Contractual status of benefits


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“In the past, we have typically paid employees a bonus of £1,000 in January as a “thank you” for their efforts the previous year.  Pay reviews are carried out at the same time.  2015 was a difficult year for our business and we need to make some cut backs.  Can we avoid paying an annual bonus and awarding a pay increase this year?”

Before going so far as to revoke any existing benefits, an employer should first look at its employment contracts and any other contractual documentation to ensure that there is no clear contractual entitlement to the same.  Obviously, if there is, then a failure to honour such terms will amount to a breach of contract.

Provisions relating to pay reviews and bonuses can often be found in employment contracts and, where the contracts are well drafted, they may stipulate that any such benefits are entirely at the employer’s discretion.  This sort of wording is designed to incentivise employees with the promise of a benefit whilst purporting to retain maximum discretion for the employer over whether a payment is made at all, the amount paid, or the timing and conditions of the payment.  However, the courts appear to be willing to accept that, if bonuses have been paid to employees on a consistent and regular basis, as they appear to have been in the above scenario, then employees may have acquired a contractual right to receive such a benefit, notwithstanding the employer’s purported discretion not to pay the same.

The traditional test adopted by the courts to determine whether or not a term has been implied by custom and practice is whether the term is “reasonable, notorious and certain”.  However, the fact that a practice has continued for a number of years is not enough to establish an implied contractual term: it must also be shown that the parties complied with the term because of a sense of a legal obligation to do so.

As the courts become more willing to imply terms relating to bonus payments by custom and practice, there seems to be no reason why the same principles cannot also be applied to the employees’ pay reviews, as employees are likely to have a similar expectation that they will receive a pay rise if these have been granted on a regular basis for a number of years.

In an effort to determine the risk of whether or not a discretionary benefit could have attained contractual status, employers should ask themselves the sorts of questions that a court would be expected to consider: Have the employees received a bonus and a salary increase without exception for a substantial period?  Are bonus payments made and/or salaries increased automatically or are they demonstrably affected by the underperformance of an employee?  Have the terms been consistently and regularly applied?  If the answer to each of these questions is yes, then a court may well deem these “discretionary” benefits to have become contractual rights.

Interestingly, employees sometimes seem to be more willing to accept that they are not going to receive a pay rise than a bonus (which they expected to receive).  It’s not clear why the psychology relating to these two types of benefits differs, and why employees seem more willing to accept the exercise of employer discretion in relation to pay increases than is the case with bonuses.  Nevertheless, the risk remains that any departure from the practice of paying employees an annual bonus or from carrying out annual pay reviews could give rise to a claim in the employment tribunal against the employer.  Such claims would be for unlawful deduction from wages or (if the claim is being brought after the termination of the employees’ employment) as a breach of contract claim.

The careful drafting (and operation) of provisions relating to bonuses and pay reviews will help to prevent terms from being implied by custom and practice in the future and should assist employers in retaining maximum flexibility in relation to the same.  However, it is important that employers are aware that merely labelling a benefit as “discretionary” does not necessarily make it so.

For further information, please contact Taj Rehal (trehal@fladgate.com) or Michael McCartney (mmccartney@fladgate.com).

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