UK: Managing Bonuses In The UK On Tighter Budgets

Last Updated: 12 June 2008
Article by Martin Warren

Legal Framework

In the current economic climate, controversy continues to surround the payment of bonuses particularly where the general consensus may be that an organisation has not performed as anticipated. It does not, however, necessarily follow that a company can avoid paying a bonus because of the prevailing public mood or economic climate. This is because bonus schemes are subject to normal contractual principles. If an employee has a contractual entitlement to participate in a scheme and meets any criteria concerning how an award is calculated, then non-payment will be a breach of contract entitling the employee to claim damages and/or to resign and claim constructive dismissal.

In addition, bonus schemes must also operate in a non discriminatory manner so that, for example, disabled employees or those on maternity leave are not unfairly prejudiced.

Performance-related bonuses that are regulated by a contract of employment should be pro-rated if they relate partly to a period when a woman was working and partly a period on maternity leave. If, on the other hand, the bonus relates entirely to a period before or after maternity leave it should be paid in full. For these purposes, the two-week compulsory maternity leave period that immediately follows child-birth should be treated as time spent at work.

In the case of incentives for future work and/or loyalty bonuses, where the scheme requires active service on a particular date, the legal position of women on maternity leave is far from clear. If the payment is regulated by a contract of employment then case-law suggests it is acceptable to exclude a woman who is on maternity leave (other than compulsory maternity leave) on the relevant date. In the case of purely gratuitous payments, however, the Employment Appeal Tribunal has held that it is sex discrimination to exclude women who are on ordinary maternity leave. If the EAT was right on this point (and there is some doubt over this) then the same principle will apply to women on additional maternity leave from October 2008, when the distinctions between ordinary and additional maternity leave will largely be abolished.

Schemes which link bonus awards to attendance or performance could discriminate on the grounds of disability and an employer would need to show that this approach is justified.

Discretionary Schemes

Labelling a scheme "discretionary" has long been considered a successful way of avoiding creating any contractual entitlement to a bonus. This can work in one of three ways. The scheme may state that the employer has a discretion in deciding whether the employee actually participates in the scheme. Or, the scheme may include discretion in the way an amount is calculated. Or the scheme may of course include both. Discretionary terms have, however, been challenged in the Courts in the last decade and as a result the usefulness of this drafting tool has been called into question. In 2000, a High Court held that a discretionary bonus dependent on "individual performance" precluded other factors from the decision making process and that within these parameters an employer's discretion must be exercised without irrationality or perversity. This decision was later approved by the Court of Appeal when considering a typically worded provision which stated "the company may in its discretion, pay you an annual bonus". The Court of Appeal confirmed that an employer's discretion may not be absolute. The employer has an obligation to exercise any discretion rationally, i.e. in the way that any reasonable employer would have approached the question. In this case the employer could not simply rely on the term "discretionary" to argue that they were under no contractual obligation to pay any bonus when the employee resigned before the end of his fixed year employment. The employee was entitled to a bona fide and rational exercise of discretion by his employer in relation to the bonus scheme and was awarded anamount to reflect what he would have earned had he worked the full term.

In practice, what this means is that a discretionary bonus scheme may actually, despite the employer's intentions, give rise to a contractual entitlement to have that discretion exercised rationally and in good faith. Whilst it is true that more recently the Court of Appeal has come to the aid of the employer by making it clear that an employee will have the burden of showing that no rational employer would have made the same decision, simply labelling a scheme discretionary is no longer an easy or guaranteed mechanism to avoid paying bonuses. An employer will have to show that it undertook a meaningful and rational analysis of the employee's entitlement and they will be best placed to do this if there is a transparent bonus scheme with clearly established principles which are communicated to employees in advance and applied objectively.

What should a bonus scheme cover?

Is the scheme contractual or discretionary? Make sure all bonus scheme documentation is consistent on this point.

If there is discretion, does this apply to eligibility, the amount or both?

What are the eligibility criteria? - is payment conditional on remaining employed and with a clean disciplinary record?

How is the amount to be calculated? - i.e. by reference to specific performance criteria of the employee or of the business or a combination?

Make it clear that the level of bonus in one year is not an indication of the amount that may be awarded in future years.

Specify how absences will be treated, taking into account the appropriate anti-discrimination principles.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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