Are bonus claw-backs lawful?

Give me back my bonus!

Question

Are bonus claw-backs lawful?

Answer

The answer is, in short, "it depends". Employers need to strike the right balance between protecting the company's interests, adhering to regulatory requirements, attracting the best people and retaining their services. It's our job as lawyers to help our clients get this balance right.

Check the drafting

Bonus schemes come in all shapes and sizes. In general, bonuses are designed (i) to secure recruitment, (ii) to reward past performance, (iii) to incentivise in relation to future performance, and (iv) to encourage loyalty. To achieve these objectives, three main types of bonus are used: signing bonuses, performance bonuses and retention bonuses. These bonuses are normally specified as either contractual (ie, payable in accordance with a stated formula or criteria) or non-contractual (ie. discretionary). Although this reward structure may seem straightforward, in practice the lines are often blurred. With a lack of clarity comes potential for dispute.

In order to achieve one or more of the four objectives listed above, employers sometimes specify that all or part of a bonus award is repayable in certain circumstances. To accomplish this, the repayment clause should stipulate (i) the basis on which the bonus has been awarded, (ii) the circumstances in which it must be repaid, and (iii) the manner in which it must be repaid. Otherwise, the repayment provision will be unenforceable for lack of certainty. There are also two public policy tests which the repayment clause must satisfy: (i) it must not constitute an unreasonable restraint of trade, and (ii) it must not constitute a penalty. Any contractual term which unnecessarily restricts an employee's freedom to work for others will be void and unenforceable unless an employer can prove that the restriction is necessary to protect its legitimate business interests. A clause will be deemed a penalty when a breach of contract exists and the sum payable to remedy the breach is excessive or out of proportion in comparison with the losses stemming from the breach.

Case law

In Tullet Prebon Plc and Others v BGC Brokers LP and others several Tullett brokers had resigned before the expiry of their fixed-term contracts. These brokers had received bonuses upon the renewal of their contracts, which were designed to secure their loyalty. Their contracts stipulated that if they resigned prior to the expiry of the fixed term, they would have to repay their signing bonuses in full.

The brokers argued that the repayment clauses amounted to an unlawful restraint of trade and a penalty. The High Court rejected both arguments and held that the provisions did not affect the brokers' ability to work after they left employment, and therefore could not be a restraint of trade. In relation to the penalty argument, the High Court held that because there was no breach of contract, the law relating to penalties was not applicable. The High Court took the simple view that the brokers were given money which they were entitled to retain if they remained at the company for a certain period, and if they did not, this money was repayable.

However, the departing brokers' contracts and repayment clauses were not identical. Some contracts divided the bonuses between past performance and loyalty, and those brokers were required to repay a percentage of the loyalty payment, but were entitled to retain a portion of their bonus for each completed month following the date of the bonus payment. The percentage of the bonus payment relating to past performance was not repayable at all.

In certain circumstances, repayment clauses have been held to be an unlawful restraint of trade. In Sadler v Imperial Life Insurance Company of Canada Ltd an employee had the right to receive post-termination commissions. However, if the employee joined a competitor in the same industry, the post-termination commission payments immediately ceased.

The High Court found that this clause prohibited the employee from freely choosing whatever employment he wished, thereby limiting the employee's future actions through financial sanctions.

Conclusions

If employers wish to claw back bonuses, they need to ensure that employees' contracts contain well-drafted clauses. Be clear about why, how, when and in what way the bonus is to be paid.

For example, if the bonus is partially based on performance and partially based on retention, specify the percentage for each. Where formulas exist in relation to the computation of bonuses, worked examples will support the provisions. Make it clear that if the bonus payment is staged, the employee must not be on notice at the time the payment is made. If the bonus is for retention purposes only, make it certain that the employee must repay the bonus should they choose to leave before the end of a certain period. Remember that the contracts will contain gross payments, but the employee will only receive the net payment. If the repayment clause requires the employee to pay back the full, gross amount, this could be seen as a penalty.

The clause should also include a pro rata repayment structure - the amount to be repaid will decline over the years as the expiration date of the clause diminishes. Providing a pro rata repayment structure may enable the employee to retain a larger percentage of the bonus the longer he/she stays on, but the employer may be seen as acting in a fair and reasonable manner in cases where litigation later ensues.

The more ambiguous the repayment clause, the less likely it is to be upheld by a court. However if we, as lawyers, provide our clients with well drafted and comprehensive repayment clauses which incorporate the suggestions made, our clients are more likely to be successful in legally clawing back bonuses.

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