How to change remuneration policies legally

In most businesses staff costs are now the most expensive overhead. There is a very real question, however, about how much thought goes into how that budget is spent. Is it focused in a way that ensures businesses get the most bang for their buck?

The combined needs of attracting, retaining and motivating staff in the difficult economic environment of 2009 are likely to change that. Not for some years has the way the payroll budget is allocated been as important as it is now. So what makes a successful remuneration policy, and what are the legal implications?

Above all, such a policy should ensure that even in difficult market conditions, businesses remain focused on recruiting and retaining the right people with the right mix of skills. There are four core elements that need to be considered:

  • The business’ needs and values, which will differ according to economic cycle, but include attracting talent, rewarding performance, motivating and retaining talent
  • The needs and aspirations of employees
  • The internal relativities between positions and roles
  • The external market value of the positions and skills needed.

If a business had a completely clean slate, there would be four main remuneration weapons in its arsenal: basic salary; non-cash benefits; long- and short-term cash bonuses; and real and phantom equity plans (the latter is a cash bonus calculated as if it was a share option – the employee doesn’t get shares or share options, but if the employer’s share price rises over an agreed period, the employee will get an equivalent cash payment).

There are many additional non-financial options that can help in attracting and retaining talent, from having a stimulating or market-leading working environment through to the availability of flexible working arrangements. So how should your basic strategy be­ ­implemented? Conceptually, at least, it’s very simple. It involves working out what variable budget is available and directing that budget in the way that best suits the business’ current needs or objectives.

Of course most businesses don’t have the luxury of a completely clean slate: there will be contractual commitments to employees that must either be complied with or varied. Generally, varying these will only be possible with an employee’s consent.

In building up the strategy budget – ie, one that aligns pay policy with business objectives – it’s important to determine how, within current contractual limits, the business can minimise the amount of its payroll budget, that is paid to employees in an untargeted fashion. There are several questions to consider:

  • Are pay increases guaranteed? Occasionally there will be guaranteed cost-of-living allowances or pay deals that cover more than one pay year, but it would be unusual for there to be a legal right to a pay increase.
  • What is the bonus position? Are this year’s bonuses discretionary: either in terms of being paid at all or, at least, as regards figures? Is there scope to add money that may have been earmarked for this year’s bonus to a ‘strategy fund’ for next year? Are you obliged to offer a bonus scheme next year? Is participation in any bonus scheme that you do have next year a contractual right of all employees?
  • What other benefits do you currently provide to employees on a discretionary basis? Can they be withdrawn?

A proper assessment of these questions will help to determine what the business’ minimum contractual obligations are to employees over the next 12 months. Once that has been established, it is then possible to quantify what funds are left to allocate to employees in a more targeted way.

This is where the legal issues involved in removing employees’ contractual entitle­ments to build up a bigger strategy budget for remuneration gets interesting.

Legally, employees’ consent is needed to authorise the removal of contractual benefits. If companies unilaterally remove contractual benefits, then aside from the obvious employee relations issues, staff may sue for breach of contract or unauthorised deductions. Some might resign and claim constructive dismissal. This is a potentially costly road which employers should be wary of travelling.

Reduced employee resistance

In the current economic climate, though, many employers are imposing withdrawals of unilateral benefits. We are seeing a number of imposed pay cuts and bonus scheme withdrawals. The reality is that, if they are properly informed, employees do seem to be accepting that these measures are preferable to redundancies – for example at JCB – because of the current economic environment.Depending on the number of employees involved, and their expected reaction, it may be possible to consult with them and have them formally agree to contractual variations.

That said, there are several ways to apply the strategic remuneration budget:

  • Giving key employees bigger pay rises
  • Setting up bonuses that are targeted at specific individuals or key outputs
  • Using the money to set up real, or phantom equity-based plans.

However, even if the changes to remuneration structure that arise out of the strategy review are able to be implemented without consent, they obviously still need to be communicated well. The underlying purpose of the proposals is to ensure that staff are properly motivated and rewarded. If the manner of implementation de-motivates them, then the battle is lost before it has begun.

Key points

The following principles should be borne in mind throughout the process:

All discretionary remuneration or benefits should be targeted at achieving certain clear deliverables. This means that they should be aimed at the correct people, and the type of benefit used should be such that it encourages the intended deliverable.

When putting in place new remuneration structures, be alert to the following legal and practical risks:

  • The ever-present issue of trying to maintain employee morale.
  • Removing what are express or implied contractual rights of employees. It might be necessary to unilaterally vary contracts, but a proper assessment of the legal risk should be undertaken.
  • The risk of constructive dismissals by reason of the way in which the message is delivered.
  • Putting in place benefit schemes that are potentially discriminatory (eg, bonuses that reward length of service, if retention is considered an aim).

by Graham Paul, partner, Dundas & Wilson

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