Employee bonuses - legal guide for employers

We help employers put bonus plans in place that motivate employees and directors to deliver. Our experience in employment matters helps us identify where employers may be vulnerable to bonus disputes.

Bonus disputes are an interesting area because they involve an overlap between contract law and employment law. An employer may comply with the terms of an employment contract but still act unlawfully under employment law, for example through sex discrimination or other discriminatory treatment.

Cash bonuses

A bonus can be contractual, discretionary or a combination of both. Discretion can give an employer greater flexibility, but it must be exercised in accordance with the terms of the bonus plan and applicable legal obligations.

Fair calculation of the bonus targets

Many bonuses are based on targets measured against company accounts. A key question is how revenue, performance and targets are actually measured. In a dispute, an employee may be able to obtain disclosure of relevant documents through Employment Tribunal proceedings and examine the method used to calculate the bonus.

Bonus payments can also be measured against share performance, using a range of valuation methods. This type of arrangement is often called a phantom share option. However, because no actual shares are granted, it is not an option over shares.

Common problem area for employers with bonus targets

Challenges can arise when the underlying financial figures and calculations are scrutinised. Employers should therefore consider the structure of a bonus plan carefully before presenting it to employees. In our experience, unnecessary complexity can backfire.

Changing a bonus scheme may also create employment law risks. Depending on the circumstances and contractual terms, an employer’s attempt to change a bonus could amount to a breach of contract or, in serious cases, a repudiatory breach. This may affect the enforceability of post-termination restrictive covenants. Further details of potential employee claims are set out below.

Fair exercise of discretion

An employer’s discretion must be exercised fairly and in accordance with the applicable contractual obligations. What is fair will depend on the facts of the particular case.

Fairness depends not only on the rules of the bonus plan but also on how discretion has been applied to the individual employee. The courts may take into account how other employees have been treated. Employers should keep detailed records, including minutes explaining the reasons for bonus decisions, as these may provide important evidence if a complaint arises.

• Terms such as “absolute”, “sole” and “reasonable” discretion can have different implications and may be interpreted differently depending on the wording and circumstances.

Share based bonuses

Bonuses can take the form of shares or share-based awards. Private companies have flexibility in how these arrangements are structured, subject to the relevant legal, tax and corporate requirements.

• Shares may be issued subject to conditions, such as performance targets or vesting requirements. Growth shares are one possible structure.
• EMI, unapproved or other tax-advantaged share options may be granted, where eligible, with exercise rights linked to the achievement of bonus targets.

Shareholder approval

Shareholder approval may be required to issue shares or implement a share-based incentive arrangement. The company’s Articles of Association and shareholders’ agreement should also be reviewed to identify any relevant restrictions, consent requirements or transfer provisions.

Compulsory transfers

In many private companies, the intention is that an employee who holds shares must transfer them when their employment ends. Appropriate provisions may be included in the Articles of Association or shareholders’ agreement, but the terms and any protections for the employee need to be considered and negotiated. These protections are not automatic.

Options

Many employee share options provide for the options to lapse when employment ends, although the outcome depends on the scheme rules and the circumstances. Employers should ensure that the relevant provisions are clearly drafted and that any required acknowledgements or waivers are appropriately worded and legally effective.

Tax

Shares provided to employees may give rise to income tax and, in some cases, National Insurance contributions. Establishing the value of shares in a private company and calculating the resulting tax liability can be complex.

If the shares subsequently decrease in value, HMRC will not ordinarily refund tax simply because the value has fallen. The tax treatment depends on the circumstances and the applicable rules. Employers should consider the potential for unexpected PAYE liabilities and whether appropriate contractual protections, including an indemnity from the employee where suitable, are needed.

Claims employers want to avoid

Employees may consider a range of claims when they believe they have not received a bonus to which they are entitled. Depending on the circumstances, these may include:

• Damages for breach of contract, including a repudiatory breach that may affect post-termination restrictions.
• Wrongful dismissal.
• Unlawful deductions from wages.
• Unfair dismissal, where the relevant statutory requirements are met.
• Discrimination, including equal pay claims.

Providing information about the bonus to the employee

Access to information about how an employer has made bonus decisions can be a significant issue in a dispute. Employers may have legitimate reasons to protect confidential or commercially sensitive information, but relevant documents may have to be disclosed in legal proceedings. Employees may also make a subject access request under data protection legislation for their personal data.

Where an employee suspects discrimination, they may raise questions with the employer and seek relevant information through a grievance or legal proceedings. The former statutory discrimination questionnaire procedure has been abolished, although employees can still ask questions voluntarily.

Refusal to co-operate

An employer’s failure to engage appropriately or comply with relevant obligations can have consequences. The nature of those consequences depends on the proceedings and the conduct in question.

• In Employment Tribunal proceedings, compensation may be increased by up to 25% in certain circumstances where an employer unreasonably fails to comply with a relevant ACAS Code of Practice.
• In the High Court, the court may make a costs order where the applicable rules and circumstances justify it, including where a party’s conduct has unnecessarily increased costs.

We sometimes see bonus disputes settle shortly before a deadline for complying with a court disclosure order. This highlights the importance of having clear bonus terms, keeping appropriate records and addressing disputes promptly.