Employee bonuses: are they discretionary?, Law Times, Vol. 21, No.11 at 7 (March 29, 2010)

06 Mar Employee bonuses: are they discretionary?, Law Times, Vol. 21, No.11 at 7 (March 29, 2010)

EMPLOYEE BONUSES: ARE THEY DISCRETIONARY?
By Nikolay Y. Chsherbinin

Aside from base salary, employment contracts frequently offer additional economic incentives. Typically, these include deferred profit-sharing plans, short- and long-term incentive plans, stock options, pension benefits, corporate discounts, discretionary bonuses, and merit compensation.

Discretionary bonuses are particularly apt to be confused with merit compensation plans. Though each category fits within the rubric of incentives, the term discretionary bonus refers to plans with no predetermined performance objectives or outcomes, while merit compensation plans rely upon the achievement of set personal or corporate performance targets.

This dichotomy often shows up in employment contracts stating, for example: “Your remuneration will be further enhanced by a discretionary bonus of 15 per cent” or, in other cases, that “your remuneration will be further enhanced by a bonus of 15 per cent should your department reach $1 million in annual sales.”

Importantly, when the employment contract provides for a discretionary bonus, the employee acquires no contractual right to it but an expectation of it.

Rights and expectations differ, of course, as do wants and needs. The right to a bonus, as in the latter scenario, is legal and relates to the employer’s liability, while the expectation of a bonus, as in the former scenario, is factual and relates to damages. Simply by characterizing a bonus as discretionary may not always shield employers from liability, however. The discretionary aspect means that it’s not automatic.

A bonus may lose its discretionary character if there is proof that it has become an integral part of an employee’s wage structure, particularly if it constitutes a significant component of the total compensation. A related observation is that the more often the employer pays the bonus, the less discretionary it becomes. Moreover, the term discretion implies reaching a decision based on wide criteria, ranging from an employer’s financial ability to pay the bonus to refusal to pay it based on an employee’s performance. Purely subjective considerations can also come into play, such as preventing the employee’s earnings from exceeding those of a manager. Having adopted a supervisory responsibility over the employer-employee relationship, Canadian courts have implied an obligation on employers to exercise their discretion in good faith.

Canadian jurisprudence provides the following scenarios when dismissed employees typically assert a claim for a bonus as part of their salary structure:

  1. When an employer dismisses an employee during the period of bonus calculation. In this case, the employee will be in a position to argue an entitlement to a pro-rated bonus based on the duration of employment and the degree of achievement of predetermined objectives.
  2. When an employee is dismissed before the period of bonus calculation. In this situation, the employee’s entitlement to a bonus will be based on the historic average during the preceding three years.
  3. When an employee is dismissed before the bonus payout date but after the period of calculation. In this scenario, employees are in the most secure position to recover the bonus because they’ve already done the work for which the money was to be paid and, arguably, the employer had reaped the benefits.
  4. The claim for a bonus that would have been attained during the notice period is subject to a higher test of whether the incentive has become an integral part of the employee’s salary structure.
  5. For example, in Derksen v. Wasa Insurance Co. Ltd. (Liquidator of), the B.C. Court of Appeal upheld the amount of the bonus awarded to the employee based on her claim for a loss of opportunity to earn it.

The key factor in this case was that the employer had promised to pay the employee a bonus if she stayed until the agreed date but then wrongfully terminated her prior to that time.

Where it’s a condition of a bonus plan that an employee must remain “actively employed” until the employer pays the incentive to be eligible for payment, the court, in Schumacher v. Toronto-Dominion Bank, held such a provision to be ineffective. The facts of this case arose out of a constructive-dismissal setting. The court held that Schumacher’s involuntary inability to comply with the condition of the bonus plan wasn’t a justification for the employer to decline the payment as part of the employee’s damages.

Significantly, the court made an explicit reference to the concept of fairness: “Where the bonus was promoted as an integral part of the employee’s . . . compensation, it would be . . . unfair to the employee to be deprived of the bonus by reason of the unilateral action of the employer.”

However, in cases where employees assert a claim for an outstanding bonus for the time period when they were actually employed, it appears to be uncertain what effect a successful defence of just cause may have upon a claim for the incentive. As a result, the designation of a bonus as discretionary creates no contractual right, but merely an expectation, in favour of an employee’s entitlement to the money.

A survey of cases demonstrates that the courts aren’t averse to conflating expectations with rights, particularly in circumstances where the employer promoted the bonus as, or it has become, an integral part of an employee’s salary structure. Moreover, the courts will deem the bonus provisions ineffective if they unfairly deprive an employee of the incentive through an employer’s unilateral action. Since the bonus operates within a contractual framework, employers are restricted, under pain of liability, in their power to unilaterally change an incentive plan or methods associated with measuring the achievement of objectives.

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