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Is a ‘discretionary bonus’ really discretionary?

EDITOR’S NOTE: ‘Legal steps & missteps: Addressing common workplace concerns’ is a weekly Talent Canada series, in partnership with John Hyde of Hyde HR Law in Toronto. This series takes a deeper look at issues in which organizations can be proactive to prevent legal issues and highlight where common errors occur.

Many employers mistakenly believe that “discretionary bonuses” can be awarded, withheld, increased, reduced, advanced or delayed at their whim, without consequence.

It stands to reason that if employees expect their bonuses to be uncertain, then anything they receive is just that — a bonus. That is exactly the point of a bonus, right? Not exactly.

The term “discretionary bonus” is one of those trigger phrases that will make an employment lawyer’s eye twitch.

What do you get when you put the word “discretion” in a bonus plan, without more? A bland (and misleading) word salad.

What kinds of bonuses are truly discretionary?

The types of bonuses that are truly discretionary are the ones, ironically, that do not matter all that much.

Courts have held that bonuses which are an integral part of the overall compensation scheme cannot be withheld unfairly or arbitrarily. Bonuses which are promised, or which become an unspoken expectation after consistent payment, lose their discretionary quality at law.

How is discretion exercised ‘reasonably’?

Employers themselves — whether wittingly or unwittingly — define how discretion must be exercised reasonably through their own practices.

Fortunately for savvy employers, a “reasonable” exercise of discretion can be modified based upon the wording of the employment contract or bonus plan. Employers can point to the specific factors that will be considered in the determination of an employee’s bonus. Factors could include company performance, individual performance, team performance, financials, or “soft” factors, such as demonstrating leadership.

The point is not simply to commit these factors to paper, but to actually adhere to them in a demonstrable and consistent way.

Many bonuses are labelled as “discretionary” when the practice shows that the employee simply receives a percentage of their base salary, year after year, without much thought. Courts will easily see through this façade and consider the repeated reward as an expected part of the employee’s core package.

So, in fact, there is nothing discretionary about it.

What bonus is an employee entitled to upon termination?

This is a question that even employment lawyers struggle to answer, and it is the single most common way in which “discretionary bonuses” are called into dispute.

Assuming no contract exists to muddy the waters, all employees who are terminated without cause are entitled to reasonable notice of termination or pay in lieu of notice. Therefore, if an employee would have normally expected to receive a bonus during that reasonable notice period, then the employee’s termination does not remove the entitlement to that bonus.

Additionally, recent case law suggests that employees are entitled to a partial bonus in respect of the “notice period” — even if a bonus would not normally be paid during that time period.

What this means is that an employee’s bonus entitlements upon termination can be very substantial — sometimes even more than the employee would typically receive in such a short time frame.

For example, if an employee who receives a yearly bonus of $12,000 is terminated the day before their bonus is normally paid, and it is determined that the employee is entitled to six months’ reasonable notice of termination, then presumptively, that employee will be entitled to not only the yearly bonus, which they were about to receive, but six months’ of pro-rated bonus for the notice period; a total of almost $18,000 in bonus payments alone, before considering salary, benefits, or any other entitlements upon termination.

Can employment contracts or bonus plans limit bonus payments for terminated employees?

Yes, in theory.

However, in practice, these agreements are very precarious, subject to challenge, and can lead employers to develop a false sense of security. Courts openly acknowledge that their preference is to not enforce such agreements, and that any technical defect in the drafting of the contractual language can, and will, undermine employers’ attempts to limit their liability.

For instance, a bonus plan or employment agreement which categorically withholds bonus payments after termination is void and unenforceable because it violates the Employment Standards Act. Language that limits bonus payments to individuals who are “actively employed” has been held to be insufficiently clear to limit such entitlements after termination.

What can employers do?

When employers allow bonus entitlements to be ambiguous, any step can be a misstep.

The company’s bonus plans and employment agreements should be regularly reviewed and updated by an experienced employment lawyer.

Employers should avoid using “layman” employment contracts and, instead, set out all agreements and understandings pertaining to bonuses in writing.

Leave no room for ambiguity.

John Hyde advises management on all aspects of employment and labour law, including representation before administrative tribunals, collective agreement negotiation, arbitrations, wrongful dismissal defence and human rights.

Nicholas Goldhawk, an associate at Hyde HR Law, co-wrote this commentary.