The High Court has given guidance on the circumstances in which employers will be bound by the implied duty to act rationally and in good faith when calculating bonuses.
Brogden and another v Investec Bank plc
The Claimants were two equity derivative dealers at Investec Bank. Their contracts of employment provided for a bonus payment, which was based on a formula calculated as a percentage of "economic value added" ("EVA") generated by the Equity Derivates business. For the year 2010/2011, the Bank calculated the available bonus pool to be nil on the basis that there was no profit and the EVA figures were negative, therefore resulting in no bonus being payable. The Claimants disputed the calculation considering that they were entitled to a bonus pool of over GBP8 million. They resigned and brought a claim in the High Court for their bonus payments.
The Claimants argued that "EVA" should be determined objectively. Failing which, to the extent that the Bank had any discretion in the calculation, it had to act rationally and in good faith. The Bank argued that EVA meant the amount the Bank calculated as EVA. Whilst the preparation of accounts which were necessary for the purposes of calculating the Claimants' bonus pool involved questions of judgment about which reasonable people may differ, the exercise of judgment is not the same as the exercise of discretion and it is only where there is a discretion that the implied duty to calculate the bonus payments in good faith and rationally would arise.
High Court Decision
The Court accepted the Bank's argument about the interpretation of the contract. EVA was a term used within the Bank as a measure of profitability and was calculated automatically by the Bank's systems throughout the year. The reference to EVA in the contract meant "the amount calculated as the "EVA" of the Equity Derivatives Business using the method normally used to calculate a measure of performance known as EVA for each business unit". However, the Court rejected the Bank's argument in relation to implied terms.
It gave guidance on what factors were likely to show that a decision is properly regarded as a discretion, which is subject to the implied constraints that the decision must be made in good faith, for proper purposes and not in an arbitrary, capricious or irrational manner. The factors are:
- where a contract gives responsibility to one party for making an assessment or exercising a judgment on a matter which materially affects the other party's interests,
- where there is ample scope for reasonable differences of view;
- where the decision is final and binding on the other party; and
- where the discretion is being exercised in the employment context, this is further reinforced by a duty of mutual trust and confidence.
Applying this, the bonus clause conferred a discretion on the Bank to determine EVA generated by the equity derivatives business, which was subject to the duty of good faith and rationality. However, it found that on the facts, the Bank's approach had been rational and that the Claimants had no right to bonus in that financial year, and dismissed the claim.
It is perhaps unsurprising that the Bank's argument that its calculation of EVA was not subject to the duty of good faith and rationality was unsuccessful. Where a party wishes to exclude these implied duties, it should use express and unambiguous wording to set this out. In practice however, such wording is likely to give rise to negative employee relations and will be unattractive.
A further point of interest in this case is the alternative argument made by the Claimants that the Bank had created "reasonable expectations" about how the bonus payments were to be calculated through its previous practice of paying a particular interest rate on the funds raised by the Equity Derivates business, which it argued the Court should have considered in the context of assessing whether the employer acted rationally. This was based on the concept of 'reasonable expectations' developed in the High Court's decision in IBM v Dagliesh (please clickHERE for a copy of our previous alert on this decision). The Court found that on the facts, the Bank's actions could not have led to anything more than a "mere expectation" which was not sufficient to engender a "reasonable expectation" to that effect. This is the first time that we have seen the "reasonable expectations" argument being made following the IBM decision and highlights the potential impact of that decision in the employment context. Before making employment changes, prudent employers should review previous communications to assess whether the company has created any reasonable expectations in the past that may be impacted by its current proposals, and take care that any communications do not create expectations for the future.