DISCRETIONARY BONUSES

01.01.07

Discretionary Bonuses

It is common for employers to retain a discretion over bonus awards. However, this discretion is not absolute. In all cases an employer is under an implied contractual duty not to exercise its discretion in an irrational, perverse or arbitrary manner. In addition there may be express contractual limits, such as where the bonus is dependent on individual performance. We consider a High Court decision which looked at whether or not an employer was entitled to award no bonus at all to a senior employee.

In Ridgway v JP Morgan the High Court decided that the employer was entitled to award a "nil" bonus to a trader who had spent most of the year on sabbatical.

Mr Ridgway was employed by JP Morgan as head of the Options Desk and was regularly awarded significant annual cash bonuses. The bank agreed to him taking a year's sabbatical commencing in April 2003. One of the terms of the sabbatical agreement was that he continued to be eligible for a discretionary bonus for the year ending December 2003. Subsequently Mr Ridgway was awarded a "nil" bonus for 2003.

After his sabbatical Mr Ridgway's job was unavailable and agreement could not be reached on an alternative role. He resigned, claiming constructive dismissal and breach of contract in respect of the decision not to award him a bonus.

The High Court dismissed his claims, following the guidelines for the award of discretionary bonuses set out in Commerzbank v Keen. In Commerzbank the Court of Appeal stated that the hurdle is set very high for an employee to show that a bonus decision is irrational or perverse. However, an employer is still required to give reasons for the level of bonus awarded and identify the decision maker.

The High Court decided that JP Morgan had fulfilled its obligation to consider Mr Ridgway for a bonus and had not ignored him because he was on sabbatical. They were entitled to award him a "nil" bonus because he had been making a loss before his sabbatical, was away on sabbatical for most of the bonus year and there were no other significant contributions to the business or other special factors to justify an award.

In practice

Although the risk of a successful challenge to a bonus award is low, it is clear that an employer must be able to produce evidence to justify its decision. Employers should bear the following in mind when making decisions on bonuses:

  • Ensure that the bonus wording provides the level of discretion required. This can be absolute (subject to the duty not to act irrationally or perversely) or subject to specific factors such as the employer's or individual's performance.
  • Fully consider what bonus each employee is going to be awarded, if any. This should be done on an individual basis with the employee being informed of the decision maker. Document the procedure followed and the reasons behind the decision making. As well as providing a defence to any breach of contract claim, a transparent decision-making process will help demonstrate that the award was not influenced by any discriminatory factors such as the employee's sex, race, religion, orientation or age.

Ridgway v JP Morgan Chase Bank National Association 2007 EWHC 1325