Bonus Disputes: what happens when things go wrong?

13 mins

Posted on 22 Jun 2022

Bonus Disputes: what happens when things go wrong?

Bonus Disputes: What happens when things go wrong?

Podcast Transcript 

Hi, I'm Rose Smith, a legal director in our Canary Wharf office, and I'm joined by one of our associates, James Morrison. In this session, we are turning our minds to when bonuses go bad and how employers might get caught up in disputes over a bonus being payable. Hi, James. Hello. So let's dive right in. Sometimes we find ourselves advising clients who have paid out significant bonuses only to discover that their employee is up to no good, or has made a big error, or far more likely, has taken a bonus and made their merry way straight to a competitor. 

So my first question for you James is, can an employer claw back a bonus?

 Thanks, Rose. To answer your question, I'll talk about two central issues here. 

  • The first depends on what the employment contract says and
  • The second is whether there are remuneration committee terms or regulatory rules. 

Bonus disputes and contractual terms

So let's look at contractual terms. If you're considering whether a bonus can be withheld, cancelled or clawed back, then normally the best starting point is to consider the employee's contract of employment. There may be laws or regulatory requirements which require some employers to withhold or claw back bonuses in certain situations. However, before all of this, employers must have a contractual right to do this. That right would normally be contained in the employee’s contract, and it would specifically say the employer is allowed to take this sort of action. If there is no contractual right to withhold or claw back a bonus, then doing this may lead to a claim of breach of contract. Even still, this isn't always as simple as making sure you put a sentence in the contract. 

Sometimes the way a contract is drafted is not very clear or doesn't contain the precise wording which is needed. This can mean that even if an employer thinks they have a contractual right to withhold or claw back a bonus, in actual fact it may be the employee who has a contractual right to be paid the bonus, in which case, if the employer tries to change, withhold or claw back the bonus, then the employee may be able to take legal action against them. For this reason, it's absolutely critical for employers to ensure that their contracts are drafted properly and contain the right wording to protect against this worryingly common type of situation. 

So claw back provisions regularly feature in terms and conditions relating to pay in certain types of companies in particular industries. Most employment contracts should also contain a separate deductions clause which gives the employer a mechanism to claim certain amounts back as a debt from the employee by simply deducting this from any future payments. 

One example here relates to executive directors and upper management in medium sized and large companies because their pay is normally overseen by an internal remuneration committee. A remuneration committee is a subcommittee on the board of directors which is responsible for setting the pay policy for executive management, setting the targets for bonus or share schemes and determining the total pay package for individual executive directors. An effective remuneration committee will have clear guidelines which set out what its objectives are. These often require the committee to ensure that the pay structures comply with legal and regulatory requirements. This can sometimes involve requiring individuals to defer some of their bonus or incentive payments, meaning that after an award is made, the actual payment is deferred for some time. This sort of provision is usually accompanied with a similar term which allows a company to withhold or claw back payment if there has been a serious breach of duties or risk management failures. 

Bonus disputes and regulatory obligations

Now that brings us nicely on to the issue of regulatory obligations. Claw back rules are quite normal in regulated industries such as the financial services sector. However, in financial services the rules apply more widely than just to executive directors and upper management. In 2015, the FCA introduced fresh rules about pay which apply to all material risk takers (as it’s called) that are within the scope of the remuneration code of their firms. These rules are designed to incentivise good behaviour and act as a deterrent to breaching financial conduct rules and prudential controls. Now, one particular feature of these rules is that they regulate paying and clawing back bonuses. So bonuses in this sector can be subject to a lengthy deferral period which can vary depending on seniority and the particular role. 

Individuals with the greatest influence over the business’s strategic direction, so called senior managers, have the longest deferral periods which can go up to a maximum of seven years. This means that part of their bonus may not actually vest until part way through that deferral period. Along with this comes a lengthy clawback period. If part of the bonus payment has been deferred, then clawback effectively means losing the right to be paid that part of the bonus. Now this can happen if, say, during the deferral period it becomes apparent that the individual may have breached certain regulatory rules. Similar rules can also actually require those individuals to return amounts which they have already received in payments.

I already mentioned before that more generally, employers must always have a contractual right to take this kind of action. So regulatory rules actually reflect this because they require firms to ensure that they have appropriate internal rules and contracts in place which empower them to claw back bonuses, for example if they discover that an employee is responsible for conduct which has resulted in heavy losses or has failed to meet the required standards of fitness and propriety. So, under the new rules, the claw back period can also be extended by up to three years, meaning a total of ten years, for senior managers who are subject to any continuing internal or regulatory investigations. This is one of the ways that the FCA regulates individuals’ conduct and overall culture in the financial sector. If there is reasonable evidence of employee misconduct or material error, then the individual risks forfeiting some or all of their vested or unlisted award. 

Thanks, James. You quite rightly mentioned that the contractual drafting has a huge part to play in what can be done when things turn a bit sour. If you'd like to hear more on this, we actually have another podcast on planning your strategy for bonuses and incentives, which is linked below this session. So do have a listen. That’s right, but for now, we're sticking to when relationships are more strained. 

Is it possible to dismiss someone to avoid paying them a bonus?

So, Rose, please can you talk about whether it's possible to dismiss someone to avoid paying them a bonus? 

This is a really good question, actually. It can certainly be very tempting. I’m afraid that once again we come back to those contractual terms. These are really going to be your starting point when considering any contentious bonus situation that might arise. An early question that comes up is whether the bonuses in dispute is discretionary or contractual. If that's something you aren't clear on, do have a listen to our other session on discretionary bonuses, which again I'll link below. 

So let's talk about dismissal to avoid payment of either a contractual or a discretionary bonus. Most bonus clauses are drafted so that an employee is not actually entitled to a bonus if he or she is not employed or is under notice at the time when the bonus is awarded or paid. Now, that's not necessarily problematic in and of itself, but courts have given short shrift to employers who have used dismissal as an extreme mechanism to avoid paying a bonus payment. 

The courts disapprove of this approach on the basis that it contravenes, most likely, the employer’s duty of reasonableness to the employees. If it's found that the decision to terminate employment was unlawful and/or that the employee's employment was terminated in such a way to avoid it having to pay out a bonus, which amounts to bad faith, was irrational or perverse, and/or was in breach of the implied term of trust and confidence which exists in employment contracts, then the employee can claim the lost bonus as part of their lost earnings, in addition to claiming compensation for loss of salary until such a time as they find a new role, and potentially making claims in respect of the fairness of the dismissal itself. 

Employers therefore need to tread carefully when terminating employment in circumstances where there's a bonus to be paid or expected in the near future, because such an entitlement can actually significantly inflate the value of any claim arising out of that dismissal. Now, dismissal before bonus payment is definitely a tactic for trying to avoid payment altogether but what happens if there’s a dispute over the actual amount of bonus to be paid, James?

What happens if there’s a dispute over the actual amount of bonus to be paid?

There are a few tricky issues which can arise when there is a dispute over the amount of bonus which has been paid. This can range from everything from making a formal complaint to bringing formal legal action. So I'll briefly go through some of these in turn. An employee may begin by complaining to their manager or HR, either informally or by raising a formal grievance. If they raise a grievance then the business will have to investigate it properly and deliver a decision which the employee has a right to appeal. If by the end of that process the employee is still dissatisfied, then this can lead to more serious formal legal action. 

Now, one example of this would be bringing a claim for constructive unfair dismissal. So if an employee has over two years’ service, then they are protected from being unfairly dismissed. If a dispute arises about their bonus, whether it has been underpaid or withheld entirely, then that may entitle the employee to resign and claim that they have been constructively unfairly dismissed. The key to this type of claim is whether the employer's decision is deemed to have irreparably broken all trust and confidence or otherwise breached a fundamental term of the employee's contract. If successful, the employee could try to recover any lost bonus as part of their total loss of earnings. Now, as Rose mentioned, this would include loss of salary for the period until they find a new role. Some of this is covered in more detail in a session about discretionary and non-discretionary bonuses. 

Another example would be bringing a claim for breach of contract. If an employer wants to vary or withhold a bonus, then they must have a contractual right to do so as I've said. If they are contractually required to pay a bonus and if they reduce that or withhold it entirely, it may be a breach of contract. In fact, even if the bonus is entirely discretionary, then there are still situations where if the employer uses that discretion in an arbitrary, erratic or irrational way, it can lead to a claim for breach of contract. Now, depending on the amount being claimed, the employee could bring this type of claim in the civil courts or alternatively, if the contract has ended, in the employment tribunal. 

One practical issue which arises if bonuses are underpaid is that it can affect employee retention. It should come as no surprise that one of the key driving factors behind employee satisfaction is pay. Bonuses incentivise employees in a number of ways. One of these is by motivating them to stay at the company because this is usually a condition for actually receiving a bonus for the previous financial year. If bonuses are suddenly reduced then it can and does lead to much higher attrition rates as there is less reason for staff to stay with the company. 

What actually happens when an employee brings a claim for the fact that they have not been paid their bonus?

Keeping with this practical thinking, Rose, can you tell us what actually happens when an employee brings a claim for the fact that they have not paid their bonus? Yes, well, the usual of course when enforcing a bonus is to do so via a breach of contract claim in the County Court or the High Court. And this is because damages for breach of contract in the employment tribunal are limited to £25,000 and often when a dispute arises, it’s over far greater figure than that. Now, in the County Court it could be as much as £100,000 and in the High Court the compensation is actually limitless so this makes it a much more appealing place to bring the claim. 

A key consideration when bringing or defending a claim for loss of bonus or breach of contract in the County or High Court is that the successful party can recover their legal fees from the losing party. Now, this is quite different to the employment tribunal where the usual position is that each party bears its own costs. As an employer, consideration needs to be given to whether the sum claimed by the employee is sufficient to warrant defending it and risking having to pay the employee’s costs if they are successful, particularly if they're an ongoing employee who you see any value in keeping in the business and keeping happy. So I think if you're an employer and you receive pre-action correspondence which threatens a claim in the County or High Court, then serious consideration needs to be given to the ramifications of this in respect of costs and more generally, particularly since if proceedings are issued, the employee's cost can be recovered from that point until the matter is resolved. So careful consideration needs to be given to the legal merits of the claim, which will include an assessment as to whether the bonus payment is contractual or discretionary before devising any response and a wider strategy around how to deal with the issue. 

That’s all we've got time for in session. Thanks very much for joining us. Thanks, James. If you need help with a bonus dispute, contact Rose or James who will be able to help you.

You may be interested in our other podcast Bonuses: Discretionary vs Contractual

Rose Smith

Rose is an employment and education lawyer. She has a track record in providing measured employment law advice, and is also part of Doyle Clayton’s renowned Education Team, providing advice to teachers, professors and schools.

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