Finance · 20 April 2021

What is a discretionary bonus?

What is a discretionary bonus?

Employers and employees all know what a bonus is. Still, when it starts getting down to bonuses, sometimes there are misunderstandings and sometimes, scarily, there are unexpected, expensive court cases.

This guide describes what a discretionary bonus is and will assist you as an employer (navigating the decisions in choosing it as an option for your staff) or as an employee (trying to understand what has been offered to you) with understanding it better.

What does a discretionary bonus mean?

A bonus is extra pay that a company agrees, orally or in writing, to provide to an employee. A discretionary bonus can be for specific or unexpected situations and are not part of the employee’s contractual monthly amount.

An employee should not see the payment of a bonus as a guarantee of a future bonus unless the stated or implied criteria are met once again.

This bonus category is typically awarded for exceptional performance, contribution, or accomplishment that goes far beyond the employee’s scope of duties.

Companies that have chosen to give discretionary bonuses once or twice per year are not legally obliged to do so by law but there are very specific parameters regarding this.

The term “discretionary” does not immediately release the employer from any contractual effect, as you will repeatedly see in each example presented in this article.

Example #1:

A leading brand in the pharmacy-led health and beauty retail sector discovered, through a court case experience, that discretionary decisions need to be exactly logical and utterly unbiased.

An employee of this company and his warehouse colleagues were TUPE-transferred from the leading brand to the holding group and then back to the leading brand over several years.

In a TUPE transfer, the employees’ jobs typically transfer over to the new company with their existing employment contract terms and conditions, and there is no break in their employment history.

When working for the leading brand, the warehouse employees had received performance-related bonuses. When working for the holding group, none of them received bonuses.

The employees approached the Employment Appeal Tribunal (EAT) claiming unlawful deductions from their wages. They won with the ruling stating that whilst the employer had stated a bonus was discretionary this did not mean it had no contractual effect.

Reducing risks in bonus schemes is discussed further on.

How does a discretionary bonus work?

A discretionary bonus is a compensation given to a staff member based purely on the employer’s logical discretion. In addition to there being no expectation of paying these bonuses, there are usually no handbook guidelines regarding how to become eligible to receive one.

The size of the bonus, why it is awarded, and when it will be awarded do not have to be made known in advance. Details relating to the bonus are usually shared afterwards.

As a business owner, you might have a cracker of a year and smash the business financial goals; hence, you may decide that the additional cash would be a pleasant surprise bonus. These bonuses were not included in the staff’s contracts, and you would not be obliged to give bonuses.

If you are planning a bonus structure or considering bonuses in ANY form, it is paramount that you are crystal clear about the category of bonus you are intent on committing to, such as discretionary versus non-discretionary.

If you retrospectively realize that your wording, discussions, or actions have tied you into a promised non-discretionary bonus ahead of time to your staff, check in immediately with your payroll advisor or HR legal counsel.

Do I have to pay a bonus if I have a discretionary bonus scheme?

Globally you will find employment contracts stating their employees may be entitled to a bonus as part of a discretionary bonus scheme. In the pure English dictionary interpretation of each word, you may think the employer can freely use their subjective discretion regarding the “what and when” of the payment.

When a business owner is filled with a sense of freedom whilst dealing with an HR issue, warning bells should sound in their head immediately.

The “discretion” in the phrase Discretionary Bonus is definitely not as broad as you might be assuming it is. There are many records of outcomes from complex, previous employment tribunals where the courts have ruled in favour of employees repeatedly. The court documents show that discretion comes with some strict ethical, humane, and logical parameters and principles.

Some of these parameters and principles are:

  • As a business owner, you are required to act in good faith.
  • Additionally, you must exercise your discretion honestly.
  • Furthermore, you are required to not apply that discretionary decision in an arbitrary, capricious or irrational way (that is some food for thought!).
The way that the Courts require the discretion to be exercised is that:

  • The trust and confidence that is stated explicitly, or in spirit, within every contract of employment must not be breached.
  • Employees must be treated in an unbiased, equitable fashion.
  • Employers are required to qualify the reasoning behind their decision when deciding to pay, or not pay, a bonus.
This can be quite tricky for employers, especially if you are a sole proprietor. Sole proprietors do not have a board of directors or partners challenging their decisions. This commonly causes sole proprietors to, unwittingly, become dogmatic and become resistant to external input whilst losing impartiality.

There are many cases regarding discretionary bonuses, which show how easily employers have limited their discretion unintentionally. You must retain maximum flexibility and objectivity, and you increase your chances of doing this by involving an experienced HR consultant at the very least or an HR manager. It is strongly advised that you be careful and be precise when drawing up discretionary bonus clauses and schemes.

A recent Supreme Court decision turned an unpaid bonus into the successful awarding of a higher bonus. The employer (a large conglomerate) did not satisfy the above criteria. Not only did the court case result in them paying out a substantially higher amount and the employee’s legal fees, but they were also charged with executing a constructive dismissal of the employee. All in all, it was a cost to the company that exceeded the value of the bonus by about 1000%.


 
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