29 Apr 2011

Discretions and bonus schemes: Can a discretion ever be absolute?

by Abraham Ash, Alexander Mednis

Employment law practitioners are often faced with clients seeking advice about the drafting of bonus schemes and the possibility of successfully bringing legal proceedings for unpaid bonuses.

The first question employment lawyers must invariably ask is whether the bonus scheme provides guaranteed bonuses, or whether they are discretionary in nature. It had long been thought that if a bonus was discretionary in nature, an employer had no contractual obligation to pay the bonus.

This was as a result of the fundamental legal principle confirmed in Lavarack v Woods of Colchester Ltd [1967] 1 QB 278 that damages are not recoverable by an employee in respect of additional benefits that the contract did not oblige the employer to confer even though the employee might reasonably have expected the employer to bestow benefits on him in due course (Macken, O'Grady, Sappideen and Warburton, Law of Employment, 4th ed, Lawbook Co, 1997, p 303).

Australian employment lawyers are however aware of English case law (described briefly in this article), limiting the extent of the absolute discretion to not pay a bonus. Importantly for Australian practitioners, a very recent and important New South Wales Court of Appeal decision has now considered this same issue.

The decision is important when advising Australian employers or employees when disputes arise concerning the exercise of a discretion in a bonus scheme.

English case law

Bonus for individual performance: Clark v Nomura International Plc

The most well-known United Kingdom decision is Clark v Nomura International Plc 2000 IRLR 767. Mr Clark was employed as an equities trader on an annual salary of £100,000, supplemented by a bonus awarded “upon individual performance” under a discretionary scheme.

Mr Clark's employment was terminated with three months notice, required to be taken as garden leave, during which time a relevant bonus payment time arrived. Despite the fact that Mr Clark had earned substantial profits for the company during the period leading up to dismissal, his bonus was not paid.

Claim and submission of former employee

Mr Clark brought a claim against his employer, asserting that the only measure by which the bonus could be awarded was his performance, which had been nothing short of exemplary. He contended that managers of departments who had made losses were nevertheless awarded substantial bonuses while he was awarded nothing.

Court decision and test applied

The court awarded Mr Clark damages of £1.35 million.

The test considered by the court was whether a reasonable employer would have exercised its discretion in that way. If the discretion was exercised in an irrational or perverse way then the employer would be liable.

Where a bonus is contractually required to be considered on the basis of individual performance, then in the absence of any deficiency or variation in individual performance, employees are contractually entitled to be treated equally.

New South Wales Court of Appeal decision

Silverbrook Research Pty Ltd v Lindley [2010] NSWCA 357

Robyn Lindley was employed by Silverbrook Research Pty Ltd on an annual salary of $210,000. Her contract provided for a discretionary annual bonus of $40,000, subject to her meeting performance objectives set by Silverbrook each quarter.

No objectives were ever established however, and Ms Lindley was never paid a bonus. Ms Lindley resigned.

Claim of former employee

Ms Lindley commenced proceedings claiming that she had lost the opportunity to meet the objectives that would have paid her a bonus.

Her claim was successful and damages of $74,000 were awarded by the District Court of New South Wales to Ms Lindley.

However, Silverbrook appealed the finding to the New South Wales Court of Appeal.

Employer’s arguments

Silverbrook raised two submissions:

  • There was a discretion, regardless of performance (the court described the essence of the submission as being that salary increases and bonuses “had been entirely at the appellant's [Silverbrook’s] discretion no matter how well (or badly)) the respondent performed. Also, the appellant had merely exercised the discretion it had not to pay any more than her starting salary”; and
  • The application of the principle that the court, in assessing damages, adopts the mode of performance that is the most beneficial to the defendant.

Court of Appeal decision

The Court held that:

"[T]he decision as to whether the respondent should receive the bonus was “entirely within the discretion of” the appellant should not be construed as to permit the appellant to withhold the bonus capriciously or arbitrarily or unreasonably; it should not be construed as to give the appellant a free choice as to whether to perform or not a contractual obligation."

A discretionary clause, the Court said:

"should receive a reasonable construction and not permit the appellant to choose arbitrarily or capriciously or unreasonably that it need not pay the money the set objectives having been satisfied."

No arbitrary refusal to pay is permitted

The Court continued:

"[T]he discretion is to be exercised honestly and conformably with the purposes of the contract. There may be many circumstances in which it would be legitimate, and conformable with the purposes of the contract, not to pay the bonus... [what is not] permitted is an unreasoned, unreasonable, arbitrary refusal to pay anything… this would be a denial of the very clause that had been agreed. If these parties wished to make payment under the clause entirely gratuitous and voluntary such that payment could be withheld capriciously, notwithstanding the compliance with solemnly set objectives they needed to say so clearly." [emphasis added]

Conclusion on implications of decision

Many employees, including, of course, sales personnel and executives, receive generous discretionary bonuses pursuant to discretionary bonus schemes, which many employers may believe can be exercised at the employer's absolute discretion.

Typically, disputes concerning bonuses arise upon termination when an understandably disgruntled employer may not wish to pay a bonus to a departing employee. The Silverbrook decision is one that employers will need to keep in mind when exercising this discretion.

The decision is also one that will now need to be referred to in written advices to clients and also at least considered when practitioners are asked to draft a discretionary bonus scheme.

It will be interesting to see how practitioners acting for employers try to draft around this decision. For example, does the decision mean that perhaps an express term that explicitly allows the employer to exercise their decision unreasonably will be upheld? What kind of employee would sign such an agreement?

Certainly, if an employer is to exercise a discretion against the interests of an employee, there should be a reasonable basis for doing so and that basis should also be recorded, so that if any records are discovered during litigation, it legitimately supports the employer's position.

 

This article was first published in Employment Law Bulletin Vol 17 No 1, April/May 2011

Related Knowledge

Get in Touch

Get in touch information is loading

Disclaimer

Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.