08 November 2016

The discretionary disappearing trick: when bonus clauses are not what they seem

This was written by Cerys Williams, Counsel

Bonus discretion, or the lack of it, has been under judicial scrutiny again this month in the Court of Appeal decision of Brogden v Investec.

The case concerned the operation of a contractual bonus scheme with a set percentage of “EVA” (Economic Value Added) by a division within Investec being put into a bonus pool for subsequent distribution to participating employees. The EVA was calculated by an automated process but impacted by factors over which Investec had control, such as the notional rate of interest applied to funds generated by the unit. For the year in question, based on the EVA calculation methodology, the unit recorded a loss and accordingly no bonus was paid. Two bonus participants challenged this outcome on the basis that EVA should have used its discretion to calculate EVA differently and with a broader emphasis on the value generated by the unit.

At first instance, Investec succeeded in showing that they had exercised their discretion lawfully, according to the principles set out in previous cases. The employees appealed to the Court of Appeal who agreed that no bonus was due. However, the interesting aspect of the judgement is that they did so on a different basis than the High Court. The Court of Appeal, reviewed the facts of the case and found that, in fact, the calculation of EVA did not involve discretion at all. It was simply a calculation according to a formula well-known within the bank. It could therefore not be challenged on the basis that discretion had been irrationally or perversely exercised; that point simply did not arise. What does this mean for employers?

The findings in this case were fact-sensitive and each situation will be different. However, this is an important reminder that not every decision made by an employer involves the exercise of discretion. Where there is doubt or dispute, it is crucial to carefully consider the drafting of the contractual clauses in question to assess whether discretion arises and, if so, to what extent. Often the clause will be a hybrid or composite, with flexibility over some aspects but other aspects being conditional on objective facts. This is a double-edged sword, of course. While the absence of discretion side-steps certain grounds of legal challenge, it leaves less room for flexibility and manoeuvring, so it will be essential that the clause incorporates at the outset all necessary factors upon which the employer wishes to rely. Equally important though is that the employer understands at the time of making the decision where it has flexibility and in which respects its options are fixed or limited.

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