Legal Q&A – City bonuses

With the recent uncertainty affecting the financial markets due to the ‘credit crunch’, it is likely that there will be a significant reduction in the level of bonuses being awarded by City employers for this year. What are the pitfalls that may await employers who intend to award lower bonuses?

Q What’s so problematic about bonuses?

A Annual bonuses are the key way in which many City institutions reward and motivate their star performers, and they may make up the majority of such an employee’s total remuneration. Such bonus schemes are mainly discretionary and the employer, therefore, retains control over whether a bonus is paid and, if so, how much. It is often the case that the way an employer reaches such a decision is unclear and, as a result, these decisions are open to challenge.

Q How can an employee challenge an employer’s decision under a bonus scheme?

A There have been a number of high-profile cases recently in which employees have challenged such decisions. These have included claims relating to a breach of a contractual right relating to bonuses and claims that the way in which a decision has been reached under a discretionary scheme is a breach of the implied term of trust and confidence (Clark v Nomura International plc, and Commerzbank v Keen). Claims have also been made on the grounds that there has been unlawful discrimination (particularly sex – Bower v Schroder Securities Limited – or a breach of the Equal Pay Act 1970).

Q What should we bear in mind when putting together a bonus scheme?

A To ensure a bonus scheme matches changing business needs, employers need to retain a degree of flexibility in the operation of the scheme. Ensure that contracts of employment and any documents relating to bonus arrangements make it clear whether the employer has any discretion and, if so, the extent of that discretion. It is also important to state whether bonuses will be payable if an employee leaves or gives or receives notice of termination. If bonuses are only payable if the employee remains in employment, it is important to state that the purpose of the bonus is to reward past performance and to encourage loyalty (Ridgway v JP Morgan Chase Bank National Association).

Q Do employers really have total discretion?

A Not entirely. Any discretion must be exercised in good faith and not in a way that is irrational or perverse, and a failure to do so will constitute a breach of the implied duty of trust and confidence (Clark v Nomura). For an employee to show their employer has breached this implied duty there is a more stringent test than simply showing their employer has not acted reasonably.

In Keen v Commerzbank, the Court of Appeal stated that an employee who is aggrieved by the way their employer has exercised its discretion relating to a bonus award must show that no rational employer would have acted in that way. The court went on to say that if an employer has a very clear contractual discretion relating to the award of a bonus, an employee will have to present an overwhelming case to persuade a court to find that the way in which such discretion has been exercised is irrational or perverse.

Clearly, employers must also ensure decisions made relating to discretionary bonuses are based on objective criteria and that the decision-making process is as transparent as possible to avoid claims of unlawful discrimination.

Q What if an employer gets it wrong?

A Any claim relating to a breach of an express or implied contractual term relating to a bonus award (or lack of one), is likely to involve constructive dismissal.

To claim constructive dismissal, an employee must resign in response to the breach of contract. The claim will involve proceedings in the employment tribunal for unfair dismissal (if the employee has more than a year’s service) and in the High Court for breach of contract (assuming that the claim is worth more than £25,000). Unfair dismissal compensation is currently capped at £69,900. Therefore, the significant value is likely to be in the breach of contract claim in the High Court.

If an employee claims there has been unlawful discrimination, the claim will go to the employment tribunal. In this situation there is no cap on the compensation that may be awarded – Julie Bower was awarded £1.4m in her claim against Schroder for sex discrimination in 2001.

Q What else should employers be wary about when trying to avoid hefty bonus payouts?

A Be wary of dismissing an employee to avoid paying a bonus as this may be a breach of an implied anti-avoidance contractual term (Takacs v Barclays Services Jersey Ltd).

Mark Hunt, partner, Reed Smith Richards Butler

Banking on the bonus doesn’t pay

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