By: Amanda Douglas
Many employment agreements contain a bonus provision which will often be couched in terms that, on the face of it, seem to vest complete control of the operation of the bonus with the employer.

As an employer, you will have an interest in having such control, given the bonus may or may not be warranted for each particular year. 

However, a common mistake that employers can make in the exercise of a bonus scheme is to presume that the terms of the bonus allow them absolute discretion. So, in situations where the employer has declined to pay a bonus, they will be surprised to find a challenge to their decision by the employee. It was, after all, their decision and theirs only…..wasn't it? - It was labelled as "discretionary", after all.

These employers will, later, be even more surprised when the Employment Relations Authority or Employment Court ("the courts") tells them they were wrong.

So, how do apparently discretionary terms end up becoming an enforceable part of the relationship?

The starting point is found at s 103(1)(b) of the Employment Relations Act 2000 (the Act), which provides for personal grievances for "unjustified disadvantage". For such a grievance to exist, a "condition of employment" must be altered by the employer, unjustifiably, and to the disadvantage of the employee.

Many employers will not naturally view a discretionary bonus as a "condition of employment". So what exactly is a condition of employment and is a bonus one of them?

The Courts have held that a condition of employment is:
"Broadly speaking, terms of employment are all the rights, benefits and obligations arising out of the employment relationship. The concept is necessarily wider than the terms of an employment contract."

A review of several bonus cases reveals that this definition has been used by the courts to capture most bonus clauses from employment agreements, regardless of labels such as "discretionary". For example, bonus payments that have been founded in documents which clearly stated that they were not a part of the employment contract, and could be withdrawn or modified by the employer as they saw fit, have still been held to be a condition of employment. The legal point the courts are making is that a condition of employment is a wider concept than the written terms of the contract.

What an employer should appreciate is where to properly focus its attention. Just because the Courts will classify a bonus clause as a condition of employment, does not mean that the employer is then obligated to pay the bonus.

What the Courts have stated is that an employer, using a discretionary bonus clause, is bound to exercise its discretion to the employee in good faith. So, where the clause provides for discretion to be exercised, the employer must do so, fairly and honestly. If at the end of such an exercise, no bonus will be payable, then so be it and the employee should have no complaint – the employer will have discharged its obligation to exercise its discretion.

The important point for employers is that it will be difficult to argue that a bonus is not caught under the widely interpreted provision at s 103(1)(b) of "condition of employment", no matter what label is put on it.

What an employer should do however is focus on what is contained within the agreement itself. The bonus calculation and whether any amount will be paid should be expressed as discretionary. From there, the employer should ensure that:
  1. there is a history of discretionary calculation treatment.
  2. the payments are not incorporated into wages and are instead paid as separate payments.
  3. the exercise of the discretion is done in good faith.
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