Discretionary Bonuses: A Word of Caution

Originally published January 2005

Bonuses are an important part of the remuneration of many employees, particularly in the financial services sector. However, even if the bonus is 'discretionary', an employer needs to be cautious when exercising that discretion as the recent case of Horkulak v Cantor Fitzgerald show.

Mr Horkulak's fixed term contract provided for an annual discretionary bonus, the amount of which was ultimately determined by the company. He resigned two years before the end of the term because of his employer's conduct and succeeded in his claim for breach of contract. However there was a dispute over the level of damages due to him. Should those damages include compensation for the loss of the discretionary bonus, which he would have expected to be paid if he had stayed in employment until the end of the fixed term?

Previous case law had suggested that the correct approach was to assume that, where there was no contractual obligation to pay a bonus, the employer would have chosen to exercise its discretion in the way that most suited it, and so award nothing. However the Court of Appeal adopted a different approach and implied a term that the parties have a reasonable expectation that the discretion will be exercised rationally, rather than on arbitrary or capricious grounds. In doing so, it followed its earlier decision in Clark v Nomura. It went on to award the full amount of the bonus had the discretion been properly exercised, amounting to nearly £650,000.

Practical Implications

The fact that a bonus clause is expressed as discretionary does not give management the power to do what it likes, particularly where discretionary bonuses are in practice an important element of the remuneration package. An arbitrary or capricious exercise of a contractual power is likely to destroy the relationship of trust and confidence, and so breach the contract of employment; or as put in this case, the parties have a reasonable expectation of 'a bona fide and rational exercise of discretion'. Employers cannot simply suit their own interests, even though the contract may appear to give them the right to do so.

Thwarting TUPE

When an undertaking is transferred, the Transfer of Undertakings (Protection of Employment) Regulations (TUPE) protect the employees' position, so that their employment automatically transfers across to the new owner. The European Court's decision in Suzen suggested that in a service industry with few assets...