Bonus Schemes: Issues for Employers

Bonuses can form a substantial part of employees' packages.  From the employer's point of view, they motivate their employees by rewarding excellent performance, and can be used to retain the best people.  Bonus schemes can therefore make sense for employers in terms of profitability and staff morale - but it is also possible for bonuses to create disputes and tensions between employers and employees.

To reduce the risk of this happening, it is vital for employers to think carefully about the structure of their bonus schemes, and to be clear to their employees how they operate.  Particular issues to consider include:

•    Contractual or discretionary?  Some employers include information about how bonuses can be earned, and how they will be calculated, in their employees' contracts of employment, as that makes the position clear for everyone.  Other employers prefer to make their bonus schemes discretionary in some way:  there could be some discretion in terms of how the bonus is calculated, or even whether a bonus is paid at all.  With discretionary schemes, employers need to be completely clear about what is left to their discretion.  Employers should also be aware that regularly paying a bonus over a number of years may result in employees acquiring an implied contractual right to that bonus, even if it had originally been discretionary.      

•    Calculation of bonuses:  Bonus payments can be linked directly to objective measures, such as company profits or individual sales; or there can be some element of discretion, in which case employers will be expected to make such judgements reasonably and in good faith, and in a non-discriminatory way.  In particular, employers should be ready to justify differences in bonuses between comparable employees, and so should always document the reasons behind their decisions.  If employers specify the factors they will consider when exercising their discretion, they should not then take into account any other factors.

•    Termination issues:  Most bonus schemes are designed to reward loyalty as well as good performance.  This means that many bonus schemes require employees to be still working on a particular date to be able to receive a bonus payment.  Alternatively, they may specify that certain leavers, such as those that are made redundant or leave due to ill health ("good leavers") are entitled to a (pro rata) bonus, whereas others, such as those dismissed for misconduct ("bad leavers"), are not.  Employers should also consider whether a payment in lieu of notice to a departing employee should take a pro rata bonus into account.

•    Discrimination issues:  Employers need to ensure that the bonus scheme does not operate in a way that is discriminatory, or which treats part-time or fixed-term employees less favourably.  

•    Oral representations:  Employees may ask their managers about the likely level of future bonuses.  To avoid any argument by employees that they have been promised a certain bonus during such a conversation, the bonus scheme should make clear that only written correspondence on bonuses will be binding on the employer.  

Once employers have considered these issues, they should set out the rules of their Bonus Scheme in clear, carefully-drafted documentation.  As the potential for dispute in this area is particularly high, employers are advised to seek professional assistance in preparing these documents.

Ashfords LLP is regulated by the Solicitors Regulation Authority. The information in this note is intended to be general information about English law only and not comprehensive. It is not to be relied on as legal advice nor as an alternative to taking professional advice relating to specific circumstances.