If the employee is dismissed as a good leaver (because they are made redundant or dismissed, other than on grounds of misconduct) they are usually eligible to receive something towards their deferred bonus, if not the entire deferred sum, immediately on their termination date. In future, it is much more likely that employers will retain the entire deferred bonus to allow for future clawbacks. Bad leavers will still sacrifice their deferred bonuses entirely. However, these clauses are bound to become heavily negotiated. The circumstances in which employees will be treated as bad leavers will in future equate with gross misconduct or breach of contract. This would entitle the employer to treat the contract as repudiated and withhold the bonus payment in any event.
Q If employers wish to claw back bonuses, what are the risks?
A The obvious difficulty will be finding assets to enforce against, particularly, where the employees have left or are based overseas. Employers will find themselves involved in fruitless litigation against former employees who, if they haven’t already spent their bonus cheques, will no doubt have safely stored the funds overseas in various tax havens.
Q What is the tax and national insurance (NI) situation if and when bonuses, or parts of them, are repaid?
A The good news is that since tax returns are usually filed two years after the income is earned, employees should be able to amend their return and pay tax and NI only in respect of the bonuses they actually received. It is also likely that the revenue will be sympathetic to retrospective amendments going back further in time, so that employees should be able to rectify the tax and NI already paid on bonuses. Ultimately, tax and NI rebates will also be subject to claw-back provisions and employers will want to ensure that employees account to them for any tax rebates they receive.
Q What challenges will employers face in drafting appropriate bonus schemes in the light of recent announcements, such as the G20 proposals to limit total compensation to a percentage of total net revenues for under-capitalised banks?
A The first challenge is uncertainty. The G20 proposals are widely drafted to ensure widespread support among the participating nations. Most employers will wait to see how these proposals are implemented into domestic legislation before undertaking a rigorous review of their bonus schemes. The proposal on bonus limits contained no indication as to what the limit should be or how it is to be assessed. Banks are already focusing on their capital reserves. Indeed, the concept of credit crunch is born out of this concern. The extent to which governments, particularly in the US and UK, will shoot the golden goose remains to be seen.
Michael McCartney, senior associate, Dechert