Discretionary Bonuses: A Word of Caution

Originally published January 2005

Bonuses are an important part of the remuneration of many employees, particularly in the financial services sector. However, even if the bonus is ‘discretionary’, an employer needs to be cautious when exercising that discretion as the recent case of Horkulak v Cantor Fitzgerald show.

Mr Horkulak’s fixed term contract provided for an annual discretionary bonus, the amount of which was ultimately determined by the company. He resigned two years before the end of the term because of his employer’s conduct and succeeded in his claim for breach of contract. However there was a dispute over the level of damages due to him. Should those damages include compensation for the loss of the discretionary bonus, which he would have expected to be paid if he had stayed in employment until the end of the fixed term?

Previous case law had suggested that the correct approach was to assume that, where there was no contractual obligation to pay a bonus, the employer would have chosen to exercise its discretion in the way that most suited it, and so award nothing. However the Court of Appeal adopted a different approach and implied a term that the parties have a reasonable expectation that the discretion will be exercised rationally, rather than on arbitrary or capricious grounds. In doing so, it followed its earlier decision in Clark v Nomura. It went on to award the full amount of the bonus had the discretion been properly exercised, amounting to nearly £650,000.

The fact that a bonus clause is expressed as discretionary does not give management the power to do what it likes, particularly where discretionary bonuses are in practice an important element of the remuneration package. An arbitrary or capricious exercise of a contractual power is likely to destroy the relationship of trust and confidence, and so breach the contract of employment; or as put in this case, the parties have a reasonable expectation of ‘a bona fide and rational exercise of discretion’. Employers cannot simply suit their own interests, even though the contract may appear to give them the right to do so.

When an undertaking is transferred, the Transfer of Undertakings (Protection of Employment) Regulations (TUPE) protect the employees’ position, so that their employment automatically transfers across to the new owner. The European Court's decision in Suzen suggested that in a service industry with few assets, if the new owner simply took over a contract but none of the staff, then there was no transfer. This appeared to open a way round TUPE’s protection: if a new owner refused to take staff on in order to defeat TUPE, he could do so. However the English courts have since attempted to block this loophole, on the basis that the transfer of staff is just one factor (amongst many) to be taken into account in determining whether there has been a TUPE transfer. According to this reasoning, if the new owner refuses to take staff on to prevent TUPE applying, then TUPE could still apply and the staff could be deemed to have transferred, even if none has in fact moved over.

Astle v Cheshire County Council explores the difficult question of the employer’s motive in refusing to take staff on. The Council had transferred their architectural services and staff to a contractor in 1994, a TUPE transfer. Some years later, regarding the contractor’s performance as ‘a disaster’, the contract was awarded to a new contractor, to whom some 65 of the original staff transferred.

The new contractor fared no better, and the Council attributed its poor performance to some of the original Council staff. This time round, the Council decided to terminate the contract and to use a panel of approved consultants, instead of awarding a contract to a single contractor. It also decided not to take on any of the outgoing contractor’s staff. Was there a TUPE transfer in this situation?

The Employment Tribunal decided there was not. Whilst the Council wanted to be rid of the underperforming staff, and so to thwart TUPE, there were also sound commercial reasons for operating a panel of consultants rather than a single contract.

Crucially, this meant that defeating TUPE was not the Council's principal motive in opting for the panel - although clearly it had been a factor in the decision. As a result, TUPE did not apply.

If staff employed on a particular service are not performing adequately, then a change of contractor may seem an attractive option for obtaining better service. Astle shows that to avoid TUPE, not only the contractor but also the method of delivering the service must be changed; and even then the desired outcome is not always predictable or obtainable. On appeal, the Tribunal's decision was upheld, but the EAT recognised that the case might have properly been decided the other way. There is no easy way of avoiding TUPE protection for staff and legal advice should always be taken.