Check your bonus entitlement - &quotdiscretionary&quot doesn't always mean what it says

Pay packages in the City of London often include a cash-based bonus scheme, either in addition or as an alternative to an equity-based scheme designed to let employees share

in the success of the business (e.g. a share option scheme).

Bonus schemes not only help employers with recruitment and retention, but

allow staff to be rewarded as and when the business is performing well,

without permanently increasing the wage bill.

There is an increasing tendency for bonuses to be performance-related. This

can operate on a number of different levels.

Some schemes, especially for senior staff, link bonuses to individual

performance. There are a variety of techniques for measuring performance -

for example, payments may result from &quotgood&quot or &quotoutstanding&quot appraisals, or

they may be linked to work targets or the acquisition of

new skills.

At the other end of the spectrum, bonuses can be related to corporate

performance of the firm as a whole, though this is becoming less common.

Increasingly, employers operate flexible bonus frameworks, with targets and

performance assessment varying by team, department or business division.

In this way, rather than looking towards remote company-level goals,

employees are encouraged to focus on targets that are meaningful to them and

on which they can have a demonstrable impact.

Some bonus schemes guarantee the employee a certain level of bonus for a

given period provided that the requisite conditions are met (e.g. the

company achieving its profits target).

Such arrangements clearly give rise to a contractual entitlement because the

employer has made a binding promise and the amount of bonus is capable of

precise calculation.

More commonly, employers seek to minimise their potential exposure on bonus

schemes by describing them as &quotdiscretionary&quot. A commonly used type of

formula is as follows:

&quotThe Executive may be entitled to be paid bonuses of such

amounts (if any) at such times and subject to such conditions as the Board

of the Company may in its absolute discretion decide.&quot

Clauses of this kind do not, however, necessarily provide a defence for an

employer seeking to justify non-payment of bonus to a particular individual.

In a line of important cases, the courts have established that, in legal

terms, there is no such thing as an &quotabsolute&quot discretion in this context.

In Clark v BET plc, 1997, a chief executive's contract of employment

provided that his basic salary &quotshall be reviewed annually and be increased

by such an amount, if any, as the Board may in its absolute discretion

decide&quot.

He was also entitled to take part in a &quotbonus arrangement providing a

maximum of 60% basic salary in any year&quot. For five years, Clark received

salary increases of around 10% each year as well as his maximum bonus

entitlement.

However, following the takeover of the company, he was dismissed without the

three years' notice to which he was entitled under his contract.

The High Court rejected the employer's argument that any discretion would

have been exercised so as to give the least possible benefit to Clark.

Rather, the court awarded damages on the basis that his salary would have

increased by 10% per annum.

Similarly the &quotrealistic assumption&quot with regard to bonus was that Clark

would have received a bonus of 50% of salary in each of the three years his

contract had to run. In the event, the court awarded 2.85 million damages.

A more recent case, Clark v Nomura International, 2000, concerned an

equities trader whose contract provided for a &quotdiscretionary bonus dependent

upon individual performance&quot.

On his dismissal, Nomura decided not to pay him any bonus in respect of his

final nine months of employment, despite the fact that he was responsible

for profits during that period of some 6.5 million.

The High Court confirmed that there are limitations on an employer's

exercise of a discretion that appears to be absolute. In this case,

Nomura's decision to award Mr Clark a nil bonus was &quotirrational and

perverse&quot in light of Clark's outstanding success in making money for the

bank. Damages for 1.35 million were awarded.

The law of contract does not, however, go so far as requiring employers

exercising a discretion to do so in a &quotreasonable&quot manner.

In another case, the Employment Appeal Tribunal (EAT) ruled that an employer

was not in breach of contract in refusing to pay a discretionary performance

bonus to an employee who was on notice of redundancy.

Although the decision not to make the payment could be described as

hard-headed or even cynical, it could not be said that the employer had

exercised its discretion capriciously or irrationally.

But even if non-payment of bonus does not actually amount to a breach of

contract by the employer, it seems that workers may still be able to force

payment by bringing a claim in the employment tribunal for &quotunlawful

deduction from wages&quot under the Employment Rights Act 1996.

In Kent Management Services Ltd v Butterfield, 1992, the employee's letter

of appointment stated that the company's commission scheme was

&quotdiscretionary and ex-gratia and does not constitute a contractual

arrangement&quot.

He was dismissed and, on the basis of the fees he had generated, was owed

commission of 1,402. The company refused to pay, on the grounds that the

scheme was discretionary and not contractual.

The EAT held that Butterfield did not have to establish a contractual

entitlement to be paid commission in order for the non-payment to amount to

an unlawful deduction from wages.

It merely had to be within the &quotreasonable contemplation&quot of the parties

that the commission would be payable in ordinary circumstances.

Employers should also be careful to avoid operating discretionary bonus or

commission schemes in a way that amounts to unlawful discrimination.

Once again, the danger for employers is in considering that a discretion

allows complete freedom in deciding whether or not to make a particular

payment.

For example, if a discretion is exercised in a way that disadvantages a

pregnant employee, or one who is on maternity leave, the employer is likely

to be found guilty of sex discrimination.

Richard Lister is a lawyer in the employment department at Lewis Silkin

solicitors. richard.lister@lewissilkin.com