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Bonus Clauses: Be Sure they Say What You Think They Say

Bonus: You will be entitled to a discretionary annual bonus of up to 40% of your base salary, to be calculated using the formula set out at Appendix A and updated from year to year, which will take into account both company and individual performance. Payment of any bonus is purely discretionary and there is no guarantee of a bonus in any particular year or the amount thereof.

Can you determine, in this example from my recent Canadian HR Law blog post, what this employee will be entitled to? Is the bonus calculated using a formula which takes into account his or her performance and that of the company? Or is it purely discretionary? Is he “entitled” to an annual bonus? If so, how much? Sadly, I see many clauses like this.

Many organizations provide employees with bonuses as part of their compensation packages. These are often intended to be “token” payments, to be doled out at the discretion of the organization and based upon factors including the performance of the organization, its financial condition, and the perceived contribution of the individual employee (and, in many cases, the mood of the owners/management). These are purely discretionary bonuses, with no obligation to pay them and no specific or required method of calculating the amount.

Conversely, some employees will be hired based upon a compensation package that includes a bonus as a significant component. In some cases, this can be 40% or more of the individuals based salary. Whatever the parties’ expectation, it is critical that the agreement be consistent with that understanding. Unfortunately, we see far too many bonus provisions which are either completely at odds with the expectations of one or both parties, and/or are internally inconsistent.

With respect to “internally inconsistent”, what I mean is a clause like the one above, which attempts to state that the bonus payment is both purely discretionary and also based upon specific objective criteria. Logically, it must be one or the other.

When we advise employees, or individuals that have received an offer of employment, we work with them to ensure that the offer of employment is consistent with their expectations. In many cases, they have been told that they can expect a bonus of a certain amount, such as 30% of their base salary. However, when they show us the written employment agreement, it states that any bonus is purely discretionary. As we explain to them, this means that they have no guarantee of any bonus payment, let alone 30% of salary. Furthermore, a well-written employment agreement will contain an Entire Agreement clause which states that any previous or other agreements, be they verbal or written, are irrelevant and that the terms and conditions of the employment relationship are only those set out in the employment agreement. In other words, those other discussions regarding bonuses, even if they are in writing and guarantee a certain amount, are irrelevant. An individual considering an offer of employment needs to be sure that they know what their rights and obligations will be. If they are counting on a bonus as a substantial portion of the compensation package, they should not agree to any offer which makes that discretionary.

From the employer’s perspective, we usually encourage our clients to maintain as much discretion as possible. We do not want them to be saddled with expensive bonus obligations in the event of a financial downturn or other challenging circumstances. We therefore encourage clients to put clear language in the agreement which states that any payment of a bonus is discretionary there is no guarantee of any payment from year to year. That said, in order to attract the best talent, employers will sometimes have to provide specific assurances regarding bonus payments. If that is the case, they will have to make a business decision as to what to offer. They should ensure that the clause is clear, as any ambiguity will be interpreted against the interest of the employer. If objective criteria are to be used, they should be clearly set out and, if the contract says that they will be updated annually, they should make sure that is done.

Bonuses can be an unexpected extra payment, or a core part of someone’s compensation package. Whatever the expectation, employees and employers should ensure that the agreement they sign is consistent with it. Contacting an employment law prior to signing a new offer of employment, or when developing a bonus policy, is always advised.

By Stuart Rudner

 


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