Discretionary bonuses often make up a large part of remuneration packages for senior executives, managers and employees who work closely with customers and clients in providing professional services. The employer’s objective in providing bonuses to staff is obvious: to motivate staff to work hard and provide excellent service to clients, which in turn, will ensure the success of the business.
Clauses are often included in employment contracts stating that an employee may be eligible to receive or participate in the business’s bonus scheme, but that participation and payment of the bonus is at the sole discretion of the employer. Most employers feel comfortable in the fact that bonuses that are deemed to be discretionary can then be varied, revoked or refused altogether dependent on the success or otherwise of the business and the ongoing good relationship with the employee.
However, despite the fact that an employment contract or workplace policy might state that the payment of such bonuses is dependent upon the employer exercising its discretion in the matter, is it really up to the employer to decide if a bonus will be paid?
A dispute regarding the payment of a bonus is unlikely to arise whilst the employment relationship is still on foot. The reason for this is obvious: neither party wants to upset the other and in most cases, wants to ensure that employment continues.
But what happens when a disgruntled employee leaves the business and then demands payment of their bonus? An employer can refuse to pay this based simply on the fact that the bonus was discretionary and it has exercised its discretion not to pay the bonus, right? Unfortunately this may not be the case.
There is a significant line of court authorities which state that an employer cannot withhold a bonus capriciously, arbitrarily or unreasonably. If performance objectives have been set and met by the employee, an employer’s decision not to pay the bonus may be held to be unreasonable, despite the fact that the bonus is said to be discretionary. This is even the case if the employee has subsequently left the organisation and was not employed on the date the bonus was to be paid.
Courts have differentiated between circumstances where it would be unreasonable to withhold a bonus and those in which it would be perfectly legitimate. If a business decides to exercise its discretion not to pay a bonus because of the business’s poor financial performance or because of the employee’s misconduct, it is unlikely that an employee would have a strong claim for payment of a discretionary bonus. However, if an employer simply decides that it doesn’t want to pay a significant amount of money to an employee who has since left the organisation, the employer could face real problems in trying to establish that this was a legitimate exercise of its discretion.
Tips when dealing with bonuses:
- Ensure bonus schemes are carefully drafted to avoid disputes.
- If it is intended that employees will not be eligible for bonuses if they have left employment or given notice before the bonuses are payable, state this in both the scheme and the contract of employment. Don’t rely purely on an employer discretion term to prevent bonuses from being paid to departing employees.
The principles which govern how an employer can exercise a discretion under an employment contract derive from the duty of good faith. The duty of good faith when performing contracts and its development in Australian employment law are summarised in the Wolters Kluwer (CCH) Australian Employment Law Guide at 4-695 You can arrange a free trial here.