The limitations on discretionary bonus clauses

24 January 2018

Kristy Peacock Smith, Leila Moddel

Employment contracts, particularly for senior or executive employees, often contain discretionary bonus clauses. Such clauses are generally drafted to give employers absolute discretion in respect of determining the amount of and entitlement to bonuses. However, the recent decision of Crowe Horwath (Aust) Pty Ltd v Loone [2017] VSC 163 confirms this decision is in no way absolute or unfettered.

Allegations

Crowe Horwath (Aust) Pty Ltd (CHA) initiated proceedings against its former employee, Anthony Loone, seeking to enforce restraints contained in the employment contract. Mr Loone brought a counterclaim against CHA, alleging that it breached various clauses in his employment contract (relating to remuneration and bonus entitlements), thereby terminating the contract and rendering any restraints unenforceable.

Mr Loone's arguments related to a series of events that occurred between October 2014 and 1 July 2016. Between October 2014 and August 2015 Mr Loone was heavily involved in CHA's acquisition of the Davey Financial Group (DFG). In the year ending 30 June 2016, the acquisition was expected to contribute an estimated $200,000 to the office's bonus pool. However, on 1 July 2016 Mr Loone was informed that the profitability from the DFG acquisition would not be accounted for in the Launceston bonus pool, of which Mr Loone was a beneficiary (the Bonus Pool Decision).

This decision followed that made earlier on 9 June 2016, whereby senior management introduced a new incentive model for bonus payments. This involved payment of 80% of the annual bonus in cash at the end of the year and deferred payment of the remaining 20% over a three-year period (the Deferred Payment Decision).

Mr Loone argued that both the Bonus Pool Decision and the Deferred Payment Decision constituted a breach of the terms of the discretionary bonus clause ("Bonus Clause") of his contract and amounted to repudiatory conduct by CHA.

Findings

The Deferred Payment Decision

The Court considered the construction of the Bonus Clause, which was worded as follows:

It found that when cl 7.5 was read in conjunction with the definition of 'remuneration' it was plain that the discretionary and non-discretionary components of remuneration were payable within a 12 month period and therefore, a reasonable construction of the clause was that it did not confer a right upon CHA to defer or withhold any bonus payment. That is, the clause did not permit CHA to 'arbitrarily choose that it need not pay a bonus in circumstances where the set objectives have been satisfied'.

The Court found CHA's fundamental obligation was to assess Mr Loone's full bonus entitlement in accordance with the prescribed mandatory criteria and pay that amount 'in any year'. 

The Court considered that if the parties wished to make payments under a bonus scheme ‘entirely gratuitous and voluntary such that payment could be withheld capriciously…they need to say so clearly'.

The Bonus Pool decision

The Court relied on the following legal principles in relation to the Bonus Pool Decision:

  • Whether the bonus pool decision constituted repudiatory conduct turns on whether CHA manifested an "unwillingness to perform a contractual obligation" imposed by the Bonus Clause; and
  • Where an employer 'unilaterally reduces his employee's pay, or diminishes the value of his salary package, the entire foundation of the contract of employment is undermined… An emphatic denial by the employer of his obligation to pay… will normally be regarded as repudiatory'.

Having considered the contract, the Court held that the Bonus Clause conferred upon CHA an absolute discretion as to the quantum of any bonus payment. However, that discretion was subject to a mandatory contractual obligation that '[t]his amount will be determined by consideration of various performance parameters…'

The clause did not give CHA the power to exclude from the assessment of Mr Loone's personal performance the DFG acquisition, which he expended hundreds of hours on.

Accordingly, CHA's refusal to comply with the mandatory criteria in the Bonus Clause was such that a reasonable person in Mr Loone's position would consider that CHA renounced a fundamental obligation under the contract.

Affirmation or acceptance of repudiation – Bonus Pool Decision

The Court then considered whether Mr Loone's delay between having knowledge of the Bonus Pool Decision on 1 July 2016 and his departure on 12 July 2016 either affirmed or accepted the repudiatory conduct of CHA. The Court found that although Mr Loone continued to receive a salary between 1 July 2016 and 12 July 2016, this did not constitute affirmation of the employment contract. Rather, he made clear that he thought the Bonus Pool Decision was 'very unfair' and informed his seniors that he would be reassessing his position. Therefore, Mr Loone was entitled to rely on CHA's Bonus Pool Decision as the basis for terminating the contract.

As a result of these findings, amongst others, CHA was found not to be entitled to enforce the restraints in Mr Loone's employment contract.

Key takeaways for employers

  • The discretion given to employers in discretionary bonus clauses will be limited by the proper scope and content of the bonus clause/policy and a reasonable construction of the clause, taking into account principles of honesty and arbitrariness.
  • Discretionary bonus clauses must be drafted clearly and carefully – the discretion may only apply to certain elements, e.g. quantum of bonuses, and in any case, all potential uses of the power should be made explicit.
  • Be extremely cautious when making any decisions to unilaterally reduce pay (including bonuses) as such obligations form the foundation of employment contracts. A breach of these obligations may constitute repudiation of the contract and may render other important provisions, such as restraints of trade, unenforceable.
  • If an employer makes a decision or will be making a decision that deviates from the pay-related obligations under the contract, take note of the affected employee's conduct, including any representations they might make. Remember that mere delay in accepting repudiatory conduct does not always constitute affirmation of the contract.

Authors

Leila Moddel

Leila Moddel

Associate
Australia

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