There is no question that the Government is actively discouraging the so-called “bonus culture”, but what, if any, legal effect will this have on City directors and employees? When are employees legally entitled to be paid their bonus? This article looks at the law and recent cases on bonus entitlement and also summarises the FSA’s guidance on remuneration.

Contractual vs Discretionary

Contractual bonuses will normally be set out in your service agreement, though, in certain circumstances, this benefit may be recorded in an exchange of emails, employee handbook or other relevant document. The wording of the relevant clause will simply require the director or employee to meet a target where upon a bonus will be triggered. Assuming the wording qualifies as legally binding (i.e. it is clear what it says, both parties agreed and intended to be bound by it), then if the payment is triggered it becomes due and payable.

Discretionary bonuses may arise out of oral discussions, course of conduct or in writing as described above. Depending on a number of factors including custom and practice (which may show the bonus is in fact effectively contractual in nature) they may be no less legally enforceable than a contractual bonus, with one important distinction: with a discretionary bonus meeting a target triggers a discretion to pay a bonus rather than a requirement to pay a bonus. Where an employer exercises that discretion not to pay a bonus then the courts require the employee to have an “overwhelming case” and be able to show that the decision not to pay is not one a rational employer would make.

Can an employer dismiss an employee solely to avoid paying a bonus?

The short answer is “not safely”. Employers have in the past dismissed employees in order to avoid paying an additional payment which would otherwise be due. This can often backfire. An employee in such a circumstance could have both an unfair dismissal claim and a breach of contract claim and, if successful, be able to force the employer to pay the bonuses earned and due.

In a recent a case a company dismissed an employee who would have been entitled to an enhanced redundancy payment had he been employed a little longer and had he been allowed to take part in the company’s redundancy programme. The court found that the dismissal was designed to deny the employee certain benefits and payments that would otherwise have become due and upheld the employee’s claim.

Change of management

There has been much consolidation lately and it seems more is on the cards. This means that many employees may well find that their employer is subject to new ownership and that the new owner seeks to impose new terms of employment. For example Commerzbank has recently acquired Dresdner Kleinwort resulting in a drive to reduce salaries and bonuses. As a result, hundreds of Dresdner Kleinwort employees have lodged claims for tens of millions of pounds in unpaid bonuses which they claim are due under their Dresdner contract, but not under the revised Commerzbank terms. As a matter of law, a change of ownership of an employer does not affect theemployee’s terms of employment and accordingly any enforced changes are subject to challenge.

Lawful reduction in bonuses

The safest way for an employer to reduce the payment of salary or bonuses to employees is to do so with their freely given agreement. Therefore if an employer can agree with an employee to vary the terms of service and, say, decrease compensation, but increase holiday and benefits, then that would be enforceable. This should be distinguished from a situation where the employee purportedly accepted revised terms, but was in reality forced to accept them or be summarily and unfairly dismissed. In such case, an employee has grounds for challenging the new contract. However, employers are increasingly seeking to justify the termination of old contracts with more generous terms, to be replaced with a new contract with reduced terms. This can in some circumstances be justified as a “some other substantial reason” defence to unfair dismissal claims – particularly in situations where insolvency may be the only other option.

What happens next?

The current public outcry as well as increased supply of quality labour on the market does mean that bonuses in future may fall for all but the most bullish of employers. Where bonuses are contractual then non payment of a bonus that has been earned may be a breach of contact. Where bonuses are discretionary then the likelihood is that targets may be increased and/or bonus payments decreased. Where the change relates to the future targets, then employees will not be able to challenge this change. Where the change relates to current targets, then in all but the most exceptional cases, employees will not be able to challenge this change.

Recent developments – Financial Services Authority guidelines

The FSA will have a key role to play in formulating a practical framework for bonuses and remuneration. The FSA has introduced a Remuneration Code (the “Code”), effective from 1 January 2010, and applicable to major banks and securities firms (though the FSA may choose to extend the Code to all FSA regulated firms). The Code aims to ensure remuneration and bonuses are consistent with good risk management. Contracts entered into on/after 18/3/2009 which are not consistent with the Code will have to be renegotiated or terminated. Where the employer has a right to amend unilaterally (i.e. discretionary bonuses) then the employer must amend the contract and its practices by 31/03/10. Where the employer has no contractual right to amend and the employee does not agree to an amendment then the employer must terminate the contract by 31/12/10. Any employees whose contracts are terminated on this basis may seek to claim compensation for an unfair dismissal. It remains to be seen whether such an action would be successful as employers are able to reply on a statutory defence, which means a termination for “some other substantial reason” does not make the termination unfair. Employers may consider various avenues, including possibly seeking written confirmation from the FSA that the contract in question does not comply with the Code before terminating. This will be a continually developing area where employees and employers will be taking legal advice.

The principles set out in the Code include:

  • remuneration should be calculated principally on profits, not revenue or turnover;
  • remuneration should be based on longer-term performance and a significant proportion of the bonus should be deferred;
  • for key individuals (i.e. directors and those whose performance affects the risk of the whole firm) the Code recommends bonuses vest over a period of at least three years and strongly discourage guaranteed minimum bonuses for a period of more than one year;
  • remuneration (including bonuses) should take into account more than just financial performance e.g. it should take into account employees’ attitude to risk management; and
  • remuneration policies inconsistent with the Code may lead to disciplinary actions against firms (or a requirement that they hold more capital because they are perceived as more risky).

There are further developments on pay and bonuses both in the UK (including the Walker Review of corporate governance in financial services firms) as well as internationally (at EU and G20 level). Quite what these developments will mean for future levels of remuneration is anyone’s guess, but it is a good bet that it will be well reported in the press!

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This article is for general information purposes only and does not constitute legal or professional advice. It should not be used as a substitute for legal advice relating to your particular circumstances. Please note that the law may have changed since the date of this article.