18 June 2007
Bonus schemes are now a common feature of reward strategies amongst employers in all sectors. The big question is do they deliver and how do you avoid the legal pitfalls? Consider the issues below to give your organisation the best chance of an effective bonus scheme.
Why are bonus schemes used?
Deciding on the aim of the bonus scheme is the first step to ensuring that an appropriate scheme is introduced. The reasons why companies introduce bonus schemes can include:
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Enhance pay/performance connection
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Communicate business goals
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Increase productivity
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Improve financial results
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Encourage teamwork
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Encourage employee involvement
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Improve quality/customer satisfaction
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Support changing culture/values
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Reduce costs
What are the different organisational levels where bonus schemes can be used?
The bonus scheme needs to be appropriate for the level at which it will operate. Bonus schemes are normally designed to operate at one of four levels:
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Corporate
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Site
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Team, or
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Individual
According to this year’s CIPD Reward Management Survey individual based schemes were the most common arrangement, used by 64% of respondents.
What factors can be used as performance measures on which the bonus is assessed?
The performance measure/s used need to relate to the overall objective of the scheme. Single factor schemes focus performance on a specific goal, such as profits or productivity. Alternatively, multi-factor schemes use a range of targets. Some common performance measures include:
When deciding on the performance measures it is important to make sure that the focus does not have a detrimental effect elsewhere. For example, team bonuses can de-motivate individual high achievers if they feel their contribution is insufficiently recognised, whereas an individual bonus can discourage team work. Similarly, rewarding staff for dealing with customer queries/complaints within a given time frame could actually undermine overall customer satisfaction in the organisation if, as result, staff give priority to calls which can be readily resolved.
When does a non-contractual bonus scheme become contractual?
In the vast majority of cases, if a company operates a regular bonus scheme and an individual is invited to participate, there will be a contractual right for the individual to participate in that scheme, even if it is stated as being non-contractual or discretionary.
For example, in Noble Enterprises v Lieberum the EAT held that, although the employer had discretion whether to operate the bonus scheme from year to year, once the bonus year began, this discretion was limited. The scheme had operated for five years, and since the employer had not informed the employee that it intended to discontinue the scheme before the start of the year, the employee had a reasonable expectation that he would receive a bonus.
An example of an entirely non-contractual bonus would be where a company decides to make an ad hoc bonus payment to staff to reward a good performance by the company or a particular job well done. If there were no expectation by the staff that there might be a bonus payable and no way to calculate the amount of bonus, there is unlikely to be a contractual bonus scheme in operation.
What are the legal considerations when determining whether or not to make a discretionary bonus payment?
The aim of most employers is to ensure that they are under no obligation to award a bonus under the scheme and will usually provide that any benefit payable under the scheme is entirely at the employer's discretion.
However, Cantor Fitzgeral International v Horkulak established the principle that in deciding whether to award a discretionary bonus the employer owes a duty to make its decision in a manner that is "rational and bona fide, as opposed to irrational and arbitrary”.
Whether an employer is acting irrationally in failing to give a bonus will depend on how the bonus scheme is described in any documentation and how it is operated in practice. In Clark v Nomura the bonus was stated to be "not guaranteed in any way and dependent upon individual performance". Mr Clark was employed when the bonus became payable and had made a substantial profit, however, he was dismissed and received no bonus. The High Court held that the requirement to base the decision on individual performance was a "contractual straitjacket" which prevented the employer from relying on other factors, including other legitimate business needs. Within that straitjacket, the employer had to exercise its discretion in a manner that was not "irrational or perverse and that no reasonable employer would have exercised its discretion in that way.
How should absence on maternity leave be treated when calculating the amount of any bonus?
This is a complex and difficult area of law! However, as a general rule, where the bonus is retrospective pay for work done, the employer may reduce it pro rata to take account of maternity absence. However, the two week compulsory maternity leave period must not be treated as absence for this purpose.
Where the bonus does not constitute retrospective pay, but is paid by way of an incentive for future performance or loyalty, there should be no reduction for a woman who has been absent on maternity leave. Note, these general guidelines only apply to the right to pro rata the bonus and there are separate legal principles which govern the right for an employee on maternity leave to be paid a bonus. That’s a whole new article!
These are just some of the issues to consider when introducing a bonus scheme. The effectiveness of the arrangement can also depend on the extent to which employees understand the objectives and measurements for determining payments and perceive them to be fair and equitable. For an organisation implementing a scheme, a comprehensive set of rules and a strong communication strategy will serve as an added bonus!
Note: buddy’s guidance notes on bonuses have recently been updated.