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How discretionary is a bonus?

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Employment contractIf a bonus is labelled as ‘discretionary’ in an employment contract, can an employer refuse to pay it or is the employee legally entitled to the payment? Charles Price offers his advice.


Whenever a recession digs its claws into the economy, politicians attack ‘fat cats’ and city bonuses. With the recent suggestion that much of Sir Fred Goodwin’s early retirement pension from Royal Bank of Scotland was ‘discretionary’, it begs the question as to whether bonuses and similar payments have to be paid at the date of termination.

Employers often fall into the trap of refusing to pay an employee a bonus, both whilst they remain in employment or afterwards, simply because it is labelled as ‘discretionary’ in the contract of employment. Tribunals often compel the recalcitrant boss to hand over the missing cash.

A discretionary bonus could be referring to:

  • The provision of an overarching bonus scheme

  • A decision to pay or not pay a bonus in a particular year

  • The method of calculation of a bonus (for example fixed amount or percentage of salary and if so what percentage)

  • The threshold or performance target which triggers a bonus.

It is a well-established law in the employment tribunal that where an employer has an absolute discretion, it must not exercise, or fail to exercise, that discretion ‘irrationally or perversely’.

The starting point in considering whether an employee is legally entitled to a bonus is to look carefully at the terms of his or her contract. When drafting contracts of employment in order to avoid claims for unpaid bonuses, and even discrimination claims, it is important to provide as much detail as possible as to when they are and aren’t payable.

“The starting point in considering whether an employee is legally entitled to a bonus is to look carefully at the terms of his or her contract.”

In the recent case of Small v The Boots Co PLC and Boots UK Ltd Employment Appeal Tribunal (EAT) on 23 January 2009, Mr Small and other warehousemen employed by Boots claimed for unlawful deduction from wages. They said that they had not been paid performance-related bonuses to which they were entitled. Again, this case highlights the importance of the inclusion of unambiguous phrases and statements in employment contracts.

The Boots’ staff handbook said: “After a qualifying period of service, there are additional discretionary benefits, such as bonuses… However, they are not intended to be contractual”. An employment tribunal decided that the bonuses were purely discretionary. Having lost at the tribunal on this basis, Mr Small and his colleagues appealed to the EAT.

Custom

The crucial element, according to the EAT, was that the original employment tribunal had failed to take into account “all relevant circumstances including the invariable practice of making payments over many years in deciding whether the discretion in the documentation is to be construed as having contractual content”.

In other words, when dealing with a staff handbook, which was ambiguous, the tribunal should look at when it was customary for Boots to pay the bonus. The customary practice of Boots in relation to bonus payments had led to there being an implied contractual term that a bonus would be paid even if its amount might be discretionary.

The discretion regarding how much should be paid could again not be exercised ‘irrationally or perversely’. In other words, the amount had to be fair, representing what would usually be paid under the circumstances.

This case highlights that there are some important points to remember for the employer that offers bonuses:

  • An employer should not assume that he can cut a bonus just because it is a ‘discretionary bonus’

  • The discretion regarding how much should be paid or if the bonus should be paid could not be exercised ‘irrationally or perversely’. The facts of the particular case will need to be carefully considered and an evaluation of circumstances (for example, the degree of judgment required and market and labour conditions) made. The fact that an employee has not been told the reasons for the exercise of a discretion or who has exercised it will be relevant, but not determinative to the question of irrationality or perversity

  • A purchaser of a business should make full enquiries about any staff bonus schemes. If a discretionary staff bonus scheme operated by the vendor of a business has contractual status, the TUPE regulations will ensure that liability to continue it automatically transfers with the business

  • A claim may have to be made in a court rather than in an employment tribunal. An employment tribunal’s jurisdiction to consider claims for unlawful deductions from wages arises under the Employment Rights Act 1996. The relevant provisions do not apply where the amount claimed is uncertain, as it might well be if a discretionary bonus is in point. In that case the claim would have to be pursued as a claim for damages for breach of contract, rather than as a claim for unlawful deduction from wages under the 1996 Act. An employment tribunal has jurisdiction to consider breach of contract claims only if the employee making the claim is no longer working for the employer – and even then cannot award more than £25,000 – so it would follow that the claim would normally have to go to a County Court or the High Court.
  • It is important that the bonus terms are written in as much detail as possible in the handbook in order to avoid ambiguity.


Charles Price is a barrister at No 5 Chambers.

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