· News

HR lessons from the recession: Make sure the contractual wording on bonus entitlement is crystal clear

The global financial crisis has spawned a number of interesting cases on the subject of bonus entitlement. Most of these highlight the problem of not paying sufficient attention to contractual clauses.

If a bonus is paid under a contractual/discretionary hybrid type scheme (for example, where it is stated that the employee is entitled to participate in the scheme but the amount is determined at the employer’s discretion) arguments can often ensue over whether the exercise of discretion was irrational or perverse or whether factors were taken into account which were not permissible within the exercise of that discretion.  The other side of the debate concerns the ability of the employer to claw back any agreed bonus award when circumstances have changed. 

You do not have to be involved in investment banking or financial services to be concerned about bonus entitlements.  One of the lessons to emerge from all of the recently reported cases is that any company wishing to impose conditions, or some basis for achieving a clawback, must set these out in clear terms within the clause or scheme dealing with the entitlement.  Also, there are other steps that the contractual wording should allow to be taken, such as limiting the amount paid out by cash as a percentage of the bonus award and paying the rest as options or some other share incentive, thus deferring the bonus award over a much longer period.  Indeed, in many ways, this could be a far more effective way of working as the vesting, or payment out, of any deferred amount could also be made subject to satisfactory business or team performance, or for individual performance being maintained in subsequent years. 

This may not deal with the situation entirely, particularly if a business does not prosper after a large bonus award has been made and a substantial part paid out, and the employee leaves soon afterwards.  Above all, if economic circumstances change in a very radical and detrimental manner, the award itself, whether deferred or otherwise, may need to be adjusted to take those circumstances into account. 

The argument against some form of clawback usually revolves around whether the clawback itself constitutes an unlawful penalty (or is an unlawful restraint of trade), or whether it was never properly incorporated into the contract of employment or the bonus scheme.  Clearly, any clawback provision should form part of the bonus scheme rules, but may only be added if the scheme rules permit changes to be incorporated without obtaining the employee’s consent.  Even then, there might be arguments if such a change is made without consultation with the employee.

A clawback arrangement should work, provided the basis for it is entirely sensible and proportionate between the amount clawed back and the reason for doing so. Thus, if a clawback occurs because the performance in terms of individual fees or revenue prove to be inaccurate, due to staggering losses or unpaid fees at a later date on that business, it may make sense to adjust the bonus accordingly.  The same might be said where a bonus is in part based on company performance and major company losses occur after the date of the bonus award is announced, although again, examples of such circumstances ought to be set out in the wording of the scheme itself. 

Further instances may occur if the award was made at a time when various features of the employee’s performance or conduct were not known and these would have had an impact on the size of the bonus award.  An example might be where, at the time when the bonus award was made, the employee concerned was organising and planning a team move that amounted to a breach of their employment and fiduciary duties.  Care must be taken to ensure that clawbacks are not introduced as a deterrent to someone leaving and joining a competitor, as this might well be regarded as an unlawful restraint of trade. 

What is staggering is the extent to which sophisticated institutions and other employers use very simple bonus clauses that do not provide them with any room for manoeuvre if circumstances change or the basis upon which the award was made, such as the assessment of individual, team, or business performance, turns out to be wrongly assessed or based on wrong or false assumptions. 

One of the clear lessons that should be taken away must be the introduction of annual incentive payments over a longer period of time, even if ‘earned’, coupled with suitable clawback provisions, so that the employer is suitably protected.  How much can be achieved will depend upon the desire for institutional change, the power of executives, and the willingness of employers generally to tackle these issues.  In economic good times there may be no need to consider these matters.  But then again employers should apply the lessons from this recession in order to be better prepared next time round.

Peter Doyle is senior partner at Doyle Clayton