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Bonus clause: how to negotiate

Incentive-based remuneration is attractive to an employer who wants to save money and retain talented workers. However difficulties often arise for employees and directors. We find problems come to light when it is too late. 

Helping employees achieve the best outcome

We set out below some essential guidelines for negotiation. Based on our experience, we see difficulties most commonly arise around:

  • Unclear bonus targets;
  • Restrictions on bonus payments; and
  • Good and bad leaver provisions.

Unclear bonus targets

The difficulty with performance targets often lies in establishing what performance is actually required and how will this be measured. Sounds obvious but is a problem in practice.

When things go wrong the employee or director is often looking back at the employment contract, scrambling around for loopholes.

How to move to a better position

Consider these questions:

How is performance measured?

There are two types of performance targets commonly deployed:

  • Objective performance targets; or
  • Subjective performance targets; or
  • A combination of both.

Objective performance criteria such as achievement of sales targets either of the individual employee or of the business as a whole, or a combination of both are straight forward to measure.

Subjective assessment of the employee’s performance is on the other hand more difficult. The greater the degree of subjectivity, the greater the likelihood of disputes arising.

Is the bonus contractual or discretionary?

Bonuses may be dependent on a number of factors and the bonus rules may change from time to time. Even where your employer has discretion that discretion must be exercised fairly.

Is the bonus adjustable?

Does the employer have the discretion to adjust the bonus if there is an external event that affects an employee’s ability to meet targets which are outside of the employee’s control?

Are there set dates to adjudicate on meeting the performance targets?

Are there regular dates set out for reviewing performance? Finding out at the end of the year that you have not met your target leaves you with no room to improve the situation.

What happens if there is breach of contract?

If the employment contract is breached by the employer or the employee, will that result in payments otherwise due no longer being due?

Are there consequences for non-performance as opposed to incentives for targets met?

Consequences could take many forms including performance monitoring or disciplinary action or employer action under a malus clause and these could lead to bonus payments being reduced, withdrawn or deferred.

Who is going to decide whether the performance target has been met?

Where the performance is to be judged subjectively, is more than one person’s view considered?

Is there an appeal system?

The best position is for the employee or director to have the right to refer to an externally appointed person who is independent. However referral to the company accountants, for example, may not promote an employee’s interests if the company accountants are keen to keep in with the company.

What is the position on leaving employment?

There may be a distinction between:

  • Leaving voluntarily – i.e. handing in your notice; and
  • Leaving involuntarily – i.e. because of redundancy, ill health, etc.

Many contracts of employment and company bonus rules state that you will only be eligible for a bonus if you are in employment on the bonus payment date.

  • For example, if it is the employer who serves notice of termination of employment is it right that the entitlement under the bonus is penalised? We do negotiate around these points.

Notice periods and the payment of a bonus

It is not unheard of for the employer to seek to take advantage of the provisions of a bonus scheme if they can by placing the employee on notice to avoid paying a bonus.  This is a common occurrence with senior employees or directors. Often the employee has grounds for claiming unfair dismissal or wrongful dismissal.

  • If the employee has negotiated well at the start and blocked that option for the employer he should get paid assuming that the employee has not breached his contract.
  • If the employee only thinks about this when he comes to resign, the position is more difficult but not impossible. There is a body of case law requiring fair treatment by employers meaning the employee may have good ammunition – all depends upon the facts.

Restrictions on bonus payments

There are ways an employer can place restrictions on bonus payments. Typically these include bonus clawbacks and malus provisions. We explain their effect, enforceability and applicable tax issues.

Bonus clawbacks

It is not uncommon for an employer to reserve a right to clawback a bonus already paid. This is particularly relevant for cash bonuses paid to employees in banks and other financial institutions although a clawback can be against shares or other awards. The idea is that in certain cases clawback provisions apply, for example as a result of a financial restatement or if it is later discovered that the employee committed serious misconduct or was reckless in his duties. Bonus clawback provisions also come into play when an employee leaves within a certain period following the bonus payment.

Enforceability of bonus clawback provisions

Clawback provisions if drafted correctly by the employer will in most cases be enforceable. If the claw back is enforceable this will mean that you will be required to pay back money that you have already spent on the Lamborghini or (for most of us) that window frame.

In practice clawback provisions are rarely exercised. Many employers including banks, insurance companies and other financial institutions have introduced alternative methods of controlling bonus payments in the form of malus clauses.

Bonus claw back tax treatment

HMRC have been ordered by a court decision to reimburse taxpayers who repay their bonus. Repayment of income tax by HMRC is to avoid individuals having to pay back more than they received in net income. The fact that an employee can reclaim income tax relief for bonuses clawed back means that the employer will first seek to clawback the gross bonus paid.

However, the National Insurance contributions’ rules (NICs) are not aligned and therefore an employee will still be out-of-pocket in relation to the NICs. Employers will also be left out-of-pocket in relation to their employer NICs liabilities. This is an area where negotiation is possible.

Benefits of a tax indemnity given by the employer to the employee

The uncertainty surrounding the repayment of tax when a bonus is clawed back means that employees and directors should seek to negotiate all encompassing indemnities. The purpose of an indemnity is to safeguard the employee by requiring the employer to reimburse them to the extent that HMRC does not.  Employers will not give in to requests for an indemnity easily and skillful negotiation is often required.

Malus clauses

Executive contracts often include ‘malus clauses’ in relation to future compensation. Malus clauses can relate to both short term cash bonuses and Long Term Incentive share Plans (LTIPs). They allow an employer to revise, defer or refuse future bonus payment or share awards if performance is below target. The result is a reduced or eliminated payout of deferred performance incentives.

In practice, Malus clauses are easier to exercise than a clawback where the employer receiving his money does depend on the employee actually being able to pay it back. Malus arrangements attempt to strike a balance between risk management and maintenance of appropriate incentives.

Where performance targets are subjective, employers have more room to manoeuvre and refuse payment of part of a bonus. However, employers need to exercise this discretion fairly and not in an arbitrary, capricious or irrational way.

We find that senior employees use our tactical advice to challenge the exercise of discretion where it’s use appears unfair and negotiate improved bonus payments.

Good and bad leaver provisions

Having good and bad leaver provisions attached to shares removes uncertainty when you leave. Generally, bad leavers have committed gross misconduct, or breached their employment contract. With a bad leaver status the employer avoids paying the bonus. Good leavers do not fall within the bad leaver bracket, e.g. termination of employment through redundancy.

Director’s service agreements and shareholders’ agreements often distinguish between good and bad leavers. Your employer chooses how to define good and bad leavers. There are no legal restraints. We can advise before entering into the share agreement.

Options

It is very common for employee share option plans to provide that unvested options lapse on leaving employment. It can be difficult to negotiate in advance against such provisions. However, we do deal with cases where upon leaving, the employer agrees to let employees exercise unvested options. Often the employer has reserved a discretionary right to permit early vesting – something worth investigating.

If you are currently facing these or any other restrictions on your bonus payments we can help advise you on the enforceability of provisions and your options to ensure you secure payment of your bonus.

Matt Gingell is a partner in our employment law team with plenty of experience in resolving issues for employees relating to their termination of employment, especially settlement amounts, bonus payments, shares and when things go wrong, litigation in the employment tribunal.

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