Mark Cornish, Partner
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Contractual bonuses for amounts often far in excess of basic salary have been widely used to incentivise employees in the City for some time. But in the last decade there have been a flurry of cases concerned with the legal nature of bonuses. Mark Cornish, an employment solicitor and Partner at Anthony Gold, looks at bonuses and the true extent to which employers have discretion when giving them.
In an ideal world express contractual terms should set out the extent to which an employee is entitled to a bonus. The contract could, and probably should, explain:
- Whether there is a contractual right to an actual payment or simply a contractual right to participate in a bonus scheme, with discretion in the actual amount awarded;
- How the scheme will work, making it clear what the performance criteria are, and what will be received for meeting them, or at least having a written explanation of the criteria that will be used in the exercise of any discretion.
- What happens with employees who leave or are dismissed, or are working notice, shortly before the decision on a bonus is made. Often contracts include an explanation as to what happens to the bonus if someone is dismissed with or without good grounds – “good leaver”/ “bad leaver” arrangements.
A well drafted bonus scheme is in both parties' interest. It gives both sides certainty and avoids disputes or resentment. It will make a position more attractive to an employee and give them a basis on which to plan their performance.
But the reality is that employers don’t normally want to commit to contractual rights or give figures even where employees meet certain levels of performance. Employers will often ask their lawyers to prepare clauses which ensure that an employee has no legal right to a bonus and that it can be withdrawn or changed at any time. At the same time, a new employee, anxious to start work and impress his new employers may not have the foresight, negotiating power, or courage to negotiate and fine tune the terms of their bonus scheme.
Bonus clauses are often ambiguous, so a well advised employee can argue that they create a contractual right to the bonus, or at least to participate in a scheme. A stray phrase in a handbook giving the handbook contractual effect could easily turn what an employer thought to be a discretionary scheme in that book, into a contractual one. Established custom and practice over the course of several years can also serve to create a legitimate contractual expectation to a bonus. This is particularly so in City employees’ contracts, where employees often legitimately expect their bonus to exceed their base salary. As such there have been many cases where employees have successfully been able to establish that a bonus was a contractual right.
In recent years, practice has moved on, so that well advised employers often prefer to acknowledge a contractual right to participate in a bonus scheme. But they then keep control over the amount that is awarded by making the manner in which it is exercised as discretionary as possible.
However, the courts have refused to allow employers a free reign in exercising discretion which ought properly to be exercised reasonably. Clearly an employer who exercises their discretion by deciding not to pay a bonus to its female employees or by paying them less than male employees would not be exercising reasonable discretion. The courts are likely to step in to find such obvious examples of discrimination unlawful, through the operation of discrimination legislation. Of course, proving the facts of discrimination is fraught with its own difficulties, as the rationale behind decisions is rarely overtly discriminatory. Often employees are left to try and rely on more subtle principles of law to protect their position.
In Mallone v BPB Industries plc [2002] EWCA it became clear that the courts would be willing to recognise the expectations of employees faced with denial of a bonus under a discretionary bonus clause. The Court of Appeal felt that an employer will effectively be in breach of contract if its bonus decision is one which ‘no reasonable employer could have reached’. Introducing reasonableness to this issue might seem like a good idea, but it inevitably creates uncertainty.
In Horkulak v Cantor Fitzgerald International (CFI) (2004, IRLR 942) the issue was whether a bonus should be paid and how the employer should have exercised its discretion as to the amount. The issue was determined in the context of considering the value of a claim for breach of contract, following the unfair summary dismissal of an employee. His bonus would have been payable during the remainder of the term of a contract, had he not been dismissed. The Court of Appeal, in considering what would have happened had the employee not been dismissed, confirmed the principles set out in Mallone and concluded that employer must not exercise its discretion ‘capriciously or irrationally’.
With the principles of the Horkulak case in mind, the High Court opened up another avenue of argument for the employee, in Takacs v Barclays Services Jersey Ltd (2006 IRLR 877). Here the High Court decided that the implied term of "trust and confidence", implied into all contracts of employment, could also be construed to include implied terms of co-operation and anti-avoidance. Hence an employer should not make it difficult or impossible for an employee to become entitled to benefits provided for by their contract.
But Takacs may come to be viewed as the high watermark for employees because in November 2006, Keen v Commerzbank AG: [2006] EWCA Civ 1536 was decided in favour of the employer. In this case the Court of Appeal held that the burden of establishing that the level of a discretionary bonus payment by the employer was irrational or perverse was very high. In this case, where much depended on the employer's discretionary judgment having regard to fluctuating markets and labour conditions and since the bank had a very wide contractual discretion, the bonus could not be said to be irrational. The Court of Appeal also dismissed an attempt by the employee to use the Unfair Contract Terms Act 1977 to suggest parts of the contract were unfair, making it clear that Act could not apply as the employee was not “dealing as consumer”, nor was the contract one containing standard terms of business.
It remains to be seen how these cases will be applied in practical terms, but it should be noted that whilst the employer’s exercise of discretion has some limits, those limits are really only a safety net for relatively extreme instances of irrationality. A test based on irrationality is likely to be an unforgiving one for employees in coming years. Indeed it is likely to be even harder to demonstrate failings in an employers’ exercise of their discretion if the employer has at least paid something under a bonus scheme.
Nevertheless, these recent cases will give employees the scope to challenge the denial of a bonus and give advisers enough ammunition to negotiate any settlement package on offer. If nothing else the major financial institutions are unlikely to want a case with facts that suggest their bonuses are low to reach a public forum.
For further information email Mark Cornish or call 020 7940 4000.
