Ask Auntie – How should we exercise discretion in determining bonus awards?

Kind regards

Mr Beau Nuss

Dear Mr Nuss

You’re correct that there have been some recent claims in this area.  The relevant cases considered bonus and commission awards following the 2015 Supreme Court decision in Braganza v BP Shipping Ltd and the requirements on employers not to be “Wednesbury unreasonable” in exercising discretion. 

What is Wednesbury unreasonableness?

“Wednesbury unreasonableness” is a legal concept which provides that a decision will be unreasonable if:

• the decision-maker takes matters into account which he/she ought not to take into account or fails to take account of matters which he/she ought to take into account;  and
• no reasonable person acting reasonably could have made the decision which the decision-maker made. 

If it can be applied to the employment relationship, Wednesbury unreasonableness could allow your ‘difficult’ employees scope to attack the process used by the Remuneration Committee in exercising discretion under the bonus scheme in order to argue for higher awards. 

The principles of Braganza 

Traditionally, courts have been reluctant to interfere with the way in which employers exercise discretion provided that they act:

• honestly and in good faith; and
• in a way that is not arbitrary, capricious or irrational.  

As a result of the decision in Braganza, employers may also need to be Wednesbury reasonable in exercising discretion. 

Although Braganza looked at discretion in relation to a death in service award, its principles have been used by claimants to challenge the exercise of discretion by their employers in determining bonus and commission awards in the two recent cases of Patural v DG Services (UK) Ltd (2015) and Hills v Niksun Inc (2016).  

Patural v DG Services

Mr Patural sued DG Services for breach of contract after discovering that two of his colleagues had received higher bonuses than him.  Mr Patural tried to rely on Braganza arguing that the bonus decisions made by DG Services were irrational and/or perverse. 

DG Services made an application for summary judgment to strike out Mr Patural’s claims which was allowed by the High Court.  There were a number of reasons why Mr Patural’s claims were struck out, however, in relation to his Braganza type claims of Wednesbury unreasonableness the court found that Mr Patural had failed to properly articulate that a Wednesbury type error had occurred in the process adopted by DG Services.   

Although Mr Patural’s claim failed, the High Court did accept that Wednesbury unreasonableness could be applied in an employment law context. The Court went on to stress that Wednesbury unreasonableness may not always be relevant in employment relationships. 

Hills v Niksun Inc

Mr Hills participated in a commission plan which stated that “Niksun reserves the right to determine what level of executive compensation, if any, is fair and reasonable … and is in the best interest of Niksun”.    Mr Hills negotiated a significant deal for Niksun from the UK office although Niksun’s US office had some involvement in negotiations.  Niksun allocated 48% of the commission arising from this deal to the UK office with the balance to the US office. 

Mr Hill brought a claim against Niksun for breach of contract arguing that Niksun’s decision to award 48% of the commission to the UK was not “fair and reasonable”.  The County Court judge agreed with Mr Hill and found that it would not be “fair and reasonable” to award the UK office any less than two-thirds of the relevant commission. 

The Court of Appeal agreed.  In particular, the Court of Appeal noted that Niksun had not adduced any evidence as to the way in which it had decided to allocate only 48% of the commission to the UK office or the reasons for it arriving at this conclusion.  This lack of evidence meant that it was impossible for the County Court judge to conclude that the decision was taken rationally.  Had Niksun adduced evidence in relation to its decision-making process the County Court or Court of Appeal might have arrived at a different conclusion.  

What should the Remuneration Committee be doing now?

Using Wednesbury unreasonableness and Braganza in bonus claims is a new area of law and it will be a difficult type of claim for your employees to run, particularly taking account of the cautionary note sounded by the High Court in Patural. 

Because this type of claim is not straightforward it’s also likely to be the preserve of well-resourced litigants with potentially high value bonus claims, at least until we get further developments in this area.  Depending on the nature of your employees this may provide you with some comfort.

Below are some practical steps which the Remuneration Committee should be taking.

1. Creating a clear audit trail is certainly a good place to start.  The Remuneration Committee should create minutes of meetings in which bonus awards are determined.
2. Clearly document the factors which have been taken into consideration and the reasons for determining awards. 
3. Make sure there is evidence which supports the decisions which are being taken. This will help the Committee to overcome arguments that the decision is unreasonable or capricious.