Employment bonus schemes – what you need to know

Bonuses are widely used by employers in an effort to incentivise their staff to perform well and meet certain objectives. Bonus and other reward schemes often play a significant role in attracting senior individuals to certain organisations and help to cultivate a valued, loyal and motivated workforce.

Bonuses come in many different forms and can vary significantly in structure in order to reflect the type and requirements of the business. They can be:

  • discretionary or contractual;
  • capped or uncapped;
  • target/performance based (individual or company) or guaranteed.

One of the most common considerations seems to centre around the difference between contractual and non-contractual bonuses and, the sort of arrangements that support the latter. This is of real importance at the moment given the changing financial position of many companies due to the impact of the pandemic.

Employers are understandably keen to ensure that any such bonus entitlement is genuinely discretionary in an effort to afford them some protection in the event of changing company performance. 

Contractual v Discretionary 

What is the difference? In general, contractual bonuses must be paid if certain criteria are met. Conversely, discretionary bonuses are not a contractual entitlement, and the employer may exercise discretion as to whether they are payable or not depending on the circumstances.

Bonus disputes

Whilst the above is a useful rule of thumb, in reality the situation can be very blurred. To this end, discretionary bonus entitlements are often challenged by employees on the basis that they are not truly discretionary. Indeed, case law continues to demonstrate that the Courts are increasingly willing to make findings that non-contractual/discretionary bonus schemes are quite the opposite and in fact give rise to contractual rights through custom and practice.

How can employers reduce the risk of bonus disputes?

First and foremost, employers should clearly stipulate the conditions under which a bonus will be payable in all relevant documentation issued to applicable employees. This includes their employment contract/service agreement as well as any corresponding bonus policy.

Employers should also avoid communicating or announcing any bonus arrangements orally in order to avoid an argument that the same is legally binding and overrides anything in writing.

In order to make discretionary bonus arrangements as watertight as possible and not open to interpretation we would suggest that employers adopt the following approach in their documentation:

  • State that the bonus is “non-contractual” and “discretionary”;
  • Make it clear that the bonus is payable at the employer’s “absolute” discretion and does not form part of any contractual remuneration. This should extend to the amount of any such bonus and the payment interval;
  • Reserve the right to vary or withdraw the terms of any bonus targets or bonus arrangement at any time without prior notice;
  • If a bonus is payable upon the achievement of certain criteria/objectives or the satisfaction of certain conditions, be transparent from the start and identify exactly what those criteria/conditions are. If they are likely to change, ensure that this exercise is repeated on the commencement of each subsequent financial year or when required;
  • Make it clear that just because a bonus may have been paid in respect of one (financial) year, it does not entitle the employee to any bonus payments in respect of subsequent years;
  • Set out what will happen to any bonus entitlement following termination/notice of termination of employment e.g. will any such entitlement be forfeited altogether or pro rata’d up to the terminate date;
  • Clarify whether the employee has to be employed for the entirety of any bonus/financial year to be entitled to the same or whether any bonus will be time-apportioned to reflect the duration of employment for that year;
  • Stipulate the timescale for payment of any bonus and avoid use of the word “immediately” when referring to a bonus that will be paid following an event e.g. “immediately following the financial year end”; and
  • Include any clawback i.e. set out the circumstances under which any bonus would be repayable. For example, if the employee were to leave their employment within a certain period.

When implementing the above, it is crucial for employers to be mindful that they have an implied obligation not to exercise their discretion perversely or irrationally when it comes to a bonus.

Whilst any Court or Tribunal will have regard to the wording of any contract or policy document, they will also take into account the arrangements in place between the parties in reality as well as any oral agreements or promises made by the employer that may supersede anything in writing. For this reason, employers need to be especially careful about how bonus schemes are implemented and discussed.

Our employment lawyers are experienced in advising on all aspects of bonuses, whether drafting clauses in contracts, preparing bonus scheme policies or dealing with disputes arising over bonuses.

For advice and consultation on bonus schemes/entitlements and how to tackle any issues arising from the same please contact Louise Rogers at [email protected] or by telephone on 07867 393210.

Please note that this article is not intended to be exhaustive or be a substitute for legal advice. The application of the law in this area will depend upon the specific circumstances and facts and you are therefore advised to seek comprehensive advice.

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