How to ensure your bonus payments withstand scrutiny How to ensure your bonus payments withstand scrutiny

How to ensure your bonus payments withstand scrutiny
16 Nov 2017

New data published by the UK’s Office for National Statistics reveals that the value of bonuses paid to British employees in the financial year to March 2017 hit a record £46.4 billion (US$61 billion), a rise of 6.5% on the previous financial year. But bonuses as a percentage of total pay amounted to only 6.2%, a small increase on the previous year but still well below the 2008 peak of 7.1%.

Unsurprisingly, the financial and insurance industries paid the highest average bonus per employee at just under £14,770 (US$19,387), while the healthcare and social work sectors paid the lowest at close to zero. So it is clear that bonuses continue to be an important element of remuneration arrangements for many employees. But what are the advantages for employers and what are the main legal issues they need to consider when offering them? Why pay bonuses?

If properly structured, bonuses can be used to:
• Incentivise strong performance;
• Increase motivation;
• Enhance loyalty;
• Reward strong performance;
• Recruit and retain talent;
• Encourage employees to take on new responsibilities or projects;
• Discourage staff from leaving at inconvenient times of the year;
• Compensate new joiners for the loss of a bonus from a former employer;
• Pay employees at a higher level – but only if the business can afford to do so;
• Pay staff members more without having to increase other payments and entitlements, which are calculated in line with basic salary.

Contractual bonuses

Employment contracts sometimes include an express right to a bonus, which may be structured in many different ways. But it is common for contractual bonuses to set out performance criteria for individual employees, the team, the business as a whole, or a combination of all of them. The clearer the contract is in relation to the required standard and how it will be measured, the less scope there is for disputes over whether or not a bonus is payable.

Contractually-binding obligations to pay a bonus do not have to set down in writing. Staff members will, on certain occasions, be able to rely on something the employer said to establish a contractual right to one. But careful drafting of the written terms relating to bonuses can reduce the risk of unintended obligations.

Discretionary bonuses

It is very common for employment contracts to express an employee’s entitlement to a bonus as a contractual right to participate in a discretionary bonus scheme. This arrangement purports to enable employers to use their discretion as to how much will be paid, and when.

But this discretion is often not as wide as you might think. Past decisions of employment tribunals and the courts illustrate that there can be substantial fetters on such discretion. For example, previous examples illustrate that:

• Employers must exercise their discretion honestly and in good faith;
• They must not exercise discretion in an arbitrary, capricious or irrational way;
• The way in which discretion is exercised must not breach the implied terms of trust and confidence inherent in every employment contract. This situation would include treating employees in an even-handed fashion. It also usually means that employers are required to explain the rationale behind their choice when deciding to pay (or not pay) a bonus.

Former cases in this area have also shown how easy it can be for employers to limit their own discretion unintentionally. To ensure you preserve maximum flexibility, it is advisable to be careful and precise when drafting discretionary bonus clauses and schemes.

Clawing back bonus payments

Bonus arrangements that require repayment - or “clawback” of all or part of the bonus - under certain circumstances are becoming increasingly common. This approach is sometimes necessary to satisfy regulatory requirements. Employers typically provide for clawback to be triggered by such events as:

• Employees resigning or being dismissed within a given period;
• Discovering staff misconduct;
• The business having to revise its accounts.

“When setting up bonus arrangements, employers need to consider what should happen if the employment is terminated – and whether the reason for this termination, for example gross misconduct, redundancy or ill health, makes a difference.”

What happens with bonuses when employment ends?

When setting up bonus arrangements, employers need to consider what should happen if employment is terminated – and whether the reason for this termination, for example gross misconduct, redundancy or ill health, makes a difference.

It is possible to draft bonus schemes to ensure that, in many circumstances, no bonus is payable if the staff member is under notice or is no longer working for you. But it may be a breach of the implied terms of trust and confidence to terminate employment in order to deprive an employee of their contractual bonus payment.

If employers include a pay-in-lieu-of-notice (PILON) clause in an employment contract, they should consider whether or not they intend to pay any sum relating to a bonus in that PILON, and also make this decision clear in writing. If there is no express provision to the contrary, a bonus that would otherwise have been due for payment during the notice period would still usually have to be paid out.

Bonuses and discrimination

Bonus arrangements, including discretionary bonuses, should not discriminate against any individual unlawfully. If employees are awarded different sizes of bonus, employers should be comfortable that this scenario can be justified.

If the reason for a lower payment is (directly or indirectly) linked to pregnancy, age or gender, for example, it will be unlawful – although indirect discrimination in bonus arrangements is not always obvious. Operating different bonus arrangements for employees who work on a part-time or fixed-term basis is also unlawful.

Regulation of bonuses

Bonus culture has undergone considerable change over recent years. Bonuses are increasingly becoming subject to scrutiny and regulation, especially if they are paid to senior managers in a publicly-listed company or in the financial services sector. As a result, schemes should provide for the possibility that new regulatory requirements could come into force in future.

Conclusion

Increased levels of scrutiny and regulation, not least as shareholders and stakeholders demand greater transparency in relation to remuneration, mean that employers would be well-advised to review their bonus arrangements and documentation to ensure that they are fit for purpose going forward.

 

Anne-Marie Balfour is a legal director in the employment, pensions and immigration team at Charles Russell Speechlys LLP. She advises employers, senior executives and recruiters on all aspects of employment law, including contracts of employment, dismissals, employment tribunal litigation, TUPE, restructuring, discrimination, whistleblowing and working time issues. She has particular expertise in dealing with immigration-related employment law issues and has a particular interest in the impact of Brexit on employment law. Anne-Marie regularly speaks on employment law topics at conferences and other events. Her articles have appeared in both national newspapers and legal and HR trade publications.

New data published by the UK’s Office for National Statistics reveals that the value of bonuses paid to British employees in the financial year to March 2017 hit a record £46.4 billion (US$61 billion), a rise of 6.5% on the previous financial year. But bonuses as a percentage of total pay amounted to only 6.2%, a small increase on the previous year but still well below the 2008 peak of 7.1%.

Unsurprisingly, the financial and insurance industries paid the highest average bonus per employee at just under £14,770 (US$19,387), while the healthcare and social work sectors paid the lowest at close to zero. So it is clear that bonuses continue to be an important element of remuneration arrangements for many employees. But what are the advantages for employers and what are the main legal issues they need to consider when offering them? Why pay bonuses?

If properly structured, bonuses can be used to:
• Incentivise strong performance;
• Increase motivation;
• Enhance loyalty;
• Reward strong performance;
• Recruit and retain talent;
• Encourage employees to take on new responsibilities or projects;
• Discourage staff from leaving at inconvenient times of the year;
• Compensate new joiners for the loss of a bonus from a former employer;
• Pay employees at a higher level – but only if the business can afford to do so;
• Pay staff members more without having to increase other payments and entitlements, which are calculated in line with basic salary.

Contractual bonuses

Employment contracts sometimes include an express right to a bonus, which may be structured in many different ways. But it is common for contractual bonuses to set out performance criteria for individual employees, the team, the business as a whole, or a combination of all of them. The clearer the contract is in relation to the required standard and how it will be measured, the less scope there is for disputes over whether or not a bonus is payable.

Contractually-binding obligations to pay a bonus do not have to set down in writing. Staff members will, on certain occasions, be able to rely on something the employer said to establish a contractual right to one. But careful drafting of the written terms relating to bonuses can reduce the risk of unintended obligations.

Discretionary bonuses

It is very common for employment contracts to express an employee’s entitlement to a bonus as a contractual right to participate in a discretionary bonus scheme. This arrangement purports to enable employers to use their discretion as to how much will be paid, and when.

But this discretion is often not as wide as you might think. Past decisions of employment tribunals and the courts illustrate that there can be substantial fetters on such discretion. For example, previous examples illustrate that:

• Employers must exercise their discretion honestly and in good faith;
• They must not exercise discretion in an arbitrary, capricious or irrational way;
• The way in which discretion is exercised must not breach the implied terms of trust and confidence inherent in every employment contract. This situation would include treating employees in an even-handed fashion. It also usually means that employers are required to explain the rationale behind their choice when deciding to pay (or not pay) a bonus.

Former cases in this area have also shown how easy it can be for employers to limit their own discretion unintentionally. To ensure you preserve maximum flexibility, it is advisable to be careful and precise when drafting discretionary bonus clauses and schemes.

Clawing back bonus payments

Bonus arrangements that require repayment - or “clawback” of all or part of the bonus - under certain circumstances are becoming increasingly common. This approach is sometimes necessary to satisfy regulatory requirements. Employers typically provide for clawback to be triggered by such events as:

• Employees resigning or being dismissed within a given period;
• Discovering staff misconduct;
• The business having to revise its accounts.

“When setting up bonus arrangements, employers need to consider what should happen if the employment is terminated – and whether the reason for this termination, for example gross misconduct, redundancy or ill health, makes a difference.”

What happens with bonuses when employment ends?

When setting up bonus arrangements, employers need to consider what should happen if employment is terminated – and whether the reason for this termination, for example gross misconduct, redundancy or ill health, makes a difference.

It is possible to draft bonus schemes to ensure that, in many circumstances, no bonus is payable if the staff member is under notice or is no longer working for you. But it may be a breach of the implied terms of trust and confidence to terminate employment in order to deprive an employee of their contractual bonus payment.

If employers include a pay-in-lieu-of-notice (PILON) clause in an employment contract, they should consider whether or not they intend to pay any sum relating to a bonus in that PILON, and also make this decision clear in writing. If there is no express provision to the contrary, a bonus that would otherwise have been due for payment during the notice period would still usually have to be paid out.

Bonuses and discrimination

Bonus arrangements, including discretionary bonuses, should not discriminate against any individual unlawfully. If employees are awarded different sizes of bonus, employers should be comfortable that this scenario can be justified.

If the reason for a lower payment is (directly or indirectly) linked to pregnancy, age or gender, for example, it will be unlawful – although indirect discrimination in bonus arrangements is not always obvious. Operating different bonus arrangements for employees who work on a part-time or fixed-term basis is also unlawful.

Regulation of bonuses

Bonus culture has undergone considerable change over recent years. Bonuses are increasingly becoming subject to scrutiny and regulation, especially if they are paid to senior managers in a publicly-listed company or in the financial services sector. As a result, schemes should provide for the possibility that new regulatory requirements could come into force in future.

Conclusion

Increased levels of scrutiny and regulation, not least as shareholders and stakeholders demand greater transparency in relation to remuneration, mean that employers would be well-advised to review their bonus arrangements and documentation to ensure that they are fit for purpose going forward.

 

Anne-Marie Balfour is a legal director in the employment, pensions and immigration team at Charles Russell Speechlys LLP. She advises employers, senior executives and recruiters on all aspects of employment law, including contracts of employment, dismissals, employment tribunal litigation, TUPE, restructuring, discrimination, whistleblowing and working time issues. She has particular expertise in dealing with immigration-related employment law issues and has a particular interest in the impact of Brexit on employment law. Anne-Marie regularly speaks on employment law topics at conferences and other events. Her articles have appeared in both national newspapers and legal and HR trade publications.