Banker bonuses – uncertainty ahead for employees?
Brogden and another v Investec Bank Plc  EWCA Civ 1031
The case and its relevance
In Brogden and another v Investec Bank Plc, the Court of Appeal dismissed two former employees' claim that they were owed substantial bonuses by the Bank.
Previously, the High Court had found that the Bank had acted rationally and in good faith when calculating the bonuses. It also provided some guidance on when a party can be regarded as exercising a contractual discretion that will be subject to implied terms.
The Court of Appeal upheld the High Court's decision, but for different reasons. It was found that payments made by an employer where there is no contractual obligation to do so will not give rise to any reasonable expectation that the employer will act in the same way in the future.
The case indicates that the decisions of banks in relation to the levels of discretionary bonus payments will likely continue to be protected by the courts. It also highlights the importance to employers in the sector of having clearly drafted remuneration and bonus terms.
The Bank recruited the employees in 2007 to set up a desk trading in equity-based derivatives. In addition to their salary, they were promised substantial guaranteed bonuses in their first year of employment followed by bonuses in subsequent years related to the profitability of the desk.
The employees' contracts stated that the bonus calculation would be based on a percentage of the 'Economic Value Added' (EVA) generated by the equity derivative business.
In their first year, the employees received their agreed fixed bonuses. In 2008/9, they were paid bonuses of £1.45m and £1.4m respectively. For the year 2009/10, their bonuses increased to £3m and £2.25m.
However, for the year 2010/11, the Bank calculated the available bonus pool as nil, meaning no bonuses were payable. The claimants resigned as a result before commencing the action against the Bank.
The dispute relates to the way in which the Bank formulated its calculation of the bonus pool. The employees thought that the bonuses should be calculated by reference to the full value to the Bank of having the funds raised by the desk at its disposal. However, the Bank considered that the bonuses should be calculated in relation to the desk's profit and loss account which for the year 2010/11 was negative.
Relevant legal principles to be applied
It is a well-established principle that a discretion conferred by a contract on one party to make decisions that affect both parties must be exercised honestly and in good faith and not arbitrarily, capriciously or irrationally. Where this situation arises, the court has the power to imply the term into the contract.
In the High Court, the judge listed the following parameters as guidance on where a decision will be regarded as an exercise of discretion:
- The contract gives responsibility to one party for making an assessment or exercising judgment on a matter which materially affects the other party's interests;
- The matter is one about which there is ample scope for reasonable differences of view; and
- The decision is final and binding on the other party such that the court would not substitute its own judgment for that of the party who makes the decision
The judge held that the Bank had discretion in relation to the formula it used to assess the EVA, and that this decision could not be challenged as it could not be shown that the Bank had acted irrationally or in bad faith.
Although the guidance provided by the High Court judge was not specifically overruled by the Court of Appeal, it was held that he had erred in concluding that the contracts conferred discretion on the Bank in relation to calculating the EVA. This is because it was apparent from the construction of the contract that the formula had been clear from the outset, and that the employees had made no proper attempt to renegotiate the way in which bonuses were to be paid.
The Court of Appeal concluded that the appellants only had a right to have their bonuses calculated in the certain way as prescribed by the contract, which correspondingly limited the Bank's obligation.
Lord Justice Moore-Bick then went on to consider whether the Bank's decision to increase the size of the bonus pool above the appellants' entitlement in the second and third years of their employment created a 'reasonable expectation' that it would do so in the future.
It was held that the Bank was permitted to make an ex gratia payment to increase the size of the bonus pool. However, these payments were not capable of giving rise to any reasonable expectation that it would act in same way in the future. Furthermore, it neither created any obligation for the Bank to act in this way nor did it entitle the appellants to have their bonuses calculated by a different method.
The appeal was therefore dismissed.
Practical guidance to employers in the financial services industry who pay bonuses
Decisions conferring discretion
When parties enter into contracts that include provisions that satisfy the factors set out in the High Court judgment, there will likely be an implied duty to act rationally and in good faith. The parameters are relevant to bonus decisions which require the employer to apply subjective thought.
Despite the evidential hurdle of 'irrationality' being difficult for claimants to prove, employers should still aim to avoid discretionary terms in their service contracts. Agreeing a formula for calculating bonuses in the provisions will aid the employer in proving it is not making discretionary decisions.
Alternatively, employers could attempt to exclude any implied duties under the contract. However, any limitation of this nature must be clearly and unambiguously worded and would likely prove problematic in terms of negotiation.
Although, in this case, the Bank's actions did not lead to reasonable expectations being created, employers should take care not to act in a certain way which gives employees a positive reason to believe that it will continue to do so in the future. Such reasonable expectations may cause an employer to be in breach of its duty of good faith to its employees.
Before making any changes to employment terms, employers should check its previous communications and review whether any reasonable expectations have been created which are contrary to any proposals for change.
If you would like to discuss any issues arising from this, please contact Jonathan Kitchin, Partner in the Commercial & Regulatory Disputes team or Tom Stenner-Evans, Senior Associate in the Employment team.