By Philip Landau
Partner, Landau Zeffertt Weir, solicitors.
Bonus time has come around and by all accounts, it should be a bumper year for some City workers. A hot topic these days, however, is whether a bonus which is expressed to be "discretionary" in an employee's contract truly gives the employer an unfettered discretion, or whether that discretion must be qualified. This is particularly relevant where an employee is under notice or has just left employment. The employee may have already performed well for the bonus year, but has no future with that employer. Can the employer then exercise its discretion to avoid payment of bonuses for past performance?
Although the terms of a bonus will usually have been discussed in detail with the employee (and may even have been built in to an offer letter), when disagreements over bonus payments arise contractual documentation is often sadly lacking. The clearest position for all parties is where the bonus is expressed to be "contractual" and based on a specific formula. For example, it may be linked to individual performances and targets achieved, or the employer's performance as a whole. There is little room for manoeuvre by an employer in these circumstances, even if the employer is under notice, but having worked the full year.
Most schemes however, are expressed to be discretionary. Such schemes usually still include some kind of bonus criteria (such as the achievement of individual or departmental targets) for determining the amount of the bonus, but will always reserve to the employer the right to decide whether those payments are actually made.
It is now accepted that there is no such thing as an unfettered discretion. Various decisions in recent years have outlined that an employer must exercise its discretion in good faith and on reasonable grounds. It follows therefore that if an employee meets his bonus criteria an employer must have reasonable grounds for not paying the bonus if it is to show that it has exercised its discretion in good faith. An employer may find it difficult to establish such a reason if it is not specified in the bonus arrangements. An employer may similarly find it difficult if it has by custom and practice paid bonuses to other employees who have similarly performed over the year, but has decided to use the non-payment of a bonus as a tool to "freeze-out" a certain employee. What better way of signalling to the employee that he is no longer welcome by paying him far less bonus than his colleagues received? As it happens, an effected employee would potentially have the right to claim constructive dismissal in these circumstances, and such claim would include non-payment of the bonus.
Often, the question arises whether payment of a discretionary bonus should still be made on termination of employment - whether the employee has resigned, or has been dismissed. If the employee has been dismissed for gross misconduct, there will almost certainly be no requirement to pay outstanding bonuses. In cases of gross misconduct, the employee will be in breach and will be dismissed summarily. Accordingly, any bonuses, which have been earned, but not paid, will be forfeited. It is worth noting, however, that if the dismissal is unfair (on procedural grounds) the employee could potentially claim his loss of earnings arising from the unfair dismissal. This would include entitlements to bonus.
However, if the employee resigns with notice in accordance with his contract of employment or he is made redundant, the position will not be so clear. In such circumstances, the employer will have three options: - to allow the employee to work his notice period; to place the employee on garden leave or; to elect to pay the employee in lieu of his contractual entitlement to notice (assuming this right is reserved in the contract).
If the employer
elects to pay the employee in lieu of notice, the employee will not
be employed at the bonus payment date and will therefore not be entitled
to receive a bonus. If there is no contractual right to pay in lieu
however, the payment in lieu would amount to a breach of contract. In
such circumstances, the employee could issue proceedings and would be
entitled to recover the sums he would have been paid during his notice
period - including the bonus.
Where the employee is working his notice or is on garden leave at the
bonus payment date and the employer has sought to withhold the bonus,
recent case law has come down on the side of the employee. The High
Court looked at these circumstances in a leading case, Clark v Nomura
[2000].
In this case, Mr Clark had a bonus arrangement fairly typical for those working in City banks. It was described as a "discretionary bonus", not guaranteed in any way, and dependent both upon individual performance and upon remaining in employment on the payment date. Mr Clark was dismissed by Nomura but was still in employment on the bonus payment date.
Mr Clark issued proceedings for breach of contract. The Court held that Mr Clark was entitled to a bonus and it assessed the amount at £1.35m, taking account of discussions, which Nomura had had in relation to the size of bonus which it might award to Mr Clark, the bonuses Mr Clark had received in previous years, and the bonuses awarded to his colleagues in that year.
The Court said that, where an employer has reserved itself discretion in relation to a benefit, there is an obligation on the employer to exercise that discretion in good faith - i.e. not capriciously, perversely or irrationally. Nomura had fettered its discretion by making it clear that the amount of bonus was dependent upon "individual performance". Mr Clark's individual performance had manifestly been of a high order since he had made substantial profits for Nomura. His performance was similar to his performance in earlier periods when he had been awarded large bonuses.
It was also held that Nomura was not entitled to bring into account its reasons for dismissing Mr Clark in assessing his entitlement to bonus; nor was it relevant that he had no future with Nomura.
The Court ruled that where a decision was taken by reference to an exercise of discretion, it would be considered to be capricious, perverse or irrational, and therefore in breach of contract, if "no reasonable employer would have exercised the discretion in the same way". This does not mean that an employer must always pay a "reasonable" bonus, but simply that its decision must not be perverse or irrational.
The decision in Nomura has since been reinforced in other cases, although every case must clearly be looked at individually. It may be that a tighter drawn bonus clause in the Nomura case might have produced a different result. There is no doubt however, that a change in culture of how employers should determine discretionary bonuses, is well overdue. Employers should no longer decide such matters behind closed doors, without any rationale to the decision being made or, perhaps worse, make their decision based on a personal dislike of an employee. There should be transparency in both entitlement and decision making. Employers could otherwise find themselves open to claims of breach of contract, constructive dismissal, or even discrimination.
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Philip Landau is a solicitor and partner, specialising in employment law, in the London legal firm Landau Zeffertt Weir.