A recent decision of the Federal Circuit Court of Australia highlights that an incentive bonusthat is described as being ‘discretionary’ will not necessarily confer on the employer an absolute discretion in relation to the bonus entitlement.  In this case, in large part due to a new manager’s failure to properly implement a performance appraisal scheme, the Court found that a highly paid employee was in fact entitled to a $70,000 discretionary incentive bonus.

What happened?

The employee, whose employment was terminated for redundancy, filed an application seeking relief on the basis that his employer had (among other things) breached his employment contract.  The employee claimed an unpaid bonus entitlement for the period 1 October 2010 to 30 September 2011.

Under the terms of his employment, the employee was eligible to participate in an investment incentive plan (Plan), which was linked to his performance and the performance of the company.  Under the Plan, employees’ performance was ranked as being outstanding, high achievement, effective, needs development or unsatisfactory.  Importantly, in the two years prior to his redundancy, the employee received a satisfactory ranking and, as a result, an incentive bonus (being $70,000 in 2009/2010).  However, in 2011, the employee’s new manager downgraded his performance to ‘needs improvement’ and alleged performance concerns.  Soon after, the employee’s position became redundant and his employment was terminated. 

The employee claimed that under the company’s redundancy policies, he was entitled to a pro-rata cash variable payment on an ex-gratia basis, subject to his direct manager’s discretion.

The Court’s decision

The company sought to argue that it assessed the employee’s performance under established performance objectives and that he was not denied an opportunity to participate in the discretionary variable reward scheme.  However, the Court found that the company had breached its own policies and exercised its discretion in a manner that was inconsistent with the objects of its applicable policies.  The Court found that, if the manager had not breached the company’s policies and the company had applied its own policies consistently, the employee would have received an ‘effective’ rating, leading to an incentive payment between 80% and 110% of his target.

Crucially, the manager had taken into consideration the employee’s performance after the relevant performance period.  The Court considered that any low score at such a time should have prompted the manager to discuss this with the employee, and put in place a written development plan.  This did not happen and further, the employee was not told of his annual rating until after his employment was terminated.

The Court accepted that the employee’s employment contract expressly stated that corporate policies did not form part of the contract, however, noted that the particular contract separately specified that if the employee’s employment was terminated due to redundancy, his entitlements would be calculated in accordance with the company’s policies.  The Court was satisfied that, on the proper construction of the particular employment contract, although the relevant policies did not have general application as contractual terms, they did for the purpose of determining his termination entitlements on redundancy.

In those circumstances, the Court ordered that the employee be paid the same $70,000 incentive payment he received the year prior to his redundancy, as well as costs.

Lessons for employers

Employers should be aware that describing bonus or incentive schemes as ‘discretionary’ is unlikely to render the scheme as truly discretionary and employers should be careful to ensure that a specific contractual term is not inconsistent with the intended discretionary nature of a relevant policy.  Even if a scheme is discretionary in nature, the Courts are likely to find that any discretion by the employer cannot be exercised in a manner that is capricious, arbitrary or unreasonable.

This decision highlights that the need for employers to consistently follow their bonus or incentive schemes and policies – even where those schemes and policies are described as being discretionary in nature.