It is quite common for employment contracts, especially for senior employees or executives, to have provision for a bonus at the employer’s sole or absolute discretion.

However, the recent decision by the Supreme Court of Victoria in Crowe Horwath (Aust) Pty Ltd v Loone [2017] VSC 163 (Crowe Howarth) shows that such clauses might not mean that employers will have an unfettered discretion in deciding whether to pay bonuses.

It is a reminder that employers need to exercise care in drafting their employment contracts and bonus provisions, and when deciding whether to pay bonuses.

Factual background

In Crowe Horwath, the employer was a national accounting firm. The employee, Mr Loone, was the Managing Principal of the employer’s Launceston office. Clause 7.5 of Mr Loone’s employment contract provided the employer would determine, at its absolute discretion, the amount of any bonus paid to Mr Loone by considering “various performance parameters” including Mr Loone’s personal performance, the employer’s performance, and broader economic conditions.

Between October 2014 and August 2015, Mr Loone spent 600 hours negotiating and completing the employer’s purchase of another Launceston accounting firm, the Davey Financial Group (DFG). This acquisition contributed a net profit of $440,000 to the profits of the employer’s Launceston office in the 2015/2016 financial year (DFG Profits).

On 9 June 2016, Mr Loone was told by the employer’s senior management that the employer would be introducing a new bonus model where bonus payments would be divided into two components:

• a “cash payment” constituting 80% of the annual bonus payment and paid at the end of the relevant year; and
• a “deferred initiative” constituting 20% of the annual bonus payment, for which payment would be deferred for 3 years.

On 1 July 2016, Mr Loone was told by his superior that the DFG Profits would not be included in the “bonus pool” for staff in the employer’s Launceston office for the 2016 financial year.

This significantly reduced the size of the bonus pool which, in turn, significantly reduced the size of the bonus that Mr Loone may have been eligible to receive.

As a result of the employer’s changes to the bonus model and its decision not to include the DFG Profits in the bonus pool, on 12 July 2016 Mr Loone resigned from his employment effective immediately.

Legal issues

In proceedings brought against Mr Loone by the employer seeing to enforce post employment restraints, Mr Loone counterclaimed that the employer had breached the contract by changing the bonus model and by not including the DFG Profits in the Bonus Pool. The employer denied that it had breached Mr Loone’s employment contract.

The Court found in favour of Mr Loone (both in relation to the post employment restraint being unenforceable and on the bonus claim). The Court relied on the New South Wales Court of Appeal’s decision in Silverbrook Research Pty Ltd v Lindley [2010] NSWCA 357 for the proposition that where an employer may award an employee a bonus at its discretion:

• this discretion must be exercised honestly and comfortably with the purposes of the contract; and
• the employer cannot arbitrarily, unreasonably, or capriciously refuse to pay the employee a bonus.

In relation to the exclusion of the DFG Profits, the Court found that clause 7.5 required the employer to have regard to Mr Loone’s personal performance when deciding whether to award him a bonus. This is because clause 7.5 provided: “This amount will be determined by consideration of various performance parameters including but not limited to your personal performance…”

Consequently, the Court held that the employer breached the contract by refusing to consider Mr Loone’s role in the acquisition of DFG when assessing the size of his bonus.

In relation to the change to the bonus model, the Court held that the employer could not arbitrarily choose not to pay a bonus to Mr Loone where his set performance objectives had been satisfied. Further, the Court found that the employer’s discretion under clause 7.5 to determine the size of any bonus did not give it the right to withhold any portion of a bonus it awarded. Â This is because it was clear from other terms in Mr Loone’s contract that the employer was required to pay any bonuses to him on an annual basis.

Consequently, the Court held that the employer breached the contract when it proposed to defer payment of 20% of Mr Loone’s bonus payments for 3 years.

Key takeaways

The decision in Crowe Howarth makes clear that an employer’s discretion to pay or not to pay a bonus under a contract must be exercised honestly and not capriciously, unreasonably, or arbitrarily.

Crowe Howarth does not mean that employers are required to pay discretionary bonuses. It is legitimate for employers to decide not to pay bonuses, for example, because of financial considerations or the employee’s conduct.

However, if the bonus provision refers to certain criteria, for example, the employee’s performance or their achievement of specified KPIs, then an employer must honestly and reasonably consider those criteria in deciding whether to pay a bonus.

Similarly, if the contract contemplates that the bonus will be paid at a particular time, for example, at the end of the financial year, then any bonus payable must be paid at that time.

Lack of care in these respects may mean that an employee is entitled to assert that the employer has repudiated the contract, enabling the employee to summarily terminate the contract and sue the employer for damages for breach of contract. This may also mean the employer is unable to enforce any post-employment restraints in the employee’s contract.

MDC regularly drafts and advises on employment contracts, post-employment restraints, and bonus schemes for employers and senior employees. We also regularly act in proceedings defending or advancing such claims.