Background
Prior to 2008, bonus disputes were staple pieces of litigation for UK employment lawyers. Post-financial crisis, however, major bonus claims started to dry up: banks were paying out more conservatively, taxes were high (reducing the net value of the bonus), appetite for risk was low and, for the most part, the law appeared settled and certain in favour of the employer. In 2014, the European Union introduced a cap on bankers' bonuses, restricting them to 100% of fixed pay (or 200% with shareholder approval). Over the last decade, the cost of litigation has, for most, far exceeded any potential bonus entitlement.
However, keen to give banks greater flexibility post-Brexit, the FCA and PRA scrapped the bonus cap from their regulations in late 2023. Since then, several major UK banks have boosted bonus payments, including Goldman Sachs, JP Morgan Chase, and Barclays.
The result is that bonuses can now be worth fighting for again. CityAm reported that, this year, London "beat Wall Street", with over £7 billion in bonuses being awarded to City bankers with average payouts up 26% on the previous year1. According to The Times, the UK is now home to "the biggest bonuses in the global [financial services] industry".2
Our team has advised on two new bonus disputes in the last few months alone, having already litigated a major dispute late last year.
The legal position
Most frequently, we see employers give employees a contractual entitlement to participate in the company's bonus scheme, which is in itself discretionary. Participation in the scheme is usually the extent of the employee's contractual rights: the quantum of any bonus in a given year, or whether the employee will receive one at all, is at the broad discretion of the employer.
However, operating a discretionary bonus scheme does not absolve employers from making reasonable and fair decisions about bonus payments. An employer's discretion can be challenged by employees, and the Court, where it has been exercised in bad faith, or in an irrational, arbitrary or unreasonable manner. This is a well-established principle of commercial contract law, the leading case being Braganza v BP Shipping Ltd, which gives its name to the so-called 'Braganza duty'.3 Although the case itself relates to insurance, the principles established apply equally to the operation of bonus schemes. This means that employers risk breaching the employment contract if they fail to exercise their discretion under the bonus scheme reasonably.
It is important that employers and employees understand how bonuses are calculated and the factors that make employees eligible for a certain amount of bonus pay. Often, but not always, this is related to performance (be it the company's financial performance, the employee's performance, or both), but may also take factors such as loyalty and retention into consideration. . Employers may choose how prescriptive they want their bonus criteria to be. Some may implement criteria for a bonus payment that is formulaic and objective, such as that based on financial targets, which reduces ambiguity and leaves less room for disputes. Other employers may take a more subjective approach, that perhaps relies on qualitative assessments of performance, for example. The subjective approach offers the employer a much wider discretion, but can lead to disappointment or resentment from employees.
What should employers be aware of?
Assuming that some degree of discretion is retained by the employer, it is the employer's responsibility to exercise that discretion reasonably. Broadly, this means: (1) taking into account all relevant factors; and (2) not making a decision so unreasonable that no other reasonable employer could have come to it. Employers should also be aware that they are bound by the mutual duty of trust and confidence, meaning that they must behave in such a way that preserves an employee's trust and confidence in the employment relationship. This principle should generally govern the employer's behaviour, and the consideration of bonus awards is no exception. For this reason, employers should be wary of creating legitimate expectations of a bonus award or bonus amount amongst employees, lest it not be awarded.
When it comes to assessing whether an employee has met the criteria for a bonus, the question is not necessarily whether the employee's performance is 'good enough', but whether it would be irrational to pay them less than their colleagues, or less than previous years, based on their satisfaction of the bonus criteria (Humphreys v Norilsk Nickel Int (UK) Ltd)4.
It is also possible for employees to acquire contractual rights from participation in a discretionary bonus scheme. In Horkulak v Cantor Fitzgerald, it was considered relevant that bonuses are a significant, and expected, component of an employees' compensation in the financial sector, so much so that this constituted an implied contractual benefit to the employee.5
The crux of most bonus disputes will be in the drafting of the employee's contract and the employer's handbook or separate bonus scheme policy. It is up to the employer as to how much it wishes to fetter its discretion, but it is the employer's responsibility to act reasonably and fairly when exercising it. Where a bonus decision is not deemed to be reasonable in light of the employer's policy, it may very well be open to challenge.