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Understanding employment contracts: Employer’s discretion on bonus payments (Part 1)

08 August 2023

4 min read

#Workplace Relations & Safety

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Understanding employment contracts: Employer’s discretion on bonus payments (Part 1)

The employment contract is the cornerstone of the employer and employee relationship. A good employment contract will set out the terms and conditions of employment in a concise manner and include necessary and well-defined protections for the employer.

However, the standard clauses within an employment contract are regularly scrutinised before courts and tribunals with judgments that vary, and sometimes nullify, the terms of the employment contract. This can be a tough pill to swallow for employers who often think they can exercise the terms of the contract in any way they deem fit because it was agreed and signed by the employee.

In this series, we set out examples of the above scenario, highlight the legal principles which restrict an employer’s ability to rely on the standard clauses within an employment contract and provide guidance to employers on how to address this risk, including suggested improvements to standard clauses within the contract.

This first instalment addresses standard bonus clauses, which generally contain a term to the effect that an employer can exercise discretion over the payment of the bonus.

Standard bonus clause and key legal principle

Bonus clauses come in many forms, however a standard annual bonus clause may read as follows:

“Annual Performance Bonus

a) you (the employee) are eligible to receive an annual performance bonus;
b) the criteria for the annual performance bonus is … (i.e. satisfaction of KPIs); and
c) the decision as to whether you will receive the annual performance bonus is entirely within the discretion of the employer.”

Based on clause (c) above, employers often assume they have an indisputable right to withhold an employee’s bonus, even when the employee has satisfied the criteria set out to be awarded the bonus.

This assumption is incorrect. The case of Silverbrook Research Pty Ltd v Lindley [2010] NSWCA 357 (Silverbrook) tells us that an employer cannot exercise their discretion to withhold a bonus payment ‘capriciously’ or ‘arbitrarily’. This begs the question – what qualifies as a capricious or arbitrary exercise of discretion?

Learnings from Russo v Westpac

The legal principle applied in Silverbook was also relied upon in Russo v Westpac Banking Corporation [2015] FCCA 1086.

In this matter, the employee commenced his employment in May 2009 as a senior manager. His contract included an annual bonus clause, which set out various performance criteria that would qualify him to earn the annual bonus, which was a maximum of $70,000. All components of the bonus clause were said to be at the “absolute discretion” of the employer.

In his first full year under the bonus scheme, the employee earned the full $70,000 bonus.

In October 2021, over ten months into his second year under the bonus scheme, the employee was made redundant.

The employee’s employment contract contained a number of termination clauses to incorporate the terms of applicable policies and required the employer to comply with those policies, including the redundancy policy. The redundancy policy contained an obligation upon the employer to pay a pro-rata bonus (i.e. the bonus the employee would have been paid if not for the redundancy, at a pro-rata basis), at its absolute discretion.

The employer opted to make no pro-rata bonus payment to the employee upon the termination of his employment by way of redundancy. The employer did so because of its findings in respect of the employee’s performance in the relevant period. However, the court found that the employer’s decision-making process in respect of its decision to make no pro-rata bonus was flawed (and arbitrary and capricious), due to the following reasons:

  • the employer considered both impermissible matters and factors outside the agreed framework in assessing the employee’s performance
  • the employer breached the agreed performance review process in the applicable period by failing to conduct an annual review session with the employee
  • an annual review rating of “effective-low” was made without giving the employee an opportunity to respond
  • an objective analysis of the criteria within the redundancy policy indicated that the employee should have been paid a bonus. 

The court found that the above failings amounted to the employer seeking to exercise its discretion in a manner that was arbitrary and capricious. The employer was ordered to pay the employee the full amount that could be paid in respect of the outstanding bonus.

Lessons for employers

Employers should understand that an ‘absolute’ or ‘sole’ discretion to withhold bonus payments, which would otherwise be payable under an employment contract, is not unfettered and should be exercised with caution.

If an employer wants flexibility in deciding whether or not to award a bonus, they should ensure that the criteria and other qualifications that apply to the bonus payment within the employment contract do not restrict the exercise of a broad discretion or limit the situations in which it may choose not to make a bonus payment.

If you have any questions on employment contracts or standard bonus clauses, please get in touch with a member of our team below.

The information in this article is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this article is accurate at the date it is received or that it will continue to be accurate in the future.

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