Money Matter

Incentive plan and bonus payments

Article exclusively contributed by
Allen & Overy

During difficult economic times, there are often disputes over whether an employer is allowed to withhold incentive plan or bonus payments when an employee's contract is terminated. The following is a recent court case on this subject.

Wong Huey Lan vs Colgate-Palmolive (HK) Ltd. 2002

This dispute arose between Ms Wong and her employer, Colgate-Palmolive, about her entitlement under the company's incentive plan. Two factors influenced how her entitlement was calculated:

(a) The Operating Target Payout, which provided an automatic payout when various operating targets were achieved - unless the employee's performance appraisal rating was below "Meets Expectations"; and
(b) Ms Wong's performance. The management also had the right to alter or withdraw the bonus plan if the business's "health" was in jeopardy. In addition, under the terms of the incentive plan, any employees who left the company before being paid their bonus would lose their entitlement under this plan.

The case was not about whether Ms Wong had already achieved both (a) and (b). Instead, Colgate-Palmolive argued that the important features of the plan (setting an operating target, assessing her performance and having the option to cancel the plan) all indicated that her bonus was discretionary. As such, they argued that they had the ultimate discretion to determine if her bonus should be awarded at all.

Colgate-Palmolive also tried to argue that under the plan, all employees who left their employment before receiving their incentive payment would no longer be entitled to it - and that, as a result, Ms Wong would not be able to receive a payment. She, on the other hand, argued that the incentive plan was a contractual end-of-year payment, although it did have some discretionary elements.

In the end, the court decided that an employer's discretion over bonus payments could never be "unfettered"; in other words, it could not be free of restrictions. It also said that it must always be exercised "in good faith", and should not be "irrational" or "perverse".

Although the incentive plan involved certain discretionary elements, this discretion could only be properly exercised if it followed certain clearly identifiable and objective criteria. When an operating target was set, it had to refer to the company's track record and prospects. In addition, this assessment had to be based on an objective appraisal of the employee. Finally, the company's option to cancel could only be used if the company's financial health was "in jeopardy".

Colgate-Palmolive's incentive plan therefore provided for a bonus based on a formula, rather than a discretionary bonus. As such, it was an "end of year payment" regulated by the Employment Ordinance, and was not payable at the discretion of the employer alone. A pro-rata payment therefore had to be paid to Ms Wong when her employment was terminated.

Q&A on incentive payments
Q1 My company's incentive plan is based on both its performance and my own performance. If both of these are satisfactory, can my company hold back from paying me, simply because I have given in my notice?
A1 No. Your employment contract means that your employer's discretion is only tied to two factors (your performance and its performance). The fact that you are leaving the company should not be relevant.

Q2 It's very common for incentive plans to use employee performance as a key factor. What does "performance" really mean?
A2 A recent case in the UK (Clark vs Normura) involved a proprietary trader. In this instance, the individual performance test included not only his financial success, but also non-financial aspects such as management skills, timekeeping, attendance at meetings, dress and appearance, team spirit and other relevant factors.
In fact, the courts attach different weight to different factors, depending on the individual case. For example, financial success could be seen as being more important for a senior trader than, say, whether or not he is a good team member.

Q3 My employment contract refers to an incentive plan, which is to be agreed with me. However, I joined the company over six months ago and I have been busy coping with my new work. Nobody has proposed or agreed to my incentive plan yet! What are my rights?
A3 If your job is terminated now, you may not be able to get any payment out of this "to be agreed" incentive plan. This is because it has never existed and because you entered into employment knowing that you would only be entitled to a payment once the terms of the plan were agreed with you (and you do not have this agreed plan now). Make sure that the details of the plan are worked out with you as soon as possible.

Taken from Career Times 14 March 2003

(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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