The People Bulletin

There remains widespread anger towards bankers who have received significant bonus payments in circumstances where the banks have performed badly, in some cases to the extent that they have been bailed out by the government and ultimately the tax payer.

Bonuses in the banking industry were central to the agenda at the G20 summit in London earlier this year which looked at ways to limit such payments. The summit agreed:

• there should be no cap on bonuses for bankers, but limitations must exist;
• bonuses should only be paid as a reward for long term performance;
• employers should consider including claw back clauses in employee’s bonus terms to allow recoupment of payments; and
• employers should consider paying bonuses in the form of stock options vested over a lengthy period, so that an individual would only benefit if the company’s performance improved.

These proposals may contribute to change in the future, but for the present there are significant constraints on employers who try to restrict the amount they pay to existing employees. It is these constraints which have been largely misunderstood by the public.

Legal right to payment

Employers may be under a contractual obligation to make bonus payments. Such terms may have been negotiated by an employee when they joined the employer and may provide either for the payment of a fixed amount of bonus at a particular time, or if an individual meets a particular target. Other bonus schemes may be worded as discretionary payments, but may gain contractual status, either because of the drafting of the scheme or as a result of the employer’s custom and practice in making payments.

If the employee has a contractual right to a bonus and the employer fails to pay, the employee may have a number of claims including breach of contract, unlawful deductions from wages, constructive unfair dismissal and, if an employee can point to inconsistent treatment between employees and they belong to a protected group, potentially also claims for discrimination.

Whilst the general public believe that those who are being rewarded for failure are under a moral or social obligation to repay bonus payments or other payments which are seen as reward for failure, in reality they are few who would feel bound to do so. A notable example of this was the controversy involving Fred Goodwin who left the Royal Bank of Scotland earlier this year with a pension arrangement which was seen by many as unjustified. However, there is little scope for employers to compel employees to repay unless they have very clear contractual wording which places an obligation on the employee to do so. As such wording would have been devised at the outset of the employment relationship and would have to provide for a number of different potential scenarios, so such provisions are relatively unusual.

An example of an employer seeking to rely on such provisions is Commerzbank which is currently facing claims from around 72 bankers employed by its subsidiary Dresner Kleinwort, who say that they were given a clear expectation that a performance related bonus would be paid. The bank relies on a ‘material adverse change’ clause contained in bonus scheme rules and argues that the change in economic conditions which faced the bank earlier this year entitles them to withhold payment. Whether this argument succeeds will be largely dependent on the facts of the case, but if the case fights, we will gain useful guidance on how such clauses are to be interpreted by the courts.

Strike a balance

Whilst the banking crisis has brought the issue of rewarding failure into the spotlight, the issue is not unique to the banking sector. Shareholders of private and public companies alike are now actively seeking more stringent checks and balances on employee’s pay. The message is that employers want to take a closer look at how employees are rewarded, and how they can strike an appropriate balance between attracting high calibre recruits and satisfying shareholder interests.

So what guidelines should employers consider when negotiating financial terms and for employees in this new age?

1. it is vital to establish a balance between fixed and variable pay in an employee’s reward package and to link variable pay to predetermined and measurable performance criteria;
2. employers must be much more prescriptive at the outset of the employment relationship about what will be paid to the employee in the different circumstances that the employment relationship may end;
3. employers should impose limits on the amount that an employee may receive on the termination of their employment and link such payments to success, rather than expressing them as automatic entitlements;
4. where stock options are used as incentives in place of cash reward, the scheme should put in place minimum vesting periods and encourage performance over the long term; and
5. employers should consider including clawback provisions in contracts of employment to give them the power to reclaim elements of variable pay if certain conditions are not fulfilled, including that economic circumstances have changed, or that the employee’s performance is insufficient.

Any other options?

There is no doubt that in view of the competitive nature of recruitment, employers may have to rise to the challenge to find more innovative and diverse ways to incentivise employees. Other incentives which are not cash based may be valuable to employees and less expensive for employers. Some studies show that recognition is at least as important as pay and benefits. However, this is not an easy concept to ‘sell’ to a potential new recruit. Here are some other non-cash options to consider:

1. establish a corporate social responsibility scheme which allows employees to play their part in their community or to assist charitable objectives ;¹
2. adopt flexible benefit packages which allow employees to manage their own benefits package and have control over what benefits are important;
3. establish flexible working schemes and give employees enhanced family friendly rights to benefit those with families;
4. grant above average holiday entitlement, or establish holiday buy-back schemes;
5. introduce recognition schemes which formally encourage better performance and motivate employees; and
6. introduce health and well being programmes such as gym membership, medical and dental services and health advice sessions which can contribute to reducing absenteeism and raising performance.

It is important to promote the value of the reward to gain long term recognition of the advantages of such schemes over cash payments.

Employee reward is currently high up on the political and social agenda, so employers who are able to think outside of the box and offer diverse benefits packages will be the first to attract high flying employees and, if they are careful, will take care of their shareholders’ interests at the same time.

[1]  See also the article in this issue of The People Bulletin ‘Time to help’