Last month we brought you “The end of the quack getaway”, a lighthearted look at the issues which face employers over employees’ expenses claims. This month we look at bonus bonanzas and ask if it is time for time to be called on bonuses.

We start with a word of warning about what can happen if your employees don’t like the terms you are offering. In nearby France, disgruntled employees are taking direct action when faced with less than satisfactory terms and taking company directors hostage. Two senior Sony executives were held overnight in their factory, which was ‘bloquéd’ with tree trunks. They were only freed when they agreed to renegotiate terms with workers.

In Pithiviers, workers at a 3M pharmaceutical plant took the Director of Operations hostage for 2 days in an attempt to force better severance terms. Where were the gendarmes, you ask? Shrugging their shoulders and letting the workers get on with it, bien sur!

Popular support in France for such direct action runs high, but bosses can draw comfort from the fact that the recent run of bossnappings has been marked by its peaceful, non-aggressive nature. Hostages are generally treated well and, in the case of the 3M Director of Operations, offered an appetising menu choice including fresh moules et frites.

There could be worse fates in life, you might think, but perhaps you’d rather not find out. Read on to find out about one particular aspect of employee terms which often causes employers difficulties: bonuses.

Bonus schemes tend to fall into 1 of 2 categories: discretionary and contractual schemes.

Discretionary schemes

Discretionary schemes have employment lawyers in court most often. In this type of scheme, the employee usually has no guaranteed right to payment of a bonus. Instead, the bonus is payable at the employer’s discretion. The employer may have complete discretion as to the bonus payable or the discretion may be more limited, for example as to the percentage of salary payable if the prescribed conditions are met.

Either way, this kind of scheme offers considerable flexibility for the employer. However, historically, discretionary schemes have caused employers considerable headaches. Most issues arise because bonus provisions are poorly drafted, so that it isn’t clear when and in what circumstances a bonus will be paid.

In recent cases such as Cantor Fitzgerald v Steven Horkulak (2004), the courts have made it clear that, even where the bonus scheme rules give an employers a discretion as to whether or not to pay a bonus, that discretion is not absolute (is not ‘completely unfettered’, in legal-speak). The courts have held that a discretion must not be exercised capriciously or perversely or in a manner which is discriminatory. An exercise of discretion which falls foul of these principles could render an employer in breach of the implied term of mutual trust and confidence which is so pivotal to the employment relationship. If you breach that implied term, there’s every prospect that you’ll be before a Tribunal fairly soon arguing about constructive dismissal and before the courts arguing over related civil claims.

Another area of contention relates to schemes where the bonus is payable based on financial performance, either of the employer or employee or both. In current times, many think that employers will be able to get out of paying bonuses quite easily. That is not necessarily the case. If the employment contract says the bonus will be payable if certain targets are hit by the employee, the employer may well be under an obligation to pay regardless of the recession. In contrast, in a scheme which pays out based on the employer’s financial results, an employer finding itself in difficult financial straits may be on reasonably solid ground reducing bonuses or cutting back bonuses completely.

Along the same lines, although the courts have been prepared to intervene where an employer has not exercised its discretion properly, the courts have been less inclined to interfere with employer’s decisions on the amount of bonus payable. In broad terms, the courts will not interfere unless the way in which the employer exercised its discretion was such that no reasonable employer would have acted so. Unless the employer has point blank refused to pay a bonus, or has paid a bonus which bears no relation to that which the employee might reasonably expect, the courts will generally leave it to the employer to decide what is a reasonable amount to pay (Commerzbank AG v James Kenn (2007)).

Another issue is where the discretion allows the employer to vary or alter the terms of a bonus scheme or even to withdraw the scheme or payments without notice. In one case, Kent Management Services Ltd v Butterfield (1992), Mr Butterfield was paid part in salary and part in commission. The commission scheme was expressly stated to be discretionary and had a provision stating that there were circumstances where payment might not be justified or possible. On termination of Mr Butterfield’s employment, the company argued that the discretionary nature of the commission scheme meant that it was entitled to withhold half of the commission which was otherwise due to him. This argument did not find favour with the judge, who commented on the commission scheme in these terms:

“This must be a form of agreement or clause which is to be found in many situations in employment. If reasonable notice is given, clearly these schemes can be varied and altered and might be abolished, but whilst the schemes are in being, the anticipation will be that in normal circumstances commission will be paid on work which has been carried out and on which the calculation is based; the anticipation of both parties is clearly that it will be payable.”

So employers need to tread carefully before withholding bonuses or in altering the terms of bonus schemes, otherwise they may find themselves facing claims of constructive dismissal or even unlawful deduction of wages. Also, employers who structure their redundancies so as to avoid paying bonuses may come a cropper. In the Commerzbank Bank case mentioned above, the court made it clear that employees could have a claim for repudiatory breach of contract if the employer terminated employment just before a bonus was due so as to avoid paying that bonus out. Further, even if non-payment of the bonus is justifiable under the terms of the bonus scheme rules, if an employee’s dismissal is found to have been unfair, there is a risk that an employment tribunal will take the projected bonus payment into account in assessing the damages due to an employee.

Contractual schemes

In contrast to discretionary schemes, the employer has no discretion as to whether or not to pay out under a contractual scheme: if the threshold specified for payment of bonuses is reached, the employer has to pay the bonus due.

Contractual v discretionary

The line between contractual and discretionary schemes is not always clear cut and it may be that a scheme which appears on the face of it to be discretionary is not in fact so. If the employer has always paid a bonus year-on-year, regardless of economic factors or performance, a court may decide that the scheme has become incorporated into the employment contract.

Practical tips

Bonus schemes are useful to incentivise staff and can be a powerful retention tool. You can get the best out of your scheme and avoid problems by:

  • Making sure that your bonus scheme is clear and unambiguous about what bonus will be payable, when and in what circumstances.
  • Incorporating provisions allowing you to vary or withdraw the scheme.
  • Ensuring that any variation or withdrawal is only done after proper consultation with staff, to avoid any arguments over breach of contract.
  • Ensuring decisions which are taken on payment of bonuses are made applying objective criteria, to avoid suggestions of discrimination or bias or inconsistent treatment.
  • Avoiding conflicts of interests in the decision-makers. If the decision-makers will draw their bonus from the same pool of funds, the risk of allegations of self-interest are obvious.
  • Training line managers to ensure proper procedures are followed.