When discretionary bonuses are not discretionary

The New South Wales Court of Appeal has recently highlighted the importance of ensuring that bonus provisions in contracts of employment properly reflect the intent of the parties. In short, the court found that a contractual stipulation that the payment of bonuses to an employee was within the discretion of the employer was not enough to avoid damages being award to the employee for breach of contract.

The case provides a lesson for employers about being active and disciplined in setting objectives for employees and managing performance against those objectives.

In Silverbrook Research Pty Ltd v Lindley, the employment contract specified that the employee had a potential bonus of up to $40,000 per annum. The employer was to set performance objectives for the employee at the end of each quarter and then assess the employee’s performance against those targets. The contract contained a clause stating that the payment of the bonus was “entirely within the discretion” of the employer.

The court said that these words needed to be read in the context of the contract and that the employer could not exercise its “discretion” to enable it to withhold the bonus “capriciously or unreasonably or arbitrarily”. In other words, the employer’s real problem was not that it failed to pay the bonus, but that it failed to set performance objectives or to assess the employee’s performance, as the contract required it to do.

As a result of this breach of contract, the court had to make an assessment of what opportunity had been lost by the employee to earn bonus, if the employer had in fact complied with those obligations.  A sum of damages was awarded by the court.

The case demonstrates some valuable lesson to employers in preparing employment contracts:

• A statement that bonuses are “discretionary” won’t excuse an employer from other obligations to consider how a bonus might be assessed;
• For a bonus to be capable of being withheld at the discretion of the employer, and despite the achievement of performance objectives, the contract must say so clearly;
• Setting performance criteria and assessing employee performance are often seen by managers as a necessary evil, but not doing it when the contract says you will do it could leave you exposed to claims for breaching an employment contract.

Peter Vitale is a lawyer who has his own practice focussed on employment and industrial relations law. Find him at www.petervitale.com.au