What is a Discretionary Payment and why are they so controversial?

This is a regular topic of conversation between us and our clients so this may help in deciding if a payment is truly discretionary. It is controversial as 'true' Discretionary Payments do not add to Holiday Pay calculations, which can greatly increase their value.

If an employer is bound under the employment agreement to make a payment, then it is not a discretionary payment. Discretionary payments are ex-gratia payments that an employer doesn’t have to pay the employee under the employment agreement.

‘Employment agreement’ should be considered widely, ie to include variations of employment agreements, letters of offer, rules of commission schemes, bonus scheme rules, policies etc, especially if the employment agreement can be said to incorporate the entitlement to participate.
If the terms of a payment scheme are intended to be binding on the employer and employees, it is unlikely to be a discretionary payment.
If an employment agreement states that a payment is a discretionary payment for the purposes of the Holidays Act 2003, this in itself doesn’t make it a discretionary payment. Whether the employer is bound under the employment agreement to make the payment is what determines whether or not it is discretionary.
If an employer is bound by the employment agreement to make a payment to the employee even if the amount is discretionary (and could be zero), it is not a discretionary payment.
If the payment is dependent on the employee and/or the organisation meeting any type of targets, quotas, performance criteria or indicators, this does not make it a discretionary payment.
If payments are made on a regular and consistent basis, for example, annually if criteria are met, it is unlikely to be a discretionary payment.
If employees have a reasonable expectation of payment based on past practice, to the extent that the payment forms part of the employment agreement, it is unlikely to be a discretionary payment.

As it is rare for payments to be excluded it is recommended that employers seek advice before determining that a payment is discretionary, or else err on the side of caution and include the payment (in Holiday Pay calculations).

Examples of payments that are unlikely to be discretionary payments for the purposes of the Holidays Act 2003.

An employee’s remuneration statement includes a bonus amount at 100%. The bonus is covered by bonus rules that state that payment of and amount of the bonus is dependent on company and employee performance.
An employee’s employment agreement has an amount for on-target earnings (OTE) for commission. The actual amount of commission earned by the employee will depend on how many sales they make.
Each year the company decides who will be participating in the bonus scheme. Letters are sent out to employees who will be participating telling them that they are eligible to participate this year. The letters state that the amount they receive depends on their performance and could be zero.
A company gives all employees a Christmas bonus each year. This helps them recruit and keep good staff and employees are told about it by their employer when they start work with the company.

Examples of payments that are likely to be discretionary payments for the purposes of the Holidays Act 2003.

A business has had a really good year and the owner decides to give everyone a one-off bonus to reward their hard work. They do not do this regularly.
A company gives all employees a Christmas bonus from time to time.
A company decides that one employee has had an outstanding year and will be given an ex-gratia lump sum payment of 10% of their wages for the last 12 months.

We work on the following basis:

If there is an expectation by the employee (in writing or verbally) that they will get a Bonus Payment, this is NOT DISCRETIONARY.
If historically employees receive a regular bonus payment, then this is NOT DISCRETIONARY.
If the Employee Contract has a clause mentioning ‘at the Director’s discretion, all Bonus Payments etc are discretionary’ then by definition they are NOT DISCRETIONARY.

Our Tests for ‘discretionary’ are:

Unexpected – the employee has no expectation of payment.
Random – there is no history of regular prior payments.
No pre-conditions – nothing can be written down regarding ‘x will happen if y occurs’.
Non-Contractual – there can be NO mention of a possible payment in the employee contracts, or verbally as any mention in ‘advance’ means the payment CANNOT be discretionary as you have pre-considered it.

Discretionary bonuses must be included in holiday pay calculations

June 23, 2020 Employment law

A full court of the Employment Court has taken a narrow approach to the meaning of “discretionary payments” in the Holidays Act 2003. As a result of the Employment Court’s interpretation, almost all incentive schemes will now have to be included in holiday pay calculations.

Background

Metropolitan Glass & Glazing Limited (MG) offered its employees a bonus scheme (scheme). The terms and conditions of the scheme provided for incentive payments (payments). The scheme was set out from time to time in letters to employees. These letters made clear that the scheme was not a term and condition of the employees’ employment agreement. The scheme provided for payments when certain criteria were met. Even if these criteria were met, the scheme made it clear that any payments were totally at the discretion of MG’s Board of Directors. No payment could be made until the Board of Directors had approved the bonus payment and MG had the sole discretion to make payment, amend the scheme or discontinue it. The scheme also stated that payments did not come within the meaning of “gross earnings” for the calculation of holiday pay under the Holidays Act 2003 as they were “discretionary payments”.

An employee’s holiday pay under the Holidays Act 2003 is, in part, determined by their “gross earnings”. Discretionary payments are excluded from “gross earnings”. A discretionary payment is defined by the Holidays Act 2003 as a payment that the employer is not bound, by the employee’s employment agreement, to pay the employee. Discretionary payments do not include payments that the employer is bound to pay even though the amount is not specified or only if certain conditions are met.

Decision

The Employment Court found that while the scheme was set out in a separate letter, employment agreements may be composed of more than one part; policies or schemes may be incorporated by reference or inference into an employment agreement. The Court inferred that the scheme was intended to have contractual force (i.e. form part of the employment agreement) because it was designed to incentivise and remunerate employees to put in more effort to meet targets. The Court also relied on the fact that MG had previously offered participation in the scheme in exchange for employee’s agreeing to restraints of trade.

MG argued that the payments were discretionary payments as MG was not bound to pay them even when all targets were met. The Court found that this argument ran counter to the purpose of the gross earnings definition in the Holidays Act 2003 which is “to capture all remuneration for an employee’s job.” It further found that the intent of the various definitions is that where productivity or incentive based payments are made, they are part of gross earnings. The Court held that the scheme’s payments were to provide an incentive and remuneration for performance and were tied to productivity – therefore, the payments were gross earnings. The Court neatly summarised its position: “Neither the variability of the amount of the payment, nor the conditional nature of it, makes the payment a discretionary payment for the purposes of the Act.” While that might be the Court’s view, it does seem to run counter to the clear words of the Holidays Act 2003.

The Court stated that “truly discretionary payments” (like a Christmas bonus paid at the employer’s initiative) will not be captured by gross earnings.

The Court went on to say that MG cannot contract out of the Holidays Act 2003. Statements that the scheme’s payments will not come within the meaning of gross earnings carry no legal weight, and responsibility cannot be avoided simply by labelling the scheme as “discretionary.”

Lessons

Unless an employer spontaneously awards employees a bonus, any documented incentive arrangement is likely to be caught by this decision. Many employers offer ‘discretionary’ incentive schemes and, thinking themselves to be operating within the Holidays Act 2003, exclude the ‘discretionary’ incentive payments made from gross earnings calculations. Based on this decision, employers who have done so may have underpaid employees’ holiday pay. This could amount to significant underpayments where incentive schemes have operated for a long period of time.

There would seem to be strong grounds to appeal this decision. However, unless MG chooses to do so, the Employment Court’s decision will be the last word (at least in the short term) on this issue. Employers may wish to reconsider both the structure and quantum of future incentive schemes and take advice as to how to address any past underpayments.

http://www.quiggpartners.com/discretionary-bonuses-must-included-holiday-pay-calculations/