UK firms strengthen oversight of bonus decisions after High Court ruling

The High Court has handed down a useful ruling which highlights the risks employers face when exercising discretion under bonus schemes. It serves as a timely reminder that managers responsible for bonus decisions must understand the legal limits of that discretion and be properly trained to apply them. 

The case is called Gagliardi v Evolution Capital Management and concerned a portfolio manager who generated around 97% of his fund’s revenue and was dismissed shortly before bonus payday while under investigation by US regulators. He was never charged with any offence, but his employer decided to award him no bonus, choosing instead to wait for the outcome of the investigation.

The contract described the bonus as discretionary; with a target range linked to the profits generated from the employee’s trading. However, the court found that the employer had relied on the existence of the investigation, a factor not permitted by the wording of the scheme and had therefore exercised its discretion improperly. Applying the principles established by the Supreme Court in a case called Braganza v BP Shipping, the court confirmed that contractual discretion must be exercised in good faith, rationally, and for the purpose for which it was granted.

The employer also argued that the employee was not in ‘good standing’ on the bonus date, but the court rejected that position, holding that the contract required a pro-rated payment following termination unless the employee had been dismissed for cause, which he had not. On a proper exercise of discretion, the judge concluded the employee should have received a bonus at the top of the target range and awarded damages of more than $5 million, plus interest.

For HR, the case is a clear reminder that labelling a bonus as discretionary does not confer an unfettered discretion. Decision-makers must take account only of the factors permitted by the contract, ensure bonus clauses deal expressly with investigations and termination scenarios, and recognise that poorly drafted schemes can significantly narrow the scope of employer discretion.

As this case illustrates, when large bonuses are at stake the financial and litigation risks for employers can be very significant. Chris Evans is an expert in this area and earlier I called him to talk about it:

Chris Evans: “The costs of getting the bonus scheme wrong, or the implementation wrong, can be extremely high for an employer. One example is a case I did relatively recently was there was a dispute with an employee who was exiting as to the amount of the bonus and the bonus schemes rules were drafted in such a way that there was a level of ambiguity. The ambiguity meant that this individual was able to come to a figure which exceeded a million pounds whereas on our interpretation of the bonus scheme it was far less, around the £100,000 mark. So you could end up in a situation because of the value of the claim, particularly that claim, where you could end up in the High Court and the legal fees alone associated with that would run into the tens, if not hundreds, of thousands of pounds. So what we are looking to do here is try and ensure that the bonus scheme is fit for purpose so that when you are presented with a challenge like that you can clearly turn around and say no, the bonus rules are clear, there's an element of discretion here, yes, but we're not acting irrationally when exercising that discretion.”

So how can you ensure that managers exercise that discretion lawfully? We know their decision must not be irrational or perverse but how are they going to know? Back to Chris on that:

Chris Evans: “The only key thing from my perspective is making sure that managers are properly trained in terms of how to exercise discretion. So if your contracts, for example, say that personal performance and company performance dictate the amount of bonus than individuals should get, it's very important that they are the factors that are taken into account when exercising discretion under the bonus scheme. Very often what we tend to find is that we have employers come to us and say, well, we would like to take X, Y and Z into account are we able to and, unfortunately, their decision-making is somewhat fettered by what is contained within an employee's contract. So, you know, that may be fine, and that may be acceptable to the company, but what's really important is that the manager properly takes into account what they are able to take into account when making those decisions because the last thing you'd want to do is end up in a situation where you're trying to defend a claim, you're speaking with the manager who's made that decision, and they turn around and say well I took into account the fact that they had a significant amount of absence over this year. If that's not something that you can legitimately take into account, because it's not hardwired into the contract then, unfortunately, you're going to be in a position where that bonus is open to challenge.”

Joe Glavina: “I can see how training managers in this area is important but to help minimise the risk I gather you also take a close look at the bonus scheme itself. Can you tell me more about that, Chris?”

Chris Evans: “What we've developed is a product which takes an employer's bonus scheme and asks a number of pertinent questions about how they implement that bonus scheme to identify whether there are any kind of red flag risks that they ought to be addressing now. So what we often see with bonus schemes is that they either very historic or haven't been looked out for a while and most years there isn't a problem because it's a very good thing the staff are given bonuses but in circumstances where there either are bonuses not being paid out, or bonuses are less than employees expect, that's very often where we see the challenge and what we're looking to do is to pre-empt those challenges by ensuring that employer’s bonus schemes, and the processes they follow through to implement them, are fit for purpose and they're going to send the best possible chance of defending any such claim if one arises.”

Joe Glavina: “As I understand it, there’s a checklist that each individual company can use. How does that work?”

Chris Evans: “So effectively as part of that checklist, you would include there what can and cannot be taken into account as part of the decision-making process and it effectively gives a guide to the manager as to how they ought to be exercising their discretion. Now, that alone may not be enough, and you may need an element of training around that, but it gives a good benchmark for staff to look at and say, well hang on a minute, this is how I'm supposed to be exercising my discretion here and if you identify that a manager has taken into account something they ought not to have, then that can be picked up before the bonuses are paid and adjustments can be made accordingly.”

If you would like support reviewing your bonus arrangements, strengthening scheme governance, or ensuring that managers understand how to exercise discretion lawfully, please do contact Chris Evans – his details are on the screen for you.

- Link to judgement: Gagliardi v Evolution Capital Management