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Discretionary Bonuses: How much discretion do you have?

Contractual Bonus Clauses & Discretion

In a recent case heard by the High Court the question of discretionary bonuses and how the discretion can be exercised was discussed and decided in what was a very high value case for both parties involved.

The Law

Contracts between and employer and an employee are like any other contract, in that each party is bound by the terms that are agreed and contained within the contract.

It is commonplace for employment contracts to include details about an employee’s bonus, and it often states that the payment or the amount to be paid is at the discretion of the employer, thus giving some leeway into how much is paid and how it is calculated.

To avoid issues with bonuses some employers will state that the bonus is non-contractual and that there is no obligation upon an employer to make the payment at all.

The Facts

This case involved two employees Mr Brogden and Mr Reid who were employed as the Head and Deputy Head of Equity Derivatives for Investec Bank (UK) Ltd (‘Investec’).

When they started work they were given contracts which provided for a basic salary of £120,000 per annum but the main part of their pay was expected to consist of a bonus. For Mr Brogden and Mr Reid when they were deciding to join Investec the fact that their bonuses were not discretionary, but a matter of contractual right, was important to them.

Their employment contracts stated that they would receive a bonus payment each year which would be calculated as a percentage of the value added to the business as a result the deals that were generated by the equity derivative part of the business they were heading up.

Despite the fact that their contracts were drafted to provide a degree of certainty about the bonus payments there were issues about the amounts of the bonus that they were to receive from the outset.

When it came to the financial year 2010/2011 Investec stated that their bonus would be nil. Mr Brogden and Mr Reid disputed this and claimed they were in fact entitled to bonuses of £3.6 million and £2.7 million.

As the issue could not be resolved they resigned and brought claims for the amounts they allege were owed.

Unsurprisingly given the amount of money involved both the employees and Investec made numerous allegations against the other of dishonesty and bad faith.

Investec’s position was that they had calculated the performance figures upon which the bonuses would be paid fairly and in accordance with the terms of the employment contracts.

Mr Brogden and Mr Reid argued that they had reached an oral agreement with Investec prior to taking up employment which set out the agreed method for calculation of the figures for bonus purposes, which had not been followed.

The Decision

The High Court decided, on the evidence presented, that there had been no oral agreement about how the performance figures were calculated, as alleged by the employees. Therefore the outstanding question was over the application of the contractual terms.

In their decision making process the High Court analysed previous decisions regarding contractual discretion and the principles which have emerged are;

·         that a contractual discretion must be exercised in good faith for the purpose for which it was conferred;

·         that a contractual discretion must not be exercised arbitrarily, capriciously or unreasonably;

·         the test to be applied is that no reasonable employer would have exercised his discretion in this way;

·         the principle applies to discretions in relation to pay like any other contractual discretion; and

·         employers have an obligation of trust and confidence which must also be considered in assessing an employer’s actions.

The High Court concluded in this case that ‘where a contract gives responsibility to one party for making an assessment or exercising a judgement on a matter which materially affects the other party’s interests and about which there is ample scope for reasonable differences of view, the decision is properly regarded as a discretion which is subject to the implied constraints that it must be taken in good faith, for proper purposes and not in an arbitrary, capricious or irrational manner.’

Accordingly Investec, in assessing the level of bonus and performance figures were required to act in good faith and rationally. Judged by that standard, the Court concluded that Mr Brogden and Mr Reid had no right to be paid any bonus for the 2010/2011 year and their claim therefore failed.

Points to note

If you are going to provide your employees with a bonus as part of their pay package it is advisable to ensure that you have a comprehensive bonus clause which sets out the calculations to be applied so that it is clear to all parties.

In any event any decision making process that you go through in deciding how much to pay with the bonus whether it is contractual or discretionary should be conducted in a fair a reasonable manner, and you should record your reasons and calculations.

As long as you exercise any discretion in good faith with proper purpose you will reduce the risk of dispute.

Also don’t forget that communication is the key!

If you would like to read the full judgement you can find a copy by clicking here

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The information contained in this blog post is provided for guidance and is a snapshot of the law at the time it is written. It is provided for your information only and should not be used as a substitute for obtaining legal advice that it specific to your particular circumstances.

The guidance should not be relied upon in any decision making process. It is strongly recommended that you seek advice before taking action.

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