Discretionary bonuses: legal Q&A

Bonus season may have just finished, but bonuses remain very much in the news. Recently, two former Deutsche Bank employees reached settlement in the latest multi-million pound bonus dispute. As more and more employees come to depend on their bonus as part of their core remuneration, even the most discretionary of discretionary bonus schemes may be subject to challenge.

Q My company operates a discretionary bonus scheme. Do I have an unfettered discretion to pay no bonus?

A No. The courts have held that an employer may not act irrationally or perversely in exercising discretion. For example, in Clark v Nomura International, the bonus was discretionary and “not guaranteed in any way”. Mr Clark received no bonus, despite having earned substantial profits for the company during the relevant period. The court held that no reasonable employer would have exercised its discretion so as to have awarded Clark a nil bonus.

Q My discretionary bonus scheme sets out the considerations to take into account when awarding a bonus. May I ignore some of these and base my decision on other factors instead?

A No. Bonus clauses, even if discretionary, are being very strictly interpreted by the courts. For example, if the rules state that the bonus is based purely on performance, it must be assessed on performance alone. Employers should therefore be clear in their bonus schemes about the factors that are of relevance to the exercise of their discretion.

Q When I award a discretionary bonus, must I explain how I made my decision?

A Possibly, yes. In the recent Commerzbank v Keen decision, the Court of Appeal commented that an employer’s failure to explain a bonus decision could amount to a breach of the duty of trust and confidence. This was not strictly a core element of the judgment, so it remains to be seen how this is interpreted in future case law.

Q My organisation’s bonus scheme stipulates that an employee must be in employment to receive a bonus. May I avoid the payment by terminating employment before the bonus date?

A This has not yet been fully tested in the courts, although case law relating to the entitlement to other benefits suggests this might be a problem. In Jenvey v ABC, the employer could not dismiss an employee simply to avoid paying him an enhanced redundancy benefit.

In the bonus context, in Takacs v Barclays Services Jersey, the employee argued in a similar vein that there was an implied term that Barclays would not dismiss him to avoid paying his bonus. The court refused to strike out the claim at an early stage, holding that Mr Takacs had a real prospect of establishing the existence and breach of this implied term. However, the case was settled before the full hearing, so there is as yet no definitive consideration of this point in a bonus case.

Q Can I take into account periods when an employee is absent from work through maternity leave?

A This is a complicated area, made even more so because employers must consider overlapping maternity and sex discrimination laws. A fundamental question is the purpose of the bonus. Is it to reward individual performance, attendance or loyalty, to motivate staff, and/or to do something else?

While each case depends on the structure of the bonus scheme in question, it is unsafe to calculate a bonus on a pro-rata basis to take account of absence due to maternity leave. Case law suggests that a performance or attendance bonus may be reduced pro rata (although the employee must be treated as having been at work during her two-week compulsory maternity leave period).

Q My company’s bonus scheme is based on length of service. Is this age discrimination?

A Benefits awarded by reference to length of service may be indirectly discriminatory on grounds of age. The 2006 Age Discrimination Regulations exempt employers from having to objectively justify benefits where the qualifying criteria are based on five years’ service or less.

For bonuses based on service longer than five years, the employer again does not have to objectively justify the service requirement, although it must show that it reasonably appears there is a business advantage (for example, encouraging loyalty or motivation, or rewarding experience) in retaining the service-related provision.

By Sophia Hermen, solicitor, Lovells


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