Legal Comment: Bonus payments and contracts

Ian Deakin says clear contractual agreements are vital when it comes to bonuses.

Bonus payments and contracts

Anger over so-called “rewards for failure” has steadily developed as the credit crunch has continued to build steam. Earlier this year, bosses at building company Bellway were criticised after being awarded large bonuses, even though Bellway’s sales had halved. Similarly, the Government has become involved in the debate surrounding bonuses paid to bankers at financial institutions which have been bailed out by the taxpayer.

The debate centres on whether or not bankers should be paid an annual bonus if their institution has performed poorly, even if individuals have performed very well. At the time of writing, the Government has acted to limit bonuses at RBS to those which the firm has liability for. This is where things get interesting.

Because it is the bonuses that are not being paid, it is the discretionary payments that are causing the biggest headache. Although these bonuses are non-binding, there is often an expectation by employees that they will be paid, and this could mean they are in effect quasi contractual, even though employers argue differently.

Deduction of wages

The issue is gaining in importance, with a recent case that could have workers nationwide speaking with their legal advisers, and employers frantically checking whether their contracts are watertight. The case was brought by warehouse workers at Boots who had bonuses halted when their jobs were transferred to a logistics company in 2004. When they returned to employment with Boots in 2007, the workers claimed that the company’s failure to make the bonus payments was an unlawful deduction of their wages on the grounds that there was a long-standing practice of payment. Boots admitted that the bonuses had been paid every year since 1967, except in two years where performance targets were not met. Even though the workers’ bonus was described as discretionary, the Employment Appeal Tribunal backed their claim and the case has gone back to a tribunal for further review.

This leaves many businesses in a catch-22 situation. They would rather not pay bonuses when times are tough, but they risk potentially being sued by staff if they do not. The Government has suggested legislation should be introduced to cap or remove bonuses, particularly in the financial sector. However, as there is no constitution in UK law, and no central Government management of collective bargaining, such moves would likely be a breach of contract and could lead to legal claims. As there are different approaches to remuneration, a one-size-fits-all method is impossible to implement.

Pay aligned to performance

The solution lies in contracts. Instead of scrapping bonuses all together, businesses should aim to create a culture in which workers’ pay is more closely aligned to performance, with very clear, measurable links to bonuses. At present, many contracts aren’t clear enough and this is where the quasi-contractual element of bonuses becomes an issue, as is likely in the Boots workers’ case. 

There are various approaches to changing contracts, each with its own risk, but the aim shouldn’t be to enforce a quick change in order to save money; that is likely to rankle with employees. The wider context of the process is cultural change and this is bound to take some time implementing. Instead, the approach should seek to persuade people that, in the circumstances, it is necessary to make the change, and to encourage them to accept restraint without resorting to making claims. In all cases, effective communication is a must, and if managed properly, the process can reap huge benefits. 

Changing contracts

Changing contracts can be done in three ways, starting by agreement. Perhaps oddly, this is not necessarily the best approach, particularly if people do not agree, because forced change for some will highlight the unlawfulness of that means of achieving change.

Next, by dismissal and re-employment. This is dismissing on notice and offering a new contract to begin after the end of the notice period, containing new terms, without the “offending” elements. This is often seen as the best way of changing contracts, but it amounts to dismissing the whole workforce, leaving a business open to potential claims for unfair dismissal and breach of contract, as well as complications in the law on informing and consulting employees in a collective situation. It needs careful management.

Finally, by just doing it. This is simply making the change, without seeking consent or dismissing; taking the risk that claims will not be made. It is important to have a strong business case for the change and to communicate this carefully with employees. While consultation with employees will obviously help, identifying potential problems should also be done before implementation.

Ian Deakin is a Solicitor in the employment team at Pinsent Masons LLP