Discretionary bonus payments a matter of ‘striking the right balance’

Bonus schemes can be a great tool to motivate and retain staff but mistakes can be very costly. If it’s a discretionary scheme, although there may be a formula for how bonuses are calculated based on criteria, such as individual performance, it is up to the employer to decide whether to pay a bonus and if so how much. It places a heavy responsibility on the decision-makers to get it right so what training, if any, do they need? We’ll consider that.

As we highlighted in Tuesday’s programme, in the banking sector there is added scrutiny. The cap on bankers’ bonuses was lifted on 31 October last year and, with the cap gone and bigger variable bonuses possible, there is arguably a greater risk of pay disputes. The more money that’s at stake, the more people are likely to fight about it.  

Some background. There are two main types of bonus schemes, discretionary and contractual. Contractual schemes will lay out in the contract of employment certain requirements for a bonus to be met and, if an employee meets these requirements, they will be entitled to the bonus. In contrast, discretionary bonuses, as the name suggests, are paid out at the manager’s discretion. However, crucially they usually have some sort of structure in place to assist in determining when and how employees should be paid and, when it comes to the exercise of the manager’s discretion, case law says that must be done in a manner which is ‘not irrational or perverse.’ So a contractual term is implied into the employment contract to that effect and the employee will have a claim for breach of contract if that term is breached.

The stakes are high and on Tuesday I talked to Chris Evans about a product he has been involved in developing which is designed to help employers avoid costly disputes. I put it to him that mistakes can be very expensive. This is what he said:

Chris Evans: “Absolutely, so 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 that brings us on to the key point – how do you get managers to exercise that discretion lawfully? So their decision mustn’t be irrational or perverse but how are they going to know? Back to Chris on that:

Chris Evans: “The one 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 opened, challenge.”

Joe Glavina: “I get that training managers is a good idea but, as a concept, understanding when a decision might be irrational or perverse is a tricky one. So how do you help managers with that?” 

Chris Evans: “So I think a training course is not a bad idea. One thing that we're doing as part of the fixed fee product is introducing a checklist sheet that each individual company can use. 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.”

On Tuesday Chris talked to this programme about a product he was involved in designing to help firms avoid disputes over payment of discretionary bonuses. That’s ‘Pay decision-making facing added scrutiny in absence of UK bankers’ bonus cap.’ We’ve put a link to it in the transcript of this programme.

LINKS
- Link to HRNews programme: ‘Pay decision-making facing added scrutiny in absence of UK bankers’ bonus cap’