When it comes to business, there is one clear truth: exceptional employees are the backbone of any successful enterprise. These high performers fuel innovation, drive productivity, and ultimately steer the ship towards long-term prosperity. Understandably, retaining such invaluable talent becomes a top priority for businesses keen on maintaining their competitive edge.

Businesses are constantly on the look-out for ways to reward and incentivise their star players, and the tool of choice seems to be bonuses. A common approach to offering bonuses is linking the quantum to an employee’s performance in a particular period (e.g., quarter, month, year), while making it clear that the provision of such bonuses is subject to the absolute discretion of the employer. This discretionary label serves a dual purpose: it offers businesses the flexibility to reward exceptional performance, while providing a safety net in lean financial times.

Perhaps to the surprise of many employers, having an agreement that allows them to exercise absolute discretion over setting the criteria for and determining if and when bonuses are paid does not necessarily mean they get to exercise the discretion in whichever way they like. The way these agreements operate, from a compliance standpoint, is far more nuanced than what initially meets the eye. The complexity tends to lie within the balance between employer discretion and ensuring employees fully receive what they have rightfully earned.

In this blog, we aim to unpack the intricacies of discretionary bonuses by examining some key decisions in this area and exploring the implications for both employers and employees. In particular, we will be canvassing the “grey areas” where certain perceptions may clash with realities, and through these, what lessons employers can learn to reduce their exposure to various legal risks.

Constraints by Contract Law: Lessons from Silverbrook and Subasic

Unlike wages, allowances and reimbursements which are heavily regulated by legislation and industrial instruments (e.g., modern awards, enterprise agreements), bonus arrangements are governed by contractual terms which have been agreed upon by an employer and their employee. When disputes about these arrangements arise, the resolution ultimately lies within the proper construction of these terms.

Based on guidance from current authorities, resolving these disputes often starts with posing two questions:

  • On proper construction, does the wording of the bonus arrangement actually give the employer absolute discretion over setting the criteria for and deciding if and when the bonus is paid?;
  • If so, are there any exceptions or limits at law to the exercise of such discretion?

If the answer is “no” to the first question, then the employer’s discretion would be limited by the terms of the bonus arrangement. How they set eligibility criteria for the bonus and when the bonus is to be paid need to be in accordance with the mutually agreed terms.

If the answer is “yes” to the first question (ie the contract clearly states that the bonus is paid at the employer’s discretion), then the story becomes a lot more interesting. Case law reveals a nuanced approach to the concept of “discretion”. Take, for instance, the case of Subasic v Hewlett-Packard Australia Pty Ltd [2020] ACTSC 2, which involves a high-performing sales employee who vastly exceeded her performance targets, rendering her eligible for an amount of bonus exceeding $400,000 (Eligible Bonus). Instead of paying out the full amount, the employer sought to rely on the “absolute discretion” clause to pay out an amount that was far less than the Eligible Bonus and impose an arbitrary cap on the maximum amount of bonus that the employee could receive.

The ACT Supreme Court ruled that on proper construction, the contract did not give the employer absolute discretion with respect to the bonus arrangement. But, the Court interestingly commented that if it had been wrong about construing the employer’s discretion, it would have found there was an implied term of “good faith”. This implied term would have operated to prevent the employer from exercising the discretion “arbitrarily, capriciously or unreasonably”.

This ruling echoes the reasoning of an earlier decision of Silverbrook Research Pty Ltd v Lindley [2010] NSWCA 357. The case involves a business strategist who, according to their employment agreement, was entitled to a base salary exceeding $200,000 and eligibility for an annual performance-based bonus based on quarterly reviews of their performance. The contract explicitly stated “the decision regarding whether Lindley should receive the bonus was entirely at the discretion of Silverbrook“. Throughout the employee’s tenure, the employer never assessed their performance, which meant the employee’s eligibility for the bonus was never considered.

Upon resignation, the employee commenced legal proceedings to seek compensation for lost opportunity to be paid an annual bonus because of their employer’s failure to assess their performance. In defence, the employer claimed there was no lost opportunity, as they would have exercised their absolute discretion to not pay out the bonus even if the employee had satisfied the eligibility criteria.

The NSW Court of Appeal, as part of its reasoning, explained such a clause should not be interpreted to allow the employer to withhold the bonus arbitrarily or unreasonably. One interesting comment made by the Court is that a discretionary bonus clause could truly be discretionary only if it explicitly states that payment could be withheld arbitrarily, regardless of whether or not the bonus’s eligibility criteria are met. We would not imagine that such an explicit clause would be well-received by employees!

The key takeaway from the above discussion is that while discretionary bonuses offer employers flexibility in rewarding performance, the discretion is never truly that discretionary – from a contract law standpoint, it is constrained by the way in which the discretion has been framed by both parties and the way in which the employer seeks to exercise the discretion.

Other Constraints: The General Protections Regime and the Australian Consumer Law

Apart from contract law constraints, there are additional limitations on such discretion that employers need to be mindful of.

The general protections regime under Part 3-1 of the Fair Work Act 2009 prohibits employers from taking any adverse action against employees because of an exercise of workplace rights (e.g., raising a complaint or inquiry in relation to their employment) or having a certain attribute that is protected by law (e.g., gender, sexual orientation, marital status).

These protections would very likely to be triggered if an employer sought to exercise their discretion to the detriment of their employee because a question or complaint has been raised about the bonus. To illustrate with an example, an employer would be exposed to the risk of breaching these protections if their employee raised a question about delays in paying out a bonus (i.e., an exercise of workplace right), and the employer subsequently decides not to pay out the bonus because of the employee’s question.

Section 31 of the Australian Consumer Law (ACL) also provides another layer of protection that can potentially act as another limit on the exercise of an employer’s discretion with respect to bonuses. This provision prohibits employers from engaging in any conduct that is liable to mislead persons seeking the employment as to the terms of their employment.

Consider a situation during the recruitment process where a prospective employee is guaranteed a specific bonus amount subject to meeting predetermined targets set by the employer. Upon commencing work with the employer, the employee is informed whether or not the bonus is paid is entirely at the discretion of the employer. Such conduct on the employer’s part may constitute a breach of the ACL, as it misrepresents the promise made during the recruitment process. Where a breach is found to have occurred, the Court may order the employer to honour the original promise (see section 232(6) of the ACL), notwithstanding the fact that the contract may have given the employer absolute discretion over bonuses.

Key Takeaways

Taking advantage of the discretionary nature of a bonus arrangement is unfortunately not a straightforward exercise of contractual entitlement/right. While employers enjoy some degree of discretion over setting the eligibility criteria for and deciding when to make bonus payments, it is important to acknowledge that the discretion is not boundless. Various legal safeguards, spanning from contract law to Australian consumer law, operate to limit such discretion.

Each situation is different, therefore, if your business has in place a discretionary bonus scheme and you contemplate withholding bonuses contrary to the scheme’s terms, or altering a longstanding arrangement potentially to the detriment of your employees, it is important to seek professional advice first!

Our team is ready to assist you in assessing the associated risks and providing clear guidance on when you should seek further legal advice. Don’t hesitate to reach out to us today!

Disclaimer

The information provided in these blog articles is general in nature and is not intended to substitute for professional advice. If you are unsure about how this information applies to your specific situation we recommend you contact HR Connect for advice.

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