Are ‘discretionary bonuses’ really discretionary?

24 Feb 2015
Author: DTI Lawyers

About this time every year, employees anticipate the value of their performance successes for their employers. Many enter into reviews or commence negotiations with their employers around an increase in their remuneration packages. For many employees, bonuses for performance over the past year are offered as part of incentive pay packages. Unfortunately, whether or not the payment of a bonus is truly discretionary is not well understood and the issue can become contentious.

Many employers consider they have the right to decide whether or not to pay a bonus and that this can be simply decided from year to year. The issue with this approach is that this does not always match up with the contractual obligations of the employer. In recent years, attempts by employees to challenge their bonus payment, or lack thereof, have resulted in successful and unsuccessful legal judgments. These decisions make it very apparent that while contributing factors such as the usual practice of the employer may be taken into account, the outcome of a case is usually determined by the clarity of the employment agreement and wording around bonus clauses.

Last year, a decision made in the Employment Relations Authority saw an executive lose his fight for the bonus he thought he was entitled to. The employer had made it clear that the bonus was optional by naming the clause “Discretionary Benefits”. The clause was abundantly clear that there was “no entitlement to a bonus”, even if certain conditions were met.

In contrast, a determination by the Authority in December resulted in a newly laid-off executive being entitled to a $16,000 bonus even though the employer company was operating at a loss. A clause in the agreement clearly stated that employees acknowledged that the company had the sole discretion to alter the contents of schedules to the agreement. However the bonus clause entitled the employee to get a bonus payment to a maximum $60,000 as long as certain conditions were met.

There was no use of the word “discretionary” in the bonus clause itself and the employee met the conditions stated, therefore the employer was obligated to pay the significant bonus.

What distinguished the success between these two cases was primarily the wording in the employee agreement. If an employer does not make it very apparent that the award of bonuses is discretionary, it will be difficult to argue that a bonus is not caught under the widely interpreted provision of the Employment Relations Act regarding “conditions of employment”. If conditions are not satisfied, this will give grounds to an employee to raise a personal grievance claim for unjustified disadvantage.

When considering payment for the previous year and negotiating terms for 2015 – 2016, employers can reduce the risk of these issues by focusing on the agreement itself, i.e. the bonus calculation and whether any amount to be paid is (or should be) expressed as discretionary. Well drafted bonus clauses will reduce the risk of a costly dispute. Employers should also ensure that there is consistency with any historic treatment of discretionary bonuses (such as informal formula developed over time), have clear communication about any change in approach, and exercise discretion in good faith.

Article first published by the Waikato Times, February 2015