The Mishcon Academy Digital Sessions. Conversations on the legal topics affecting businesses and individuals today.
Mark Levine, Partner
Mishcon de Reya
With the bonus season nearly upon us, what can employees expect with regard to their bonus awards? Will there be a change in the form of bonus awards and what will be the implications of any deferred awards?
Hello, and welcome to the Mishcon Academy Digital Sessions podcast. I am Mark Levine, a Partner in the Employment Department at Mishcon de Reya and I am joined by my partner, Neil Sharpe, a Partner in our Incentives Team. With the Covid rules in place, we are recording this podcast from the comfort of our homes. Hello Neil.
Neil Sharpe, Partner
Mishcon de Reya
Hi Mark. Thanks for inviting me along today. So Mark, what can employees expect this year when it comes to their bonus awards?
Mark Levine, Partner
Mishcon de Reya
Well, inevitably with Covid and the hit that many companies have taken to their finances this year, I expect that bonus payments will be much lower than in previous years and, in many cases, maybe no bonuses will be paid at all. However, the type of bonus scheme operated by employers will be the key to determine how bonus decisions should be made by employers. There are many types of bonus schemes but the most are either performance based or discretionary or a combination of the two. The first type of bonus scheme is one that provides an entitlement to a certain bonus payment often in accordance with a specific bonus formula. Sometimes the amount will be determined solely by objective criteria such as revenue targets for a sale employee. If those targets have been met, the bonuses should be paid regardless of the company’s overall financial position. In other cases, there will be subjective criteria such as a general assessment of the employee’s performance. This will give the employer more scope to set the bonus award. Another category of bonus awards are guaranteed bonuses. These are often paid to new joiners to incentivise them to move jobs or to buy them out of their bonus expectations with their previous employer. Again, regardless of the company’s overall finances, these guaranteed bonuses should be honoured.
The second type of bonus scheme and by far the most common, is a discretionary one. This is where payments are made at an employer’s discretion and on the employer’s terms. Whilst bonus pots will inevitably be lower for most companies, those that award discretionary bonuses will need to be mindful of the limits placed on the exercise of their discretion. The duties overlap but in essence, an employer must first exercise the discretion honestly and in good faith. Second, must not exercise the discretion in an arbitrary, capricious or irrational manner and thirdly, they must treat employees even-handedly. Employers should also be aware that they may be required to give reasons for their bonus decisions so those reasons should be carefully considered and documented.
Neil, given that discretionary schemes allow employers to decide the form of bonus awards, do you think that more bonuses this year will be paid in shares rather than in cash?
Neil Sharpe, Partner
Mishcon de Reya
Mark, I think there’s a good chance that that will be the case. A lot of companies have been trying to preserve cash through the Covid pandemic and one way they can do that is instead of paying bonuses in cash, they pay bonuses in company shares. This was done in fact by a number of companies at the beginning of the pandemic when they were paying out bonuses for the 2019 performance year. Typically, when bonuses are paid in shares, actual delivery of the shares is delayed by one, two or three years and the delivery of the shares themselves depends upon the employee remaining employed with the company, so in this sense deferred bonuses act as a retention tool for employees. The value of the shares which go into a deferred bonus award, is normally worked out by companies looking at the share price at the time when they would have awarded a cash bonus and then they take the value of that cash bonus and divide it by the share price and that gives the number of shares which go into the deferred award. In terms of tax, the employees normally only get taxed when they actually receive their shares so it’s not normally the case that they get taxed up front when they would have got a cash bonus, instead they are taxed when they actually receive their shares.
Mark, do you expect conditions to be applied to any bonus awards this year?
Mark Levine, Partner
Mishcon de Reya
I do Neil. I think we may see a greater adoption of repayable bonuses and maybe clawback terms, the sort of terms that are applied on a mandatory basis in the financial sector. I think we may see those terms applied more widely in other sectors. This could see performance adjustment conditions applied. Typically, this would allow employers to recover cash bonuses where, for example, a company has had to restate its accounts or has become aware of serious wrongdoing. This may now be extended to maybe cover an overall decline in revenues between the bonus being awarded and paid several months later. I also expect that employers will be strictly applying the condition that employees will not be entitled to a bonus if they are no longer employed on the bonus payment date. As a result, employees who are dismissed between their award and the payment date by say, reason of redundancy or any other reason or if they happen to resign, then they may well see their bonuses forfeited.
Neil Sharpe, Partner
Mishcon de Reya
And in fact, actually with deferred share bonuses, the companies have even easier way of withholding payment. Because of the deferral of the bonuses for several years, this gives the company the opportunity to forfeit the bonus or to reduce the size of the bonus in the form of the shares which are delivered to employees at the end of the deferral period.
Mark Levine, Partner
Mishcon de Reya
And Neil, what are the pros and cons of deferred bonus awards?
Neil Sharpe, Partner
Mishcon de Reya
Well, the obvious con for the employee is the fact that they won’t receive their cash up front, instead they have to wait, usually a number of years, before they will receive any value and normally, they have to remain employed so if an employee wants to resign and go and work for another company, it’s often the case that they will lose their deferred bonus. This of course would not be the case if they had already received a cash bonus instead of a share bonus. However, one potential advantage of a share bonus is the fact that the value of the shares will change over the deferral period and there is the possibility that the share price will be higher when the shares are actually delivered than they were when the award was first made and so this would mean that the employee would actually receive more value than they would have received if they had got a cash bonus. However, of course this situation can work the other way round so that the share price declines and the employee actually gets less than they would have got if they had received a cash bonus. Another aspect of deferred share bonuses is that the theory is that it makes employees focus on the company’s share price and be motivated to improve the performance of the company, however it’s a moot point as to whether this actually works with more junior employees who have less ability to influence the performance of the company.
Mark Levine, Partner
Mishcon de Reya
Well, for now, let’s wrap up there. I’d like to say a huge thanks to Neil for joining me for this Mishcon Academy Digital Sessions podcast. I am Mark Levine and in the next episode, my colleagues Katy Colton and Emily Nicholson will be discussing proposed reforms to judicial review and the interaction with issues of rule of law.
The Digital Sessions are a series of online events, videos and podcasts, all available at Mischon.com and if you have any questions you’d like answered or suggestions of what you’d like us to cover, do let us know at digitalsessions@mishcon.com. Until next time, take care and stay safe.
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