Difficulties with performance clauses

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Payment in an employment contract linked to performance can appear very attractive to a business.  Why not save money as well as the obvious other advantages of linking payment to performance? Performance clauses may well be a good thing – they give the business or employee something to aim for and allow measurable success or failure.  But, there can be problems as we explain below based on our experience.

Common oversights

The difficulty with performance targets is in adequately and clearly establishing what performance will be required and in understanding and thinking through potential differences or issues which may arise with these sorts of arrangements. Each case tends to be different and it would be very risky to seek to rely on “do it yourself law” or off the shelf templates which can be a recipe for disaster.

The right contracts are important to enable profitable business for both parties but with an eye for a worst case scenario, and when things have deteriorated to the extent that you are looking back to the contract, the parties are rarely on good terms. In an already contentious situation, both sides are scrambling around for loopholes.

Consider these questions in connection with your employment contract

  • Is there any cap on how much can be paid?
  • Is the reward for meeting the performance target to be pro-rated if there is some external and unavoidable event that causes performance to stop mid-way through the year?
  • Is a date set to adjudicate on meeting the performance target?
  • What happens if there is breach of contract – will that result in payments otherwise due no longer being due ?
  • Are there potential penalties for non-performance as opposed to incentives for targets met ?
  • Who is going to decide whether the performance target has been met?

Employment contracts

For an employment contract, performance targets are an especially difficult area to negotiate. The courts will not always recognise the employer’s intention that a payment for meeting these targets is discretionary, and a repeated payment of a particular bonus can make it contractual, whether or not it is worded that way – more advice on employment contracts here.

Example

Another example Sometimes performance clauses which appear to be favourable on first consideration do not turn out to be so attractive as this article in the context of hedge fund management fees makes clear. This is a classic example of where even the most savvy can be blindsided without the benefit of a trained eye.