Navigating the murky waters of employee bonuses and incentive payments

Legal experts shed light on how ‘absolute’ is an employer’s ‘absolute discretion’ when it comes to bonuses and incentive payments, and provide some handy HR tips for avoiding claims of breach.

Picture this: the paperwork has been signed, the champagne has been popped, and the deal team is still reeling from securing its largest acquisition in years. The team’s fearless leader – let’s call him Gary – sees the dollar signs flashing before his eyes as he pictures his annual performance bonus for the year. “Just in time to place a deposit on that new Maserati,” he thinks to himself.

Just as Gary feels like his sports car dream is about to become a reality, senior management notifies the deal team that the multimillion-dollar deal, the deal of Gary’s career, will be excluded from the office’s bonus pool for this financial year. Not only this, but management is introducing a new incentive scheme effective immediately, where 80 per cent of any annual bonus payment will be made at the end of this year, and the remaining 20 per cent will be a deferred payment over the next three years. Gary can’t believe his ears. Without the deal being included in the bonus pool, his bonus payment amounts to a pittance. “Surely they can’t get away with this…” he thinks.

The facts of the above scenario are based on a real life case of Crowe Horwath (Aust) Pty Ltd v Loone [2017] VSC 163, heard by the Victorian Supreme Court last year. Following a claim made by a former employee – real name, Mr Loone – the Court ultimately held that the business’s conduct amounted to a fundamental breach (or repudiation) of the employment contract. Mr Loone was awarded a total of $423,445 in damages including a sum of $142,778 in respect of his unpaid bonus entitlement. This was despite a clause in the employment agreement which said that the company would determine “at its absolute discretion” the amount of any bonus payment that may be made to the employee.

The limits on an employer’s discretion in relation to bonuses and remuneration

It’s a question that comes up time and time again from our clients – particularly at this time of the financial year – how discretionary is an employer’s discretion when it comes to things like awarding a bonus or setting an employee’s annual remuneration?

As with most things involving the law, there is no quick cookie cutter answer, but there are some tips from case law which provide good guidance.

The scope of an employer’s discretion really depends on the wording of the employment agreement or bonus plan in question. It may be tempting to see words in an employment agreement like “any incentive payment will be paid at the employer’s absolute discretion” as a get out of jail free card.

However, case law shows us that regardless of the language included in writing, an employer cannot exercise its discretion capriciously, unreasonably or arbitrarily. The exercise of its discretion must be a legitimate one, and must be exercised honestly and comfortably within the objectives of the agreement itself.

There may also be particular criteria in the clause or agreement which places additional limits on the business’ discretion. In the case of Mr Loone, the Court said that while the wording of the bonus clause gave the company absolute discretion as to the quantum of any bonus payment, the exercise of that discretion was subject to the next part of the bonus clause. It said: “[t]his amount will be determined by consideration of various performance parameters…” and listed a number of factors to be taken into account. Ultimately the Court said this did not entitle the company to exclude Mr Loone’s significant performance in the deal from its assessment of his overall personal performance.

Three ways HR can avoid these sorts of claims of breach (or repudiation) of the employment contract

Check if your bonus clause or scheme is up to scratch

When considering what sort of discretion you have in awarding or not awarding a bonus or incentive payment, make sure you check the wording of the relevant employment agreement clause or bonus scheme in question. Some written agreements will not even have a clause that the payment is at the employer’s absolute discretion, which can give the employee an unfettered contractual right to the payment! If this is the case, consider inserting some wording that any bonus or incentive is at the employer’s absolute discretion. Also check if there are certain criteria that must be taken into account when determining the payment, for example personal performance or company performance. These factors should also be subject to the company’s absolute discretion.

Make sure to follow procedure in determining and exercising discretion

Make sure you correctly follow procedure and policy in determining and exercising discretion. For example, if the procedure requires you to have regard to an individual’s performance, any performance criteria you use should be measurable and clearly documented in regards to that person.

Have some solid evidence for any reduced or non-payment

Where you make a decision not to pay a discretionary bonus or incentive payment (or to make a lower payment than might be anticipated), there should be clear evidence of the reasons payment was not made – for example poor performance or misconduct – to minimise the possibility of a claim that the exercise of your discretion was capricious, unreasonable or arbitrary. If possible, you should also provide an opportunity for the employee to comment before the non-payment or reduced payment is made.

Navigating the payment of bonuses or incentive payments can be a curly legal issue, so don’t hesitate to reach out for assistance. Sometimes having a second opinion on the scope or parameters of your discretion can be just what you need before flexing and exercising your discretion.