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%.

If these examples sound like a decision you are about to make, note that as an employer, you might be held to fall short of the requirements by a court of law.

Review these helpful examples:

Example #2:

When wording a contract, you must say that the discretionary bonus is based on the individual’s performance. If you are basing the bonus payment decision (for or against) on a company-wide performance or non-individual performance factors, you are opening your company up to risk.

Example #3:

If one of your managers is biased during the bonus calculation, resulting in a low bonus due to a personal dispute between themselves and the employee, your business is at risk. This is amplified if other staff members know about the dispute.

Example #4:

If an employee has been in employment for a full year and:

  • They have performed at a level that you have historically used to justify a bonus,
  • They were not in your employ at those historical occurrences when the bonuses were paid (for performances at the level that they have delivered during their employment period) OR,
  • Their employment contract did not clarify that a bonus might not be paid even if exceptional performance is achieved; you might fall foul of the Courts if a bonus is not paid.

How can you reduce risks related to bonuses?

Before you cancel all thoughts of bonuses, out of frustration at the legal gauntlet, here are some helpful hints to reduce bonus related risks:

  • The employment contract wording must include a clear point stating that any bonus is at the employer’s absolute discretion. This helps avoid the creation of a complete contractual right to bonuses, devoid of employer discretion, formed by the practice of paying bonuses.
  • The employment contract wording must include a clear point stating that the employer retains the right to choose not to pay a bonus if bonus calculations and payment dates occur AFTER the employee is no longer employed or during the time that the employee is under a notice of termination. Be careful with the execution of this point.
  • If your company has a bonus scheme document/handbook within which the bonus scheme description covers how a bonus will be calculated then include wording clarifying that a bonus payment:
  • Can still be varied at the company’s absolute discretion.
  • Might not be paid at the company’s absolute discretion, and these will both be without limitation for reasons by the company such as personal performance, overall group or company performance, personal misconduct, etc.
  • When there are occurrences when no bonus will be paid, it would be prudent to document reasoning for this. The same is advised if the bonus is very low. Give the employee to peruse the reasoning and ask for commentary from them.
  • Make sure your actions are ethical and unbiased so that you do not stumble into a discrimination claim.
  • Constantly review communications before releasing them that have any reference to a bonus scheme. They must always be consistent and refer to bonuses as being of a discretionary nature.
Consider this helpful example as a clarification:

Example #5:

A London-based employer in the retail, investment, and merchant banking industry experienced the fettered discretion permitted for bonus payments under a discretionary bonus scheme.

The employee was an equities trader and their employment contract was carefully written to state that a discretionary bonus scheme existed and was awarded based on “individual performance”.

The employee was a top performer with a phenomenal result in his first year.  He reeled in profits for the firm of almost £14 million/$19 million. Whilst not being a “Bill Lipschutz” level of result, it was still lauded within the business. That year a bonus of >£2 million was awarded to him.

In the following year, unfortunately, success had a side effect of causing significant episodes of misconduct. The employee’s contract was terminated for misconduct. He received no bonus payment.

Even though bonus calculations had not been done, and no bonus had been theoretically awarded before his dismissal, the High Court agreed with the defendant that the decision to withhold a discretionary bonus was irrational and biased. The employee, whilst cognisant of the misconduct, had still earned the company £6 million of profits for that year by the time of dismissal was executed.

The bonus was required to be awarded as well as substantial damages for breach of contract.

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