Discretionary bonuses – how much discretion have you got?

Imagine that you’ve employed someone for about five years, and that in your employment agreement with them, you’ve allowed for a discretionary annual performance bonus. 


Then the employee terminates the employment agreement.  So, as well as paying your former employee the salary you’re legally obliged to, you give them a discretionary A$48,165 as an “ex gratia” or good faith payment.


How surprised would you then be if your former employee issues legal proceedings against you in relation to the annual performance bonuses you did not pay?  After all, these bonuses were at your discretion, right?  Surely, the employee is not entitled to bonuses you decided not to bestow on them?


Not so fast…


The New South Wales Court of Appeal recently found that an employer, Silverbrook Research Pty Ltd, in this very situation was required to pay its former employee $74,000 for the loss of commercial chance or opportunity in relation to this bonus (a contractual law-based remedy).


What was important in this case was that the employment agreement stated that Silverbrook would assess the employee’s performance against set objectives, in determining whether a bonus was applicable.  Throughout the term of employment, no objectives of this nature were set, which was held to be a breach of the contract by the employer.


Although the bonus was discretionary, the Court of Appeal noted that discretion does not “permit [someone] to withhold the bonus capriciously or arbitrarily or unreasonably; it should not be construed so as to give [an employer] a free choice as to whether to perform or not a contractual obligation”.


In other words, if your agreement with an employee anticipates that a bonus is payable at your discretion, it is important that you consider whether to make the payment.  If the agreement sets criteria which must be considered, these need to be considered when exercising your discretion.


The Court said that there may be circumstances, including “financial stringency or misbehavior”, where exercising discretion will be legitimate, even where an employee’s performance meets the standards anticipated.  However, an employer is not permitted to make “an unreasoned, unreasonable, arbitrary refusal to pay anything, come what may” – unless the discretion clause is exceptionally clear on this point.


As some consolation to Silverbrook, the ex gratia payment was taken into consideration when determining what was awarded to the employee, reducing the amount payable to $25,834.87.


Tip: If you have made provision for a bonus in your agreement with an employee, you should give genuine consideration to paying the bonus on the terms set out in the agreement (whether quarterly or annually, for example).  Even if the agreement states that you have discretion in relation to this bonus, you may still be found liable to the employee for loss of commercial chance or opportunity if you do not give due consideration to the bonus.  Make sure you document your consideration of the employee’s performance, and refer to the set performance criteria. 

Author: Sonnie Bailey 

Discretionary bonuses – how much discretion have you got? by Holley Nethercote Commercial Lawyers is licensed under a Creative Commons Attribution-Noncommercial-No Derivative Works 2.5 Australia Licence.

Comments

Post a Comment:

<< Back