Bonus clauses: how employees can negotiate

Cash or share bonuses can be attractive to employers seeking to incentivise and retain talented employees. 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 required and how it will be measured. This sounds obvious but can be a problem in practice. When things go wrong, the employee or director may find themselves scrambling to identify gaps in the employment contract when it is too late.

We help directors and employees negotiate bonus arrangements, drawing on our experience of working with a wide range of employers.

Negotiating points and pitfalls

When negotiating employment contract terms, including a contractual bonus, it is worth considering:

• How is performance measured? - The types of performance targets commonly used are objective, subjective or a combination of both. Objective criteria, such as individual or company sales targets, are generally straightforward to measure. Subjective assessments are more difficult, and the greater the scope for interpretation, the greater the potential for disputes.
• Is the bonus contractual or discretionary? - Bonuses may depend on several factors, and bonus rules may change from time to time. Even where an employer has discretion, it must exercise that discretion in accordance with the contract and applicable legal principles.
• Can the bonus be varied? - Does the employer have discretion to vary the bonus where an external event beyond the employee’s control affects their ability to meet targets? If the contract does not permit variation, an attempt to change the terms may amount to a breach of contract. Employers generally cannot unilaterally change contractual terms without the employee’s agreement, subject to the circumstances.
• Clarity on performance targets - Are clear dates set for reviewing performance? Finding out at the end of the year that a target has not been met may leave no opportunity to improve.
• What happens if there is a breach of contract? - If either party breaches the employment contract, can this affect bonus entitlement or payments otherwise due?
• Is there a mechanism to resolve a bonus dispute? - An independent external decision-maker may help resolve disputes. Referral to the company’s accountants, for example, may raise concerns about independence where they have an ongoing relationship with the employer.

What happens to bonus entitlement on termination of employment?

There may be a distinction on termination between:

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

Many employment contracts and bonus schemes state that an employee is eligible for a bonus only if they remain employed on the payment date. Whether such a condition is enforceable and how it applies will depend on the wording and circumstances. For example, if the employer gives notice of termination, should the employee lose an otherwise earned bonus? We help negotiate terms that address these situations.

Notice periods and the payment of a bonus

Employers may seek to rely on bonus scheme provisions to avoid paying a bonus by placing an employee on notice. This can be particularly relevant for senior employees and directors. Depending on the circumstances, the employee may have grounds for a claim, including for breach of contract or unfair dismissal.

• If the employee has negotiated appropriate contractual protection at the outset, they may retain their bonus entitlement, provided the relevant conditions are met.
• If the issue is only considered when the employee resigns, the position may be more difficult. However, the outcome will depend on the contract, the facts and any applicable legal principles governing the employer’s discretion..

Withholding bonus payments

Employers may include provisions allowing them to withhold or reduce bonus payments. These typically include malus provisions and bonus clawbacks, which operate differently.

Malus clauses

Executive contracts often include malus clauses relating to future compensation. They allow an employer to reduce, defer or cancel unpaid or deferred bonuses or share awards where specified conditions are met. Malus clauses can apply to short-term cash bonuses, long-term incentive plans (LTIPs), options (including EMI options) and share-based awards such as growth shares.

In practice, malus provisions can be easier to apply than clawbacks because they concern compensation not yet paid, whereas clawbacks seek to recover amounts already paid. Both aim to balance risk management with appropriate incentives.

Where performance targets are subjective, employers may have greater scope to reduce or refuse a bonus. However, any discretion must be exercised in accordance with the contract and applicable legal principles.

Good and bad leaver clauses in share awards or options may also allow an employer to reduce or forfeit awards when an employee leaves. The outcome depends on the relevant terms and circumstances. The protections available may differ between share awards and contractual cash bonuses.

Bonus clawbacks

Employers may reserve the right to claw back a bonus already paid. This is particularly relevant to cash bonuses in banks and other financial institutions, although clawbacks can also apply to shares or other awards. They may be triggered by events such as a financial restatement, serious misconduct, reckless behaviour or departure within a specified period after payment.

In practice, clawback provisions may be difficult to enforce, depending on their wording and the circumstances. A clawback is not automatically unenforceable because it is alleged to be a penalty; its enforceability depends on the applicable legal principles and contractual terms. Many employers, including banks, insurers and other financial institutions, also use malus provisions to manage bonus payments.