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Drafting a Discretionary Bonus Scheme: Key Considerations for Employers
Adrian Fryer
Discretionary bonus schemes can be a valuable tool for recognising performance and driving engagement, but they also present legal and practical risks if not carefully drafted. Employers need to strike a balance between retaining flexibility and providing enough clarity to avoid disputes over fairness, eligibility or entitlement.
A common question is whether to specify the factors taken into account when exercising discretion. Leaving discretion completely open gives employers maximum control, but it can also leave decisions more vulnerable to allegations of unfairness, discrimination, or bias. A middle ground is often more effective, for example, setting out that company, individual, and potentially team performance may all be considered when assessing bonus awards.
Eligibility for bonuses can also become tricky when employees join or leave part-way through a bonus year. Employers have several options when dealing with new starters: excluding them until the next bonus year, allowing immediate participation with pro-rating, or requiring completion of probation before eligibility. Each approach has advantages, but clarity is essential to avoid disputes and administrative complexity.
Similar considerations apply when employment ends mid-year. Employers may choose to exclude leavers entirely, take a hybrid approach where only “no-fault” leavers, such as redundancy or ill-health cases, receive a pro-rated bonus, or adopt a more generous position and pro-rate for all departures. The importance of clear drafting was highlighted in Clark v Nomura International, where the absence of a clause allowing the employer to withhold or apportion bonus meant the full amount had to be paid.
Beyond joiners and leavers, employers should consider wider circumstances in which they may wish to withhold payment, such as where an employee is subject to disciplinary investigation or suspension. Including provisions to defer payment until outcomes are known can be particularly useful in industries where investigations are lengthy.
Clarity around dates is also crucial. Employers should define the bonus year and specify exactly when entitlement is lost – for example, whether giving notice or the termination date triggers forfeiture.
Finally, clawback provisions can help protect the business where bonuses have been paid but repayment is justified. These clauses must be carefully drafted to be enforceable and ideally included within the employment contract. Alternatives such as deferring payment over time can give employers greater control.
A well-drafted discretionary bonus scheme can provide flexibility while reducing risk. Clear rules, thoughtful design and careful documentation will give employers the best chance of administering bonuses fairly and consistently.