With bonus payments set to climb in the UK by 18 percent to a record £19bn and a reported 4,000 workers each taking home £1m in bonuses this year, an important summary judgment has been recently handed down by the UK's Court of Appeal.

The case of Keen v. Commerzbank AG1 concerned James Keen, the manager of a proprietary trading desk of Commerzbank. Mr. Keen had worked at the bank for three years but was made redundant in June 2005, when the bank ceased proprietary trading. Mr. Keen's annual basic salary was £120,000 a year and he was eligible to participate in the bank's discretionary bonus scheme.

Mr. Keen received bonuses in 2003 and 2004 but not 2005 and made claims in respect of each of these bonuses, the first two for being too small and the third for payment of an appropriate bonus. The bank applied for summary judgment against Mr. Keen's claims on the basis that they had no real prospect of success. Much to the alarm of employers, the Commercial Court dismissed this application. The bank appealed to the Court of Appeal.

The 2003 and 2004 Bonuses

Mr. Keen was awarded a bonus of €2.8m for 2003 and a bonus of €2.95m for 2004, making him one of the most highly paid employees in the bank's global banking operations (of some 24,000 employees). However, Mr. Keen was not happy with these bonuses and claimed breach of contract on the basis that the bank had exercised its discretion irrationally or perversely by not awarding larger bonuses.

Mr. Keen argued that the bank should have taken into account the extraordinarily good performance of his desk when deciding the bonus pool (the desk generated profits of €41.5m in 2003 and €57.5m in 2004). Another central argument made by Mr. Keen was that the bank should have followed the recommendations of his line manager when deciding the bonus pool. For 2003, the line manager recommended a bonus pool of 15 – 18 percent of profit, although the bank decided on a reduced pool of 10 percent of profit. For 2004, the line manager recommended a bonus pool of 17.5 percent of profit, although the bank decided on a reduced pool of just under 10 percent of profit.

The bank argued that it was not under an obligation to make a bonus pool at all. It had taken the recommendations into account and there was no contractual obligation to accept the recommendations of the line manager. Furthermore, other divisions of the bank were making losses.

The Court of Appeal agreed with the bank. It found that the bank had a very wide contractual discretion which depended, to a large degree, on the fluctuating market and labour conditions. The burden was on Mr. Keen to show that the bank had exercised its discretion irrationally or perversely by not declaring larger bonuses, and he would need overwhelming evidence (expert or otherwise) to show that the bank's decision was irrational in setting the size of the bonus pools.

The 2005 Bonus

Mr. Keen was not awarded a bonus for 2005 on the basis of a term of the bonus scheme which provided "No bonus will be paid to you if on the date of payment of the bonus you are not employed by the [bank]..."

Bonus payments were payable in the March of the following year (i.e., March 2006) and Mr. Keen was made redundant in June 2005. However, Mr. Keen argued that the bank was in breach of contract by exercising its discretion irrationally or perversely and that he should have received a bonus for the time he was in employment as the bank had reaped the benefit of his services. He also argued that this term of the bonus scheme was unreasonable under the Unfair Contract Terms Act 1977 ("UCTA").

UCTA applies to contracting parties where one of them deals as a consumer on the other's written standard terms. In short, if these two conditions are present, then the party putting forward the written standard terms cannot rely on any provisions which are unreasonable. Therefore, the Court of Appeal had to consider whether Mr. Keen was dealing as a "consumer" and whether he was dealing with the bank on its "written standard terms of business". If UCTA did apply to the provision of the bonus, then it would be open to the Court of Appeal to decide if the terms which governed the payment or non-payment of the bonus were reasonable and, if the terms were not reasonable, then Mr. Keen may have been entitled to a bonus payment in respect of his employment in 2005.

The Court of Appeal rejected Mr. Keen's arguments and unequivocally stated UCTA does not apply to employment agreements. Lord Justice Moses succinctly said "an employee does not deal with an employer as a 'consumer'. A bank's business is not entering into contracts of employment with its employees." This followed from the fact that the discretionary bonus scheme formed part of the terms of remuneration of certain employees and were not standard terms of the business of banking. This conclusion is of fundamental importance to all employers operating bonus or other incentive arrangements in the UK (for example, share option plans and long-term incentive plans) where it will seldom be an employer's business to operate such arrangements.

Therefore, the terms which governed the payment or non-payment of the bonus term applied as they were drafted. On this basis, the bank was not obliged to pay Mr. Keen any bonus in respect of 2005.

Mr. Keen has vowed to take his claim for unpaid bonuses to the House of Lords.

Can Employers Relax?

This case is important, in that it quite rightly confirms that UCTA does not apply to contracts of employment and, secondly, shows that courts are reluctant to interfere with the exercise of discretions. However, this does not mean that employers can now throw caution into the wind. An employer must be mindful that it exercises its discretion in good faith or it risks being found in breach of contract.

In the case of Takacs v. Barclay Services Jersey Limited, Mr. Takacs (a trader) was contractually entitled to a bonus if he achieved certain sales targets. These targets were not reached and he was dismissed. He brought a claim at the High Court and argued that the implied term of trust and confidence (which is implied in all employment agreements under English law) also implies:

  • An "anti-avoidance" term - this means that employers cannot dismiss employees to avoid any payment obligations.
  • A "co-operation" term - this means the employer must co-operate in helping the employee to achieve targets.

Mr. Takacs argued that Barclays undermined his position by restructuring the business and bringing in a specialist team. He alleged that this team then interfered with a transaction and prevented it from completing - if the transaction had gone ahead he would have achieved his sales targets. Barclays argued that the transaction was abandoned due to its possible risks. However, Mr. Takacs claimed that this deal was resurrected after he was dismissed and that the real reason for his dismissal was to avoid having to pay him a bonus.

Barclays applied to have these claims struck out and the High Court denied this application and stated that there was a real prospect of success in arguing these implied terms. The full case is yet to be heard.

Whilst Mr. Takacs' arguments have not yet succeeded, employers should be aware that the terms of "anti-avoidance" and "co-operation" may be found to be implied into bonus schemes so further dictating how discretion should be exercised. This case could also impact on how restructurings take place and how risk analysis decisions are made.

So What Does This Mean?  

  • Employers should draft their bonus schemes carefully. The types of wording that can be included are:
  • The participation in a bonus scheme is at the employer's sole and absolute discretion.
  • Any participation in a bonus scheme does not mean that any bonus will be payable.
  • The level of a bonus pool and bonus payable (if any) is at the employer's sole and absolute discretion.
  • Bonuses are not payable if the employee is not in employment or on notice (whether given or received by the employee) at the payment date.
  • The employer is able to terminate transactions/deals for any reason even if this will impact on any bonus targets/criteria. The employer will not consider such implications and no compensation will be payable.
  • The employer may restructure the operations/business for any reason even if this will impact on any bonus targets/criteria. The employer will not consider such implications and no compensation will be payable.
  • The exercise of discretion in one year does not bind nor act as a precedent for the exercise of discretions in any other year.

In addition, we strongly recommend that the internal decision making processes are carefully documented to help demonstrate good faith and that discretion is not exercised in a discriminatory, irrational or perverse manner.