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Discretionary bonuses – is it a pot of gold at the end of a rainbow?

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Case Study – Silverbrook Research Pty Ltd v Lindley [2010] NSWCA 357

An employee was entitled to damages for her employer’s failure to assess whether she had earned annual bonuses during her five-year period of employment.

The employee commenced work as a business development strategist in 2003 with Silverbrook Research Pty Ltd (“Silverbrook”) under a “service agreement” that provided for a $210,000 annual salary.

In addition to annual remuneration reviews, the employee was also entitled under the contract to an annual performance bonus of up to $40,000, subject to the contractual proviso that the decision as to whether the employee should receive the Performance Bonus is entirely within the discretion of Silverbrook.

The employee claimed that during the period of her employment the company failed to review her remuneration, set the objectives to receiving the bonus or assess whether she was entitled to a bonus.

A month after the employee resigned in July 2008, Silverbrook made an ex gratia payment of $48,165.13, equal to three months’ remuneration, to the employee.

District Court

At the District Court of NSW, the employee alleged that Silverbrook breached the service agreement and claimed damages for the loss of the opportunity to earn a bonus.

A director of Silverbrook told the court that she had made a deliberate decision not to pay her a bonus, and that her decision on the matter would not have changed even if the bonus objectives had been reviewed.

Judge Walmsley found that Silverbrook breached the service agreement when it failed to review the employee’s remuneration, set the objectives or determine whether she should be paid a bonus, quantifying the loss of opportunity to earn a bonus to be worth $74,000. An order for damages for that amount was made.

NSW Court of Appeal

Silverbrook appealed the decision to the NSW Court of Appeal, arguing that Judge Walmsley was wrong in:

  1. finding that the employee was entitled to damages for loss of an opportunity; and
  2. failing to take into account the ex gratia payment.

Court of Appeal President, Justice Allsop rejected the first limb of the employer’s appeal, finding that Judge Walmsley had correctly approached the case as involving the loss of a valuable commercial opportunity.

Justice Allsop acknowledged that the employer had discretion under the service agreement to decide not to pay the employee a bonus, but said the agreement “should not be construed so as to permit the appellant to withhold the bonus capriciously or arbitrarily or unreasonably”.

The employer was required to exercise the discretion “honestly and conformably with the purposes of the contract”, which in some circumstances could involve refusing to pay the bonus. “What, however, would not be permitted is an unreasoned, unreasonable, arbitrary refusal to pay anything, come what may. This would be a denial of the very clause that had been agreed”.

The employer had more success on the second limb of its argument, with the majority ruling that the $48,165.13 ex gratia payment should offset the damages awarded.

In accordance with the majority’s decision, the Court ordered that the $74,000 damages payment the employee won in the District Court should be reduced by the amount of the ex gratia payment, leaving her with $25,834.87.

Practical Application

The Silverbrook decision demonstrates that discretionary-type clauses can be enforced against an employer in limited circumstances where the employer applied unreasoned, unreasonable and arbitrary refusal to pay discretionary entitlements. Such clauses should not be included in employment contracts where the employer has no intention of making bona fide discretionary payments.

Further, if discretionary clauses are used in agreements, it must be carefully drafted to avoid the scenario where an employer can fails to implement requisite steps involved in achieving the results anticipated by the clause.

MST has extensive experience in assisting its clients to comply with the most current employment laws, including advising on obligations arising from employment agreements. Please contact one of our Workplace Relations lawyers for further information.

Author: Chao Ni

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