By Duncan Jones, trainee solicitor, Fox Williams LLP
An employee’s entitlement to a bonus or share incentive used to be a one way street — once payment conditions under the bonus agreement were met, the employee would be entitled to the bonus and that was that. However, in recent times, employers, mainly international banks, have started clawing back parts of bonuses following events which come to light after the bonus was awarded. How can this be done without triggering successful tribunal claims?
When are clawbacks being used?
Bonuses tend to be paid annually to employees in cash. However, more often than not in the City, significant chunks of bonuses are now paid under deferred incentive plans. Under such an arrangement, performance is measured over a period of time and the bonus is deferred accordingly, thus providing an incentive to the employee to perform well. It is these deferred incentive plans which are being clawed back in practice.
Below are a few examples of how clawbacks are being used in practice:
- Where a bonus was paid on the basis of performance which was later found to have been overestimated.
- During an express restricted period of time after the bonus was paid, a specific negative development occurs, triggering the clawback. For example, it has been reported that a number of Lloyds directors are being forced to surrender significant parts of their bonuses following the decision to pay £3.2 billion in compensation to customers who were wrongly sold Payment Protection Insurance. In addition, UBS has disclosed that SFr 200 million in bonuses awarded in 2010 have been forfeited as a result of the bank suffering a $2 billion loss last year due to unauthorised positions being taken by a London trader.
- When an employer discovers that the bonus was paid at a time when the employee was in serious breach of his duties, which would have blocked the payment if known to the employer at the time.
When will a clawback be enforceable?
In most cases, an employer will not be entitled to clawback any part of a bonus unless such an entitlement is provided for in the bonus arrangement from the outset. However, if the bonus payment is purely or significantly at the discretion of the employer, there may be scope for an employer to introduce a clawback provision as a new condition before or at the time that the bonus is awarded.
There are a number of issues to consider with clawback provisions. Unless they have been drafted with extreme care, an employee may have scope to argue that the provision is a penalty clause or a restraint of trade, and is therefore unlawful.
- A clawback provision is likely to be an unenforceable penalty clause if it appears that the primary purpose of the clause is to disproportionately penalise the employee, rather than merely compensating the employer for the actual loss suffered by the employer in the event that an employee breaches the bonus arrangement.
- If the clawback provision is triggered by an employee breaching a restrictive covenant, then the provision may be a restriction of trade and therefore void. In Sadler v Imperial Life Insurance Company of Canada (1988), an employee’s right to post-termination commission was subject to the proviso that his entitlement to the payments would cease in the event that he moved to another employer in the same industry. This was deemed to be an unlawful restraint of trade as it restricted the future freedom of the employee. In contrast, a provision requiring an employee to repay a ‘golden hello’ and loyalty bonus if they resigned within a certain period was found to be enforceable in Tullett Prebon v BGC Brokers (2010). The provision was not a restriction of trade because it did not effect the employee’s activities once the employee had left the employer. Nor was it a penalty clause, because the clawback was not reliant on the employee breaching his contract.
Retaining talent v shareholder activism
One of the principal purposes of having a bonus or share incentive scheme is to ensure that talent is recruited and retained by an organisation. If an employer develops a practice of aggressively clawing back bonuses, the scheme will be undermined and the employment relationship may become fraught. On the other hand, shareholders are becoming increasing vociferous, especially in relation to public companies - as recently seen with Cairn Energy, where earlier this year its original founder and former chief executive’s bonus was effectively blocked by the shareholders. Under the Companies Act 2006, even minority shareholders have the right to require directors to call a general meeting and force resolutions onto the agenda of an annual general meeting (public companies), thus requiring directors to justify their remuneration packages.
The management of a company have to juggle the interests of the shareholders whilst ensuring that it offers incentives to its employees which ensure that it is able to recruit and retain the appropriate talent.
Remedies available to an employee
Unless the bonus arrangements are carefully drafted and the circumstances in which an employer can clawback a bonus are objective and reasonable, the employer may find itself facing an action for breach of contract (including breach of the implied term of trust and confidence) or unlawful deduction of wages. Complaints of discrimination may follow if certain employees feel targeted and they believe this is only because of a protected characteristic.
Whether a clawback will be permitted will mainly be down to the interpretation of the clawback provision, but in no circumstance should the provision be drafted so as to restrict an employee’s freedom on leaving the employer or be so onerous so that it will be deemed to be a penalty.
Duncan Jones is a Trainee Solicitor in the Employment department at Fox Williams LLP and can be contacted by email at email@example.com or on 020 7614 2647.
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