Bonuses: High Court finds that the assessment of a bonus pool involved contractual discretion
Published 2 September 2014
In this case the High Court considered whether a bank was required to act rationally and in good faith when it calculated the bonus pool available for distribution to its employees.
The two Claimants were recruited to establish an equity derivatives business, from scratch, for a bank. They had guaranteed bonuses in their first year of employment of £6.2 and £3.8 million, provided they stayed with the bank until the end of June 2011. For subsequent years their employment contracts provided for payment of a bonus calculated as a set percentage of "EVA (Economic Value Added) generated by the equity derivative business." After some negotiation over the amounts, the Claimants were awarded substantial bonuses for the second and third years of their employment totalling £4.5 million and nearly £3 million pounds. However, for the financial year 2010/2011 the Claimants' desk's profit and loss and EVA figures were in the negative, so the bank calculated the available bonus pool as nil. The Claimants disputed the bank's calculation. They resigned and claimed multi-million pound bonuses.
The Claimants argued that there had been an oral agreement about what EVA meant and the way their bonuses would be calculated, before they joined the bank. This was dismissed by the judge. They also argued that the bank had no discretion to calculate the bonus as there was a set formula which should be adjudicated on by the court. Alternatively, the Claimants argued, if the bank had any discretion over how it calculated the bonus pool, the bank had a duty to exercise that discretion rationally, which it had not done. The bank argued that although preparation of accounts were necessary for the purposes of calculating the Claimants' bonus pool, this only involved questions of judgement, about which reasonable people might differ; it did not involve the exercise of a discretion. The bank's argument was that, as there was no discretion, there could be no implied term that the bonus pool calculation must be rational.
The judge found that the bonus clause did in fact confer a discretion on the bank which was subject to implied constraints of good faith, taken for proper purposes and not exercised in an arbitrary, capricious or irrational manner. On the facts, the judge found that the approach used by the bank in calculating the bonus pool was rational; it was not one that no reasonable investment bank could have used. As such he found that the bonus pool should stand and the Claimants had no right to any bonus for the 2010/2011 financial year.
What this means for employers
Despite agreeing a contractual formula for their bonus, a significant and costly dispute arose over what bonus, if any, was due. This dispute might have been avoided had the term "EVA" been further defined in the bankers' contracts of employment. However, the decision in this case should be welcomed because it shows, once again, that unless an employer has acted irrationally and abused its decision making power, a court will be slow to interfere with a decision about the size of bonus pools and bonuses.