The law about bonus payments and employers and employees duties and rights

What are bonus payments?

The term "bonus payment" is used in the employment context to describe a payment in addition to salary or wages which is made after a certain period of time, such as a year. A court has described it as a sum of money paid in addition to salary, as a reward for past service. Ex gratia payments are often referred to as bonuses but are not bonuses.
Currently there is no statutory definition of a "bonus payment" although there are various references to bonuses in the Employment Rights Act 1996, for example in the context of unfair dismissal where a bonus is part of a non-contractual payment. Common types of bonus payments that are offered by employers to employees include:
Performance bonuses are awarded to reward risk-taking and exceptional performance. One-off payments may be made to an individual or within certain peer groups. Businesses may offer bonuses to teams or departments to reward their achievements across a particular period or for a successful project completion.
Sign-on bonuses are intended as an incentive for a prospective employee to join the business, for example if they have to relocate or for their specific skills.
Staff may be paid a holiday bonus as a reward for their loyalty to the business, as the holidays draw near, e.g . Christmas.
Many businesses now pay a retention bonus to staff members who are critical to the business to reward them for their loyalty to the business and to retain them. Retention bonuses often pay a multiple of a basic salary and/or are based on performance.
"Loyalty bonuses" are promised to employees over a certain period of time, particularly if their skill set is in high demand. They are also intended to increase employer/employee retention.
Discretionary bonuses are those which do not have any contractual requirements for the employer to pay them, meaning that the employee has no entitlement to receive a bonus (although this will depend on the terms of the employment contract).
Contractual bonuses are those which employers are required to pay, so that employees have a clear entitlement to them. This type of bonus is often linked to a set figure or benchmark, such as a percentage of salary, their being no discretion on the part of the employer to withhold the bonus.
A contractual bonus should be clearly stated in the contract of employment, employee handbook or in a separate written document. Careful consideration should be given to whether a discretionary or contractual bonus would be most beneficial for both the employer and the employee.

The general law

The law requires employers to pay their employees. How much and for what reasons is a matter of negotiation between the employer and employee. However, once the employer and employee agree to a particular type of compensation, the employer is legally bound to deliver on that promise. For example, employers are bound to pay an employee bonuses when certain conditions are satisfied.
The first step in determining whether a bonus is due is to consider what, if any, agreement exists between the employer and employee regarding the bonus.
Bonuses are supposed to be paid for work performed. If the bonus is for work previously performed, then it may have already become wages under some state wage laws. Under California law, for example, bonuses paid quarterly become wages after the first workweek of the quarter, unless there is an agreement to the contrary. Thus, employees who leave employment after the first work week of the quarter, but prior to the end of the quarter, are entitled to the bonus, despite not fulfilling a condition precedent to the payment in the bonus plan.
If the parties agree to a bonus for future work, then it is less likely that a bonus will have already become wages under state law (although this could change depending on the terms of a bonus plan). Regardless of the words used to describe the bonus, the legal principles governing wage payment apply.
Virtually every state requires contract provisions regarding bonus payments to be in writing. If there are any errors or discrepancies between the written bonus plan and what the employer intended, it is likely that the employer will lose on that discrepancy.
In addition to the statutory requirements imposed by federal and state labor laws, there are contractual requirements (governed by general contract law) that impact bonuses. For example, many employees are covered by a collective bargaining agreement that requires a bonus to be paid to all employees who work past a certain date or complete certain jobs. Failing to pay the bonus to employees covered by such a CBA can lead to liability.
Bonus plans must also comply with ERISA if they plan intends to defer the payment of any bonus until some time in the future. This rule only applies to discretionary bonuses, which must be evaluated by the following criteria: is the payment mandatory, have the conditions for receiving the bonus, if any, been met, and have employees come to expect the payment as a result. If the discretionary bonus fails this test, then it is considered a pension plan subject to ERISA.
Finally, bonuses covered by ERISA are further regulated in a variety of ways, including under the qualified code section 401(a), which grants tax advantages to bonuses provided by employers through a qualified cash or deferred arrangement.

The employer’s duty to pay the bonus

The obligations and conduct of employers in deciding distributions and structuring the bonus are strict.
Contractual Provisions
Employers need to bear in mind that bonus entitlements (or lack of entitlements) can be binding on both parties. As such, bonus provisions should be as transparent as possible and set out exactly what an employee is entitled to.
Any discretion a business reserves in respect to bonus payments must therefore be used consistently and applied on a commercial basis. When interpreting these clauses, tribunals and judges have increasingly been applying a "commercial common sense" to whether an employee is entitled to such payment.
If bonuses are to be distributed over a period longer than one holiday year, it may be advantageous to ask employees to acknowledge their entitlement and the process by which it is calculated and paid. This would limit any eventual claims for constructive dismissal (ie if the employee was to claim that the bonus was a term of his contract which the employer was in breach of). An employee’s written acceptance will then support the contractual basis on which the bonus is paid.
There is no statutory requirement to have a minimum bonus policy. However, if an employer does establish a minimum bonus, it needs to be very clear whether this minimum is guaranteed or discretionary. If an employer chooses a minimum, it also needs to identify clearly the circumstances in which the employer is entitled to remove or return to no bonus at all.
Some employers go further and issue a policy statement including:
• eligibility and apportionment for bonuses;
• the calculation of the bonus, including deductions, performance targets and the "gatekeeper" (the individual responsible for the calculation);
• exclusions; and
• details of when and how the bonus is paid.
Written communications with the workforce are also helpful. To avoid the business being financially exposed, it is good practice to communicate with staff the amount of a bonus, how it was calculated, and any conditions required to be satisfied, before the bonus is paid.
Furthermore, you should communicate any changes to the scheme to your employees. Backtracking on a bonus will not just aggravate the situation, but may also expose your employees to unfair dismissal and pay claim liability.

The employee’s right to a bonus

Employees have a right to be paid any contractual or discretionary bonus payment. If an employee can show that their employer has withheld payment, or paid less than their entitlement without good reason, or has been paid a bonus but under different terms than that to their colleague, it is likely that he or she will have a claim for breach of contract and/or unlawful deductions.
Common examples of cases in which breaches of bonus agreements are alleged include: Any dispute over a bonus that cannot be resolved internally or by agreement between the parties is likely to result in an Employment Tribunal claim for unlawful deductions from wages or breach of contract. A Tribunal may consider the intentions of the parties and how the wording should be understood. It will also consider the parties’ intentions in order to decide whether a bonus has been paid in accordance with the terms of the agreement. It is important, therefore, that bonus provisions are drafted clearly, with unambiguous wording that will minimise the risk of challenge through Employees Tribunal claims. The key is to embrace clarity: ambiguity or uncertainty can lay the groundwork for an Employer’s expensive mistake.

Disputes regarding bonus payment

Disputes over bonus payments are not uncommon, as differing views on their nature and form can arise between employers and employees. For example, does the payment of a bonus constitute a contractual obligation or a mere discretionary act by the employer? Should a bonus be calculated as a percentage of a fixed target or based on performance against more flexible targets? These are just a few questions that may lead to a disagreement about the nature and amount of a bonus payment and, as a consequence, may require resolution through a number of potential avenues.
The first and often most effective step is for the employer and employee to reach a mutually beneficial resolution to the dispute through negotiation of a suitable resolution. If this fails, the parties may then consider mediation to assist with the settlement of the dispute on mutually agreeable terms. If these avenues are unsuccessful, the parties may then consider proceedings before an appropriate court or tribunal to resolve the matter.
In some cases, there may be scope for pursuit of a contractual claim for breach of contract following non-payment, or underpayment, of a bonus. However, whilst a bonus is often regarded (or at least alleged) as a contractual entitlement or right, it is nevertheless important to bear in mind the time limits for bringing legal action for breach of contract (six years), and for recovering a debt (six years). A claim for breach of contract is typically brought as part of a wider claim for breach of contract of employment , where the employee claims that they have been constructively dismissed because the employer has breached the contract of employment (including in relation to the payment of a bonus). This head of claim for constructive dismissal will be severely constrained where the employee has left the employment by way of resignation, unless the employer is alleged to have been acting in a manner so seriously in breach of the contract of employment as to entitle them to treat continuing employment under the contract as having been terminated. In contrast to claims for breach of express term of a contract of employment, claims for breach of an implied term of quiet reflection (arising from the implied term of trust and confidence) need to be made within three months of termination of employment under Section 111(2) of the Employment Rights Act 1996.
A claim for a bonus under an incentive scheme may also give rise to a claim pursuant to discrimination legislation, for example, where an employee has claimed that the award of a bonus has been calculated in a discriminatory manner such as to disadvantage employees in a particular protected class, or to favour men over women. A claim in this respect would need to be brought within three months of the less favourable treatment (i.e. the award of the bonus) occurring, either pursuant to a tribunal claim (under the Equality Act 2010), or a settlement claim (claim presented to ACAS for early conciliation).

Recent case law

An example of the potential for uncertainty around bonus terminations arose in the 2015 BC Supreme Court case of Caron v Equiscript Ltd, in which a salesperson’s agreement entitled him to a performance bonus set as a percentage of the company’s annual pre-tax earnings. The earnings clause provided: The Earnings Bonus will be paid one year in arrears, depending on the company achieving its gross sales targets as determined by the company from time to time but in no event in excess of [100]% of the gross sales set out in the annual budget as approved by the company. [emphasis added] In that case, the employer had unilaterally reduced gross sales targets by more than 50% so as to cap the amount of the performance bonus by reference to the lower target. The Court found the employer’s actions were in bad faith and that they had "adopted a confrontational, antagonistic and unreasonable approach to reducing Mr. Caron’s earnings." As a result, the salesperson was awarded a bonus calculated by reference to the original sales target size and not the reduced target under the terms of the agreement.
The BC Court of Appeal addressed a similar issue the following year in Campbell v 2520987 Ontario Limited (NEEZO), a case involving a technician’s incentive payment structured as a minimum-plus-overage formula. The employer initially engaged the technician pursuant to an oral agreement and agreed to pay an hourly wage plus a commission bonus calculated as 10% of sales above a certain threshold. Later, the parties reduced the agreement to a written contract. However, despite being aware of the original agreement, the written agreement provided for a substantially lower threshold for overage commission. Additionally, any amounts earned above the cap were clawed back. The employee was dismissed shortly after the parties executed the amended contract, and he sued for the balance of his commissions. The employee was awarded about $25,000, more than the amounts owed under the written agreement but far less than the amounts he would have received under the terms of the initial agreement. In awarding the sales technician his commission, the Court distinguished the Caron case on the basis that the NEEZO agreement’s language did not directly involve a performance target, nor did it specify a date in the future at which the employee’s compensation would exceed the maximum amount under the written agreement. As these cases demonstrate, consideration is given to the intentions of the parties when interpreting the language of a bonus provision. Further, where an indefinite term is used, the Court will be slower to make a finding of fixed-term status. Because an employer is required to provide reasonable notice of termination (which is usually at least two weeks), where a bonus is triggered by performance for a year or more, the employer is vulnerable to liability for the additional bonus payments if it terminates before the specified period has elapsed.

Useful tips

To avoid the risks associated with bonus payments, employers should adopt a sequence of best practices. These include ensuring that bonus plans are well-drafted, comprehensive and compliant from the outset; providing appropriate disclosures to participating employees on an ongoing basis; taking appropriate tax and withholding steps – ideally before the bonus is paid; and regularly reviewing and updating plan terms. The following guidance may assist in keeping bonus practices and policies within the legal limits: Employers should ensure that their plans are not only compliant with the specific legal requirements applicable to a particular bonus plan (e.g . , the impact of ERISA or Section 409A issues), but also consistent with the employer’s overall approach to employee compensation, and with those components of the business strategy that the employer desires the plan to support. Employers should consider incorporating elements of the bonus payment plan into the employment agreement of relevant employees. While companies often do not want to disturb what are considered "standard" at-will employment agreements, updating these agreements can be helpful to ensure that there are no contractual ambiguities related to the bonus plan. Employers may wish to have a non-employee source review their bonus plan, as it may be difficult for someone close to and part of the process to see potential issues and flaws in the language.