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Is it bye bye bonuses?


BonusAre we witnessing the demise of bonuses? Will the government’s intervention to prevent the payment of ‘exorbitant’ bonuses result in financial institutions and businesses revisiting their remuneration packages? Pam Loch considers the pros and cons of the bonus conundrum.

Today’s world involves the business secretary, Lord Mandelson, urging self-restraint on executives’ bonuses and the government imposing restraints on executive pay packages at RBS and Lloyds Banking group. Is this the start of the demise of bonuses?

In short I think the answer is probably not. First of all there is the rationale for having bonus schemes in the first place. Then there is the likelihood that it forms part of an employee’s remuneration package which cannot lawfully be unilaterally altered by the employer.

The rationale for bonuses

Bonus arrangements have become an increasingly common element of remuneration packages. The main reason for this is that they have been an effective tool to motivate and incentivise employees – a lawful performance enhancer.

Bonus schemes come in various guises. The main ones are:

  • Non-contractual bonus arrangements

  • Contractual bonus schemes with discretionary terms

  • Contractual bonus schemes with contractual terms

The courts have increasingly been persuaded that bonus schemes, designed to be non-contractual or discretionary arrangements, actually do give rise to contractual or quasi-contractual rights. Consequently, legal advice on the terms has increasingly played an important part when disputes arise.

“Many employers prefer the discretionary approach, believing it can provide flexibility.”

For employees, their ideal scenario is a contractual bonus they can enforce. Many employers however prefer the discretionary approach, believing it can provide flexibility to pay less and reduces the scope for an employee to pursue claims.

With discretionary arrangements, the employer is trying on the one hand to reassure the employees they have a good opportunity to earn a bonus, and on the other hand using the bonus as a carrot to recruit employees or retain them. At the same time the employer will want to avoid giving any guarantees to a bonus.

A discretionary entitlement, however, could become a contractual one if custom and practice come into play. If an employer has paid bonuses on a regular basis, assessing it on a similar basis each time, an employee can argue they now have an implied contractual entitlement to the bonus.

To achieve certainty, many employees have negotiated contractual bonuses, assessed against certain achievements. The employees then have the ability to enforce their entitlement to a bonus on the terms they negotiated.

Fit for purpose?

If the bonus arrangements have been designed well then they should incentivise the employee, and the employer should benefit from their good performance. In addition, if the employee’s productivity is poor due to the economic climate or their own performance, the employer should not be exposed to the downside.

Problems can occur when the bonus schemes have been poorly negotiated and/or been badly drafted. The employer could then find it has a bonus scheme that has become a drain on the business and in some instances a magnet for bad press.

What can an employer do if they want to change the bonus arrangements?

Ironically the first thing that needs to happen is that you have to find out what you are dealing with. If a director is involved then this should be an easy task. The Companies Acts, the Listing Rules and the Combined Code place certain obligations on companies to disclose the director’s emoluments, which includes their bonus arrangements. Any bonus information therefore should be easy to locate.

“Obtaining an employee’s agreement to vary their bonus terms, even in a recession, is not always easy to achieve.”

Junior staff are unlikely to have tailored individual bonus arrangements. Therefore staff handbooks are usually the most likely place to find any applicable bonus arrangements for this group.

The main difficulty is with the mid to senior management tiers, where specific individual bonus arrangements may have been negotiated on joining or when they have been promoted. The bonus terms may be contained in an offer letter and variations set out in subsequent letters. Alternatively the arrangements may have been agreed verbally and an ‘understanding’ exists as to the terms.

If there is no record of the bonus arrangements then you would need to ascertain from their line manager what the arrangements are and what has in fact been paid over the years. From this you should hopefully be able to determine if there is an implied contractual entitlement.

If there is a contractual entitlement to bonus, either implied by custom or practice or expressly set out in the contract, the employee must usually agree to vary the arrangements. If this consent is not given then the employee could claim:

  • There has been an unauthorised deduction;

  • They could resign and claim they have been constructively unfairly dismissed; or

  • Continue to work on under protest.

By working on under protest the employee protects their position. The employee preserves their right to resign and/or bring a breach of contract claim at a later stage.

Obtaining an employee’s agreement to vary their bonus terms, even in a recession, is not always easy to achieve. The employee may seek an incentive to agree to such a change. For example, in return for giving up part or all of their bonus the employee may want a higher basic salary. This could have an impact on other benefit entitlements in their package as well. To a large extent the negotiating strength of each party will have a significant impact on the outcome.

During a recession, employers will want to retain the best employees, and in order to achieve this they will still have to consider the overall packages they offer their staff. Incentivising their employees will remain an important, if not most important, factor in managing the business through tough times.

Pam Loch is founder of employment law firm Loch Associates and managing director of HRAdviseMe

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