Rewarding employees: Are your bonus schemes fit for purpose?

Bonuses allow employers to reward good performance and increase motivation amongst their workforce. However, employers may be exposed to potential disputes with employees if bonus schemes aren’t implemented correctly.

A non-contractual/discretionary bonus scheme will normally provide that there is no right to a bonus and that payments may be made “entirely at the employer’s discretion”. Such discretion must be exercised in good faith and on reasonable grounds.  Failure to do so could be considered a serious breach of contract by the employer.

Even if a bonus scheme is stated to be discretionary, employees can argue that they have a right to a bonus if they have been paid by the employer on a regular basis in the past. Employees could also try to argue that although a scheme was discretionary, a certain sum was expressly promised so employers must be very clear on this.

For example, a bank announced a guaranteed minimum bonus pool entitling all employees to a discretionary bonus. Before the bonuses were paid, the bank got into financial difficulties and tried to reduce projected bonuses by 90%. The courts stated they were obliged to pay their employees what was promised orally.

The safest option is to choose a contractual bonus scheme which is based on a specific formula or conditions, for example an employee reaching a monthly sales target. Employers are contractually obliged to pay the employee the agreed sum if conditions have been met. Failure to adhere to the contractual arrangements could give rise to a breach of contract and/or a constructive dismissal claim.

What if the employee resigns before the end of the financial year or is dismissed for gross misconduct before the bonus is due to be paid? If the employer wishes to withhold payment in such circumstances, the contractual bonus scheme needs to be drafted accordingly.

An IT company set out a bonus scheme based on employees reaching and exceeding sales targets. However, their employment contract stated that they had the right to reduce enhanced bonuses in “exceptional circumstances”. One employee achieved three times over her annual sales target and the employer could not afford to pay her bonus. The court found that this was not an exceptional circumstance and they were liable to pay the full bonus.

It is important that bonus schemes are not discriminatory to avoid a possible claim. For example what will happen if a female employee takes maternity leave? Will she be entitled to a full bonus or will she receive a pro rata amount based on the time she has actively been at work in the bonus year?

Given the complexities involved in drafting and implementing bonus schemes, it is essential to seek specialist legal advice at an early stage. This will help to avoid potentially damaging disputes by ensuring that the bonus schemes are fit for purpose and all parties are clear of the basis on which bonuses can and will be paid.