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Paying discretionary bonuses? Check scheme rules, warns lawyer

Out-Law News | 19 Jul 2022 | 11:57 pm |

James Sullivan-Tailyour tells HRNews about avoiding the common pitfalls when awarding discretionary bonuses
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  • Transcript

    Across the UK the level of discretionary bonus awards has hit a 9-year high. It explains the rise we have seen in the past couple of years in disputes over bonus payments – a mismatch between what a company believes should be paid and the individual’s expectations about how the scheme rules should operate. We’ll consider that problem.  

    As the FT reports, bonus payments stand at their highest since 2013 as a share of UK earnings, as employers seek ways to pay workers for higher living costs without committing to inflation-busting wage deals. The latest official data from the ONS suggest employers have increasingly been using discretionary awards to compete for scarce workers, while trying to limit the overall rise in their wage bill.

    Most bonus disputes stem from non-payment of discretionary bonus schemes. Very often employers believe that because a bonus scheme is labelled as ‘discretionary’, it is essentially within their gift to decide who receives a bonus and the amount of it. Only when challenged do they realise their ‘discretionary’ scheme is not truly discretionary at all - potentially opening up disputes from the wider workforce who may feel unfairly treated.

    Share plans specialist James Sullivan-Tailyour advises clients on the drafting of schemes, including discretionary bonuses, and earlier James joined me by video-link from the London office to discuss this. I put it to James that it’s a bit odd that a scheme labelled ‘discretionary’ is not living up to that description.

    James Sullivan-Tailyour: “Yes, that's absolutely right, Joe, and it might perhaps seem a little bit unfair because if a bonus scheme is labelled as discretionary it's a fair assumption that it ought to be treated as discretionary but there are a number of areas where companies can trip themselves up and tip what they intended to be a discretionary bonus scheme into something that's more contractual in nature, or where the scope of their discretion is limited. The first area where companies can trip themselves up is when a new employee joins the business, in their employment contract baking in some kind of contractual entitlement to participate in a bonus scheme. If that's the case, then it can really cut across any discretionary bonus scheme rules you have in place. The employment contract entitlements will trump the bonus scheme rules unless you've got that employment contract drafting very carefully limited to make sure that the bonus scheme rules prevail. Even where a bonus scheme is discretionary, and labelled as such, sometimes there can be a little bit of lack of follow through in actually how the bonus scheme rules work themselves. A discretionary bonus scheme might go on to talk about the fact that payments will be made on a certain date rather than payments may be made or might be made of poor performance conditions are met. Then the other area where there can sometimes be some issues is if there's a lack of follow through. So, if a discretionary bonus scheme truly is a discretionary bonus scheme, you might think that would get you all the way but there can be some legal limitations on the extent to which an employer can exercise its discretion entirely as it sees fit. There are obviously limitations such as the duty not to act arbitrarily or capriciously and to act honestly and in good faith but, also, sometimes bonus entitlements can crystallise into contractual entitlements through custom and practice. So, if you think you operate a discretionary bonus scheme but in fact you always pay out bonuses by reference to particular pre-set criteria every year and you've done it for 10 or 15 years, in year 16, when you suddenly decide that you want to change the bonus parameters and take into account other factors, you may find that the law is effectively going to prevent you from doing that because you've created contractual entitlements for your employees. So there are all these areas that can limit the scope of a company's discretion and potentially even convert what you think is a discretionary bonus entitlement into something that's more akin to a contractual right.”

    Joe Glavina: “So what’s the practical advice on how to help protect the business from disputes like this?”

    James Sullivan-Tailyour: “Well, I think firstly you need to make sure that your bonus scheme rules are really carefully and tightly drafted to make sure that all the discretions you and your board may need to rely on are referenced and captured in your bonus scheme documents. This is an area where we sometimes see that the drafting is wanting in a few areas. So bonus schemes can often have been knocking around a business for a number of years and the drafting is a little bit out of date. Also, I think in a very well thought through in terms of how bonuses are intended to be calculated, and all of the profit metrics that might go into that, but there isn't the same level of detail and precision in the drafting when it comes to things like leavers or payment dates, or other factors aside from those financial performance metrics that the board might want to consider when making a bonus determination. So I think that's the first thing that it's really important to get right. I think the second thing it's really important to get right is how you go about communicating how the bonus scheme works with participants and that’s about emphasising to participants the truly discretionary nature of the scheme. It isn't just the case that if we have a good financial year, bonuses will be paid, and helping participants recognise that there are wider stakeholders that the board needs to consider, and a whole host of other factors that might go into determining a bonus outcome and that can be a really useful way of mitigating the likelihood of any future disputes because participants should, at least in theory, be aware of the discretionary nature of the scheme and not just think that ,well, if we've achieved this amount of profit I should be receiving this amount of bonus. The final point I'd make is it's also really helpful if you do get into the position of having a dispute, that you've got a really clear paper trail that evidences how the board has in previous years, and in the bonus year that's in dispute, gone about properly exercising its discretion. What can often be very unhelpful is all of the documentation is set up to create a discretionary bonus scheme but then the board minutes, or the RemCo minutes, either are not there to support the fact that in this particular year a bonus outcome was determined on a discretionary basis, or even the board's or RemCo’s minutes point in an entirely different direction and show that in all previous years the RemCo has just looked at profit and nothing else. It is in those types of scenarios where you're giving potential ammunition to a litigant who might want to come along and dispute their bonus outcome for a year.”

    On the subject of bonus disputes, Pinsent Masons has developed a product to help avoid disputes over the payment of bonuses. Earlier in the week Chris Evans talked to this programme about that in ‘Discretionary bonus awards hit 9-year high’. That is available for viewing now from the Out-Law website.