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Employment contracts and discretionary incentive schemes

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Everything else is just a bonus

Bonuses and incentive schemes can be extremely successful in driving individual employee performance and overall business performance. A significant amount of work can go into crafting such a scheme - from market predictions to setting appropriate targets, drafting motivational communications to employees, and, very importantly, careful drafting of scheme documents.

Bonuses and incentive schemes can be extremely successful in driving individual employee performance and overall business performance. A significant amount of work can go into crafting such a scheme - from market predictions to setting appropriate targets, drafting motivational communications to employees, and, very importantly, careful drafting of scheme documents.

The documents that comprise the total understanding between an employer and an employee about an incentive scheme can be numerous and those documents can interact with each other in unexpected ways if they are not carefully drafted and well thought out.

For example, an employee may be offered participation in a scheme under a contract of employment. The terms of that scheme may be contained in a separate document. The actual targets for the employee may be contained in another separate document and the employer may publish various clarifying documents or amendments to the scheme throughout the employee’s employment.

This can result in a complex web of commitments that may have unintended consequences for an employer.

The ACT Supreme Court was recently required to consider a case that involved an incentive scheme and a range of scheme documents (Subasic v Hewitt-Packard Australia Pty Ltd [2020] ACTSC 2). In this case, the question for the Court was whether an employee had a contractual entitlement to payment under a “discretionary” incentive scheme in circumstances where she exceeded her targets and was not paid for the full extent of her achievements.

The employee was a sales executive and had entered into a contract of employment which stated that her remuneration would be paid in two ways - a fixed base salary and a “Target Incentive Amount.”

The contract stated,

“You are invited to participate in our Base Plus Program that includes a Target Incentive Amount (TIA) of $57,000 per annum in additional to your base pay. The Program and the TIA are subject to change or cancellation at [the employer’s] discretion and are aligned to market date research conducted from time to time by [the employer]”.

The terms of the Base Plus Program (the Program) were set out in a policy document and the targets for the employee were set out in a “Sales Letter”. The incentive Program also offered an accelerator incentive whereby the employee’s payment under the plan could exceed their TIA.

During the course of the employee’s employment, the employer chose to exercise its discretion and make changes to the Program. Significantly, the employer chose to uncap the amounts that could be paid to employees under the Program and instead, it implemented a system whereby any sales achievements over 250% of set targets would be subject to a management review. The management review could result in changes to the sales plan, a hold on incentive payments until the review was complete or stopping or recovering unapproved payments to ensure fairness to employees and the business.

In the sales period relevant to the employee’s claim, she achieved 500% of her targets. She calculated her commission payment based on her commission rates and sales achievements as $446,250.39. Her employer did not pay her this amount and instead paid her $136,500.00, which was an amount equal to 350% of her TIA.

The employee eventually left her employment and later commenced proceedings to recover the remaining $309,750.39 she claimed she was entitled to under the employer’s incentive scheme. The employee argued she had a contractual right to the full amount of the incentive payment that she earned in the period and the employer had breached its contract with her by not paying that amount.

The employer argued that its Program and the payments to the employee were expressed as discretionary under the employment contract and the other documents relied on by the employee (namely the policy and the Sales Letter) were guidance material and did not create any contractual entitlements. Further, the employer argued that it was entitled to conduct the management review of the employee’s payment and decide to cap any payment to her at 350%.

The Court found in favour of the employee. It held that she had a contractual entitlement to be paid the incentive amount as calculated in accordance with the criteria established by the employer. The Court said that the TIA was included in the employee’s contract of employment and clearly formed a component of her remuneration. The criteria for the employee to be entitled to the payment were that she participated in the Program and met the targets set by the employer, which she did.

The Court said that the employer did have discretion to change or cancel the Program, which it did when it removed the payment cap. However, the employer’s discretion to change or cancel the Program did not negate its contractual obligation to pay the employee for her participation. The Court held that any decision to amend the Program had to be exercised “honestly and conformably with the purpose of the contract.”

In this case, the employer had unreasonably exercised its discretion and this was not permitted by the contract of employment.

The Court found that there was also a term implied into the employment contract requiring the employer to act in good faith and cooperate. That implied term was breached when the employer capped the payment to the employee without notice and after she had performed the work that entitled her to the payment.

Accordingly, the Court ordered the employer to pay the outstanding incentive payment plus interest.

Lesson for employers

Employers that operate an incentive scheme are entitled to express the terms of that scheme as discretionary. However, in exercising that discretion, an employer must ensure that it does so reasonably.

Deciding simply that you do not want to pay an employee the full incentive payment they have worked for after they have done that work will not constitute a reasonable exercise of that discretion.

Information provided in this blog is not legal advice and should not be relied upon as such. Workplace Law does not accept liability for any loss or damage arising from reliance on the content of this blog, or from links on this website to any external website. Where applicable, liability is limited by a scheme approved under Professional Standards Legislation.

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