Money Matter

Exercise of discretion in payment of bonus

by Susana Ng, senior associate, Allen & Overy

Article exclusively contributed by Allen & Overy

One of the effects of the current economic downturn is that some companies are cutting back on staff. Unsurprisingly, employers often cite a number of reasons for refusing to grant bonus payments to laid-off employees.

Employment contracts usually contain clauses stating that bonus entitlements are of a discretionary nature and based on a number of criteria. This empowers employers to change the terms of bonuses, or to withdraw them completely. Employers faced with claims for bonus payments can therefore simply refer employees to the relevant clauses in their employment contracts.

The non-payment of bonuses is undoubtedly a key concern for employees whose bonus entitlements form a significant part of their remuneration. One such person was Mr Clark, the plaintiff in the case of Clark v Nomura, heard in a UK court in 2000.

The case was the result of a dispute between Mr Clark, a proprietary trader, and his employer over Mr Clark's bonus entitlement. According to his employment contract, he was entitled to a discretionary bonus that was dependant on his performance.

After the company terminated Mr Clark's employment, his employer refused to pay him any bonus, although his track record showed that he had made a lot of money for the company during his employment.

The UK court stated that the employer's discretion regarding bonus payments was not free from restrictions and ruled that the defendant had been under a contractual obligation to assess Mr Clark's individual performance for the purpose of the discretionary bonus and not to do so "irrationally or perversely".

As a result, the court awarded Mr Clark a substantial amount of damages, adding that an employer exercising its unfettered or absolute discretion would be in breach of contract if no other reasonable employer would have exercised its discretion in a similar way.

The upshot is that, when operating discretionary bonus schemes, employers must exercise their discretion rationally and in good faith.

The Hong Kong courts adopt a similar test. In the case of Bruce Gordon Hut v Special Assets Ltd (2006), a dispute arose between Mr Hut, an investment manager, and his employer over, among other things, Mr Hut's bonus entitlement.

Where Mr Clark's bonus scheme had been based on an employee's individual performance, the scheme offered to Mr Hut provided that all employees (including Mr Hut) were granted a number of "bonus points" at the beginning of each year. However, the payment of bonuses to employees was subject entirely to the discretion of the defendant company's board of directors.

In Mr Hut's case, the board had decided to suspend the bonus plan, taking into account the company's financial situation. As a result, Mr Hut did not receive a bonus.

Highly dissatisfied with the board's decision, Mr Hut took the matter to court, but his application was unsuccessful. In its ruling, the court stated that it would be reluctant to interfere with the exercise of a clearly stated discretion unless the discretion was exercised "irrationally or perversely".

Q & A on bonus payments
Q1 What are the consequences for employers who wrongfully withhold bonus payments?
A1 An employer's failure to pay a bonus to an employee is likely to constitute a breach of contract, which would probably permit the employee to claim constructive dismissal. Alternatively, the employee could remain employed and simply bring a claim for unlawful deduction of wages.

Q2 May an employer withhold payment of an year-end bonus?
A2 This depends on whether the year-end bonus is of a contractual or gratuitous (payable only at the discretion of the employer) nature. Unless the employment contract provides otherwise, there is a presumption that an annual payment or annual bonus contained in an employment contract entered into after 27 June 1997 is of a contractual nature and not payable only at the discretion of the employer.

Taken from Career Times 12 December 2008, p. B11

(Last review date: 23 August 2013)

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Disclaimer: The opinions expressed in this article are those of the contributor

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