Bonus clauses: how employees can negotiate

Cash or share bonuses are attractive to an employer who wants to save money and retain talented workers. However difficulties often arise for employees and directors when negotiating a bonus clause.

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 when it is too late.

We help directors or employees find a path drawing on experience gained in working with many different types of employers.

Negotiating points and pitfalls

When negotiating over the terms and employment contract including a contractual bonus, it is worth considering :-

• How is performance measured? - The types of performance targets commonly deployed are objective performance targets, 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.
• Can the bonus be varied? - does the employer have the discretion to vary 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?  If the bonus is not expressly drafted as variable  and the employer tries to vary the terms this could be a breach of contract bringing post termination of employment  restrictive covenants to an end for the employee - could be very convenient for an employee or director. Generally employers cannot change employment terms without written consent.
• Clarity on performance targets - are there clear 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 a 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?
• Is there a mechanism to resolve a bonus dispute? - 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 happens to bonus entitlement on termination of employment?

There may be a distinction upon termination of employment 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.  The Employment Tribunal is unlikely to find such a clause is unenforceable. 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.

Withholding bonus payments

There are ways an employer can place withholding requirements on bonus payments. Typically these include bonus claw backs or the more popular malus provisions. We explain the effectiveness below.

Malus clauses

Executive contracts often include ‘malus clauses’ in relation to future compensation. 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. Malus clauses can relate to both short term cash bonuses and Long Term Incentive share Plans (LTIPs) as well as options (including EMI options)  and share based awards such as growth shares.

In practice, malus clauses are easier to exercise than a claw back 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.

Good and bad leaver clauses set out in share awards or options are usually easier for the employer to enforce.  Employers can waive all liability with share payments in a way which is not possible with payments under an employment contract.  It all depends upon the small print.

Bonus clawbacks

It is not uncommon for an employer to reserve a right to claw back a bonus already paid. This is particularly relevant for cash bonuses paid to employees in banks and other financial institutions although a claw back can be against shares or other awards. The idea is that in certain cases claw back 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 claw back provisions also come into play when an employee leaves within a certain period following the bonus payment.

In practice, we find that claw back provisions are rarely exercised.  If the employee can establish that the claw back is a penalty the employer may find the claw back provisions are unenforceable. Many employers including banks, insurance companies and other financial institutions have introduced alternative methods of controlling bonus payments in the form of malus clauses.