Sunday, 8 September 2013

Legal risks emerging when introducing and varying a bonus scheme

Once organizations agree with employees the payment of a bonus, irrespective of the circumstance that this is granted on the basis of a written document or a verbal promise, these are subject to a series of restrictions and constraints, which could be tantamount to the employer being trapped in a vicious circle from which this may find it extremely difficult to escape. Henceforth, deciding to no longer pay a bonus or to pay it partially cannot be invariably considered as an employer viable prerogative. Yet, needing to make decisions about the appropriateness of paying a bonus when, for instance, an employer has just resigned or has been dismissed can prove to be a very daunting feat to perform. Bonus schemes may represent an important component of a company employee retention and attraction practices, but can potentially cause employers many troubles. Knowing in advance the pitfalls habitually associated with the management of this type of variable pay arrangements can indeed help employers to avoid these and the problems and waste of money habitually associated with them.
Paying reduced or no bonuses
Refusing to pay a bonus, in full or in part, might under some circumstances give raise to legal disputes. This can be in general averted by means of properly and clearly communicating to, and agreeing with, individuals the rules on the basis of which the overall bonus programme has been introduced and is thus managed. Notwithstanding, in some instances, especially in those in which a specific agreement has been negotiated and reached between an employer and the individuals filling particularly significant roles, the risk of litigation can be potentially higher and disputes trickier to manage and resolve whether brought before a court.
The source of a bonus payment: express or implied terms?
Express terms
The payment of a bonus, as all of the other terms and conditions of employment, may be provided for either in writing in the employment contracts and written particulars or verbally.
Despite the written form of a bonus agreement might not be required ad substantiam, meaning by that that the written form might not be considered necessary for the validity and enforceability of the agreement, the practice of invariably subscribing a written document with employees can definitely help employers to solve the disputes eventually arising at a later time. A written document, albeit not required ad substantiam, can in fact invariably be used ad probationem, that is, to provide evidence of the terms and conditions agreed between an employer and its employee and to prove that the employer made a specific and precise offer to the employee and that this accepted it as formulated by the employer in the written document.
In case of litigation, the main document and source of information is invariably represented by the contract of employment. Whether this should contain a clear and unequivocal entitlement to the payment of a bonus, this would be clearly fully considered part of the express terms and conditions of the contract of employment.
What in general typifies the express terms of employment, that is to say their distinctive characteristic, is that these have been explicitly discussed in details between an employer and an employee and hence agreed and accepted by both parties. These terms become thus legally binding for both of the parties involved. The formulation used in the contract of employment to entitle an individual to a bonus payment is and must be considered by employers as extremely important (Gannons, 2011). As a general rule, whether an employer aims at keeping a degree of latitude as regards the payment of a bonus, this should avert phrasing the bonus clause in a way which entitles individuals to receive the bonus payment under any circumstances. The caveat should rather be formulated in a way enabling the business to retain the latitude and right to pay the bonus fully or in part considering the circumstances.
Staff handbooks, e-mails and notice boards, albeit not necessarily having a contractual and hence legally bounding status, can contains information which may be used by the court to decide the way to resolve a dispute. Employers and the business management should consequently take extra care when devising these documents and writing whatever type of letter and note.
Implied terms

Are deemed implied the terms of a contract of employment, which albeit overlooked and not explicitly agreed at the moment of starting the work relationship, are considered necessary to regulate the matters not covered by the written documents and hence essential to integrate and complete these. The tenet on the basis of which a court will eventually establish an implied term is that whether this should have been discussed by the parties it would have been agreed in a certain way, consistently with their presumed intentions.
According to the UK law, the most relevant implied terms to the extent of a bonus payment are: “mutual trust and confidence” and “not to act arbitrarily, capriciously or inequitably.” In order to establish whether an alleged implied term may be considered as such, the courts are also very likely to attach a high degree of importance to the practical conduct of the parties.
Cases in which an employer can pay a reduced or nil bonus during employment
According to the implied term on the basis of which an employer should not act arbitrarily, capriciously or inequitably there are basically two factors which can restrict an employer’s latitude to pay, fully or in part, annual bonuses, to wit: the incapacity of the company to explain and sustain its decision not to pay a bonus and the breach of discrimination law.
Whether a firm’s decision not to pay, or pay a reduced amount of the agreed bonus, should be supported by rational and convincing arguments (the employer has therefore acted neither arbitrarily nor capriciously), as emerged from the UK court case Clark v Nomura International Plc. (2000), it is unlikely that the courts may impose a business to pay an employee the full bonus. With reference to this aspect, a court decision may be based, for instance, on the assessment of the overall business performance and actual circumstances. Despite an individual has objectively performed well in fact the payment of the bonus might be in contrast with the current financial state of the business. In Europe, this tenet is provided for by the Capital Requirements Directive no. 3 (CRD3) promulgated with respect to the financial sector organizations; observing this principle, nonetheless, can undoubtedly reveal to be useful for all the employers irrespective of their industry (Gannons, 2011).
It depends on the real employers intentions, but firms wanting to consider bonus payment as discretionary, should take extra care with the way their employment law specialists device the relevant caveat in the employment particulars and/or in the terms and conditions of the contracts of employment. Even in those cases in which a bonus has been agreed in express terms as discretionary in fact the way it is couched in writing can prove to be crucially important and should leave no doubts as regards its discretionary attribute.


The term discretionary needs indeed to be fully explained and the degree of its application clearly identified. The importance of this tenet actually emerged, in the UK, from Small and Others v The Boots Co. Plc. and Boots UK Ltd. (2009). The Judge of the EAT considered “ambiguous” the generic use of the adjective discretionary in the documentation provided by the Respondent, considering that it could have been referred either to the decision whether to pay a bonus at all or to its calculation method or to its amount or to other factors or to all of these aspects considered together. Simply defining the bonus as discretionary is not hence sufficient to determine the degree to which an employer’s discretion applies.
Despite in the employment contract it has been clearly stated that the bonus payment is discretionary, this precaution may not suffice to totally protect the employer from the consequences of possible claims. As discussed earlier, expressing in the terms and conditions of employment that the payment might not be made, either in full or in part, may prove not to be enough whether the circumstances to which the employer refers to in order to justify the non-payment are not sustainable and rational. In essence, what matters the most in order to support an employer decision not to pay a bonus, in addition to having clearly detailed the cases in writing, is the employer’s ability to prove that its decision is consistent and coherent with the financial situation of the company, the current circumstances and the employee actual performance and contribution.

In Ridgway v JP Morgan Chase Bank National Association the court held that the “nil bonus” awarded to the Appellant was consistent with the circumstance that the employee had made losses, rather than providing income for the bank in the year considered for the bonus payment. The Appellant had actually applied and been authorized by the bank for a sabbatical year from April 2003. The bank did not pay any bonus to the Appellant providing evidence that the decision not to pay was made on the basis of the Appellant performance during the period he was working in 2003, whereas related by no means to his absence.
In order to meet the implied term not to act inequitably employers’ bonus payment decisions must not be made on the grounds of discrimination-related reasons either. Gannons (2011), to this specific respect, stresses the importance of considering the circumstance that discrimination based on nationality, as all of the other forms of discrimination, is protected by regulations, namely race discrimination law; this entails that foreigner businesses based in a given country cannot pay home country employees higher rates than local employees.

An additional important tenet emerged from the UK’s jurisprudence relates to the so-called anti-avoidance term. The expression anti-avoidance refers to the circumstances in which an employer might decide to make, to put it mildly, not completely correct and transparent moves in order to avoid complying with some employment terms. As contended by Cabrelli (2007), the anti-avoidance term in the UK mostly emerges from the employers’ authority to dismiss employees and enable thus organizations to withdraw contractual benefits according to the changing circumstances. In Takacs v Barclays Service Jersey Ltd emerged that the Appellant in mid-November 2004 had not yet met his objectives, he was hence dismissed with a letter sent to him on November 15th stating that his contract of employment with the Defendant would have been terminated with effect 13 December 2004. No bonus was thus paid to the Appellant who claimed hence the Defendant’s breach of the implied trust and confidence, anti-avoidance and cooperation terms. The Appellant also claimed a sum of money considered, pursuant to the contract, as a “guaranteed minimum capital EPP award.”
The High Court of Justice held that the Claimant might have had real chances to succeed and the case to proceed therefore to full trial. The parties however settled the dispute one year later prior to the case to be brought before the court.
Payment of a bonus during notice period and after employment termination
The circumstance an employee might leave the organization soon after or just before the date set for the bonus payment definitely represents a rather particular, bur realistic eventuality. To avert employers being prompted to erratically deal with such circumstances, it is definitely better to provide details in the employment contract of what it will happen should these cases arise. This may clearly help employers to prevent claims but might not necessarily suffice: the courts might in fact consider employee entitlement to the bonus payment to be effective whether this has fully attained his/her objectives and the business is in the position to honour its pledge.

As maintained by Gannons (2011), a company decision can clearly vary according to the different circumstances. It is most likely that an employer decides to reward a “good leaver” or an employee made redundant, whether it is likely that this might be less incline to award a resigning employee or an employee dismissed for gross misconduct. The best approach is to clearly state in the contract of employment that in case of termination the bonus will not be paid. In general, courts in the UK tend to impose employers the payment of the bonus when this is paid for the attainment of past objectives and these have been actually achieved, and not whether intended as a means of motivating or retaining individuals. Notwithstanding, to prevent the risk of breaching the anti-avoidance term employers should definitely refrain from dismissing people in coincidence with the bonus payment period. This move might be intended as triggered by the employer unwillingness to pay the bonus and as such as a breach of the contract of employment.

In McCarthy v McCarthy & Stone Plc. (2007), nonetheless, the court held that whether an employee has met his performance objectives as detailed in the firm’s employee share option programme, the employer has no more latitude to decide whether to pay or not to pay the bonus, albeit an employee may be dismissed for gross misconduct. The Judge, nonetheless, also held that a bonus clause expressly regulating this circumstance would have actually enabled the employer to refuse the payment of the bonus.
An employee might be indeed considered to still hold his right to the payment of a bonus in those cases in which s/he has been dismissed for having breached a contract term, not only for the part of the bonus accumulated at the time of dismissal, but also for the part of the bonus this would have received whether still working during the notice period. In general, whether a contract encompasses the “payment of a sum in lieu of notice” (PILON) clause, and the employer counts on this clause to eventually terminate a contract of employment, the cases of a bonus payment and of its refusal during the notice period should be detailed in the clause (Greenberg Traurig Maher, 2011).
In Locke v Candy & Candy Ltd. (2010), the Appellant’s contract of employment provided for this to receive a discretionary bonus, whereas no further detail were provided to identify the extent to which the bonus payment had to be intended as discretionary.  The court deemed hence the definition of discretionary ambiguous. After twelve months in employment the Claimant bonus would have been quadrupled whether the employer would have still been “employed by the company.” In the contract of employment the employer reserved the right to terminate the contract making a payment in lieu of notice, as it actually did before the payment of the bonus. The generous bonus was therefore not paid in that, as it was, the employee was not employed by the company at the time of the bonus payment. The Appellant based his claim on the circumstance that it should have been considered as an axiomatic fact that the PILON clause also included the total bonus. Notwithstanding, the court held that the extra bonus should have been paid if and only if he was still employed, whereas he was not so that the claim was dismissed.

Also in this case, the appropriate wording of the clause would have certainly helped the employer to better manage the issue. However, the doubt that the anti-avoidance implied term was actually breached by the employer remains. The FILON express term was in fact used by the employer to invalidate another express term of the written contract, that is, the one concerning the payment of a particularly generous bonus to the Appellant. This would have been paid to the Appellant only whether this would have been employed by the firm after twelve months; but this condition was not met because the Defendant exercised its power or prerogative to apply the FILON clause to the detriment of the Appellant who undergone it.

Each case is clearly different from the others and details sorely count. In Reda v Flag, for instance, where two senior executives were dismissed by their employer to allegedly exclude these from the benefits of the company stock options programme, the court held that according to the terms of the Claimants’ contract the employer had the right to dismiss these for any reason, albeit by doing so the employer would have put itself in a position not to pay them the sum linked to the company stock options programme. In this instance, the lack of ambiguity and a carefully written contract of employment and particulars enabled the employer to be successful. Yet, as properly stressed by Greenberg Traurig Maher (2011), since the Appellants had claimed that the employer’s tactic had represented a breach of the implied duty of trust and confidence, this case also shows as a properly devised contract of employment can enable employers to protect themselves against the potential consequences of some implied terms.
Organizations should be aware that after a bonus has been paid to an employee the chances to claw it back, if any, are very limited. The most likely circumstance under which a bonus payment can actually be clawed back is when the employee has breached a post-termination pact. The seminal case is represented by an employee breaking the terms of a restrictive covenant agreement. Other cases in which employers may claw bonus back are those in which these can prove that the objectives set for the bonus payment were attained dishonestly or that the employee has voluntarily altered the facts or data on the basis of which his bonus has been paid.

The legal aspects associated with bonus payments are indeed many-faceted and the best way to prevent problems to arise is do everything it is possible to do beforehand, prevention is definitely better than cure. Reward managers and employment law specialists should hence work in close collaboration to formulate a thorough, detailed and consistent clause concerning the payment of the bonus, trying to regulate all of the possible cases they may be potentially prompted to deal with in the future.
Varying schemes and bonus terms and conditions
With the exception of some statutory terms, each term of a contract of employment once agreed and accepted by the employer and the employees can be changed only with the consent of both parties. Whether an employer should change unilaterally a term previously agreed with an employee without his/her consent, this variation will be considered unlawful. To this respect, nonetheless, gains particular significance the practical behaviour displayed by the parties, which is indeed used to determine whether a contractual term or its variation can be actually considered as an implied term. Whether the employee does not object to the variation implemented by the employer and adapts his/her behaviour to this, the term is considered accepted by the employee and changed by conduct. This basically represents the flip side of the same mechanism, bonus schemes implemented for years by employers initiative, albeit not being part of any express terms, are accepted by individuals who receive the sums of money and become as such legally binding for the employer.
It clearly emerges that the existence of a bonus scheme within an organization can pose legal threats to an employer also when this would like to introduce changes in the existing programme. In such instances, changes could be considered by employees as a breach of the current terms and conditions. Before introducing amendments to a bonus scheme employers should hence ensure that these are consistent with the current employment terms and conditions and do not entail any substantial modification of these (Brettle, 2003).
Whether individual entitlement to a bonus payment is explicitly included in the written contract of employment, this can be modified only with the mutual consent of both parties. The agreement may be either expressed in writing or emerge by conduct. Employers need hence to be aware of the way the scheme is actually operated and executed. The mechanism of the scheme as initially agreed might also change in practice over time and the new resulting mechanism considered by employees as having replaced the original or previous one.
The first thing to do before changing the terms of a bonus programme is therefore inform the employees concerned. Whether a bonus scheme has been operated for a number of years employees would take it as axiomatic that it will continue to be operated in the same way. The importance of this implied, by conduct term emerged from the court case Quinn v Calder (1996) where the employer had operated a bonus scheme which albeit not included in the express terms of the contract of employment was considered as such by the employees in that it had been consistently executed over the years. The court held that individuals continue to be employed considering the bonus as part of their terms and conditions and that the employer was aware of this circumstance. In essence, the by conduct term is in this case based on the making and the acceptance of a bonus offer.
This tenet actually applies irrespective of the circumstance that a bonus has been offered and accepted in writing. In Noble Enterprises Ltd. v R. L. Lieberum (1998) it come out that albeit the bonus payment had not been agreed as an express term (with the exception of 1994, when a written document was actually produced by the employer to regulate the bonus programme), the bonus scheme had been operated by the employer for a number of consecutive years, namely from 1992 to 1997 when the Appellant left the organization. The EAT therefore upheld the Employment Tribunal conclusion that the scheme had to be considered as contractual: it had been operated for several consecutive years, employees could exactly calculate the amount of their bonus and each of them worked knowing that a bonus would have been paid to award their efforts. The court also held that since the scheme was effective also the Claimant had the right to receive the bonus payment. No documentation or information was in fact provided to the Appellant to notify him of having lost his right to the bonus payment. The Appellant was hence expected to be awarded the bonus as it had occurred during all of the previous years of employment.

One of the most important factor, arguably the most important factor, employers should consider when planning to introduce a bonus scheme within their business is that the moment the scheme is implemented, irrespective of the circumstance that this has been introduced because of express or implied terms, individuals establish expectations. The longer the system is functioning and used within the firm, the more individual expectations stabilize and consolidate. As such, these expectations, or rather, the bonus scheme at the basis of their establishment becomes part of the individuals’ psychological contract. Whether individuals should consider that their employer has not met these expectations and complied with the unwritten norms consolidated over the years, individuals feel that the employer has breached their psychological contract. This unwritten agreement is indeed underpinned by mutual trust and the promise that both parties will perform as implicitly agreed. Both sides inevitably establish expectations by reason of this mechanism. Despite it might reveal harder for an employer to provide evidence of an employee breach of the psychological contract, employee expectations can fairly easier be protected before a court, which in any circumstances made its decisions considering whether employee expectations have been met or otherwise. It could consequently be argued that in many respects the employee psychological contract also benefits of some legal protection.

Employers should timely inform the employees concerned, at least before the beginning of the period of time with reference to which the bonus payment decisions are made, of the circumstance that the bonus scheme cannot or will no more be operated. This is extremely important to: ensure employees transparency, prevent individuals to establish unrealistic expectations, avert to cause employee disappointment and ultimately to have more chances of success should the case be brought before a court. When communicating employees the elimination or variation of the current bonus scheme transparency and timeliness may definitely prove to be of paramount importance. Employees can redress their expectations accordingly and not perceive the change made by the employer as breaching the pact previously agreed, psychological contract included.
Employers should indeed carefully consider the potential breach of the implied duty of trust and confidence also when varying the current bonus scheme. Individuals affected by the programme change could potentially claim that the variation unilaterally implemented by the employer in the scheme has seriously jeopardized the relationship of mutual trust and confidence existing between them. An employee may in fact claim that the employer has engaged in such a tactic just to force him/her to resign. Under such circumstances, it is very likely that the employee may claim a constructive dismissal. The change implemented by the employer would be certainly considered as detrimental by an individual as to let this perceive that the implied mutual trust and confidence term has been irreversibly breached and that s/he has no option but to resign.
As contended by Brettle (2003), in the UK an individual entitled to claim constructive dismissal may also claim unfair dismissal against the organization. Most importantly, whether the court should establish and recognize the constructive dismissal, this implies that the employer has breached all of the contractual terms. In such instances, also the express terms, like the restrictive covenants, would be considered unenforceable.
Before implementing any changes to a bonus programme employers should invariably inform and consult with unions or workforce representatives to explain the reasons behind the bonus cancellation or variation and give apparent, thorough communication of that to the entire employee population. This information will prove that the employer did whatever he could to modify or cancel the programme with the staff agreement and that the organization was acting with transparency and in good faith; it could hardly be argued that the employer breached the implied term of trust and confidence. This attempt will also provide evidence that the employees were informed of the employer intent to vary the programme before changes were actually implemented.
Whether a new agreement should be reached between employer and employees it is good practice to let the latter sign a waiver letter to be attached to the original agreement or policy to prove that the amendments were actually implemented with the consent of both parties (Brettle, 2003).
Longo, R., (2013), Legal risks emerging when introducing and varying a bonus scheme, Milan: HR Professionals [online].