This blog delves into the question: ‘When does a bonus become contractual?’ Discover the critical considerations and legal insights surrounding this key aspect of incentivising your workforce.

It has been reported that England manager Gareth Southgate scored an eye-watering £250,000 bonus after England booked a place in the World Cup finals.

Although not usually to the same scale, employers often link pay to the performance of an individual employee, a team or department, or the business as a whole. Bonuses can be a useful tool to incentivise, reward and retain current employees, and attract prospective talent. But they should also come with a warning sign.

Types of bonus

Broadly, bonuses can be contractual or discretionary in nature.

If the bonus is contractual, the employer must make these payments if the employee meets the required criteria. For example, if you set clear performance targets and the employee meets them, you will need to pay out the bonus.

If the bonus is discretionary, it means the employer can choose when to pay the bonus, how to calculate it and the total amount that will be paid out. However, case law has made it clear that employers must not use their discretion in an irrational or perverse way.

It is common for bonuses to be a mixture of the two. For example, an employer may provide a contractual right for the employee to be eligible for the bonus scheme, but it will be subject to the discretion of the employer as to how much the employee will get.

What to look out for

Courts and tribunals are not concerned about labels. Stating that the bonus is discretionary is not enough. They will analyse the nature of the bonus and the circumstances around it.

Factors which may be taken into account when considering whether a bonus scheme is discretionary or contractual will be the wording used. Using words such as ‘entitled’ or ‘will be paid’ may suggest that the scheme is in fact contractual. Other relevant factors include the frequency of any such payments and the basis on which they are made.

It may become an implied term of the employee’s contract of employment if there is a long-standing or established custom or practice across the workplace or industry. For instance, this may be the case if an employer pays a Christmas bonus over a number of years. Although the contract does not say this and the employer has never sat down with the employee to specifically agree to it, it can form part of the contract.

In general, this will be the case where the practice

• is clear and certain
• is fair and reasonable
• has been going on for a long period of time (the law does not set out a specific length of time)
• is known to employees and they have a reasonable expectation of receiving it
• has been consistently applied to employees.

Finally, employers need to take great care that when they are exercising their discretion – they must not do anything that could amount to discrimination.

Get the experts view

It doesn’t matter how big or small your enquiry is, it is worth contacting your Employment Law Adviser. They can give you tailored advice aligned to your business interests.