Are discretionary bonuses really discretionary?

An employee was recently awarded $74,000 in damages (reduced by an ex gratia payment the employer made to the employee on appeal) because the employer failed to set objectives and review the employee’s performance.

Under her employment agreement the employee was eligible for an annual performance bonus of $40,000 if her performance satisfied quarterly objectives set by the employer. However the agreement stated that the decision to pay the bonus to the employee was entirely at the employer’s discretion.

The NSW District Court found that the employer had breached the employment agreement by failing to formulate objectives for the employee and review the employee’s performance against those objectives for the purpose of determining her entitlement to the bonus.

The Court stated that the employer’s discretion must be “exercised honestly and it does not permit the employer to choose arbitrarily or unreasonably not to pay the bonus once the set objectives are satisfied”.

Lessons for employers

When drafting a bonus clause or scheme employers should:

• ensure any bonus clause is carefully drafted and that it achieves what is intended;
• clearly state if the bonus is intended to be entirely discretionary;
• be aware that a bonus scheme that claims to be discretionary but then includes set targets and objectives that the employee is required to meet may not be discretionary at all, and may impose legal obligations on the employer to pay the bonus.