The Background
Bonus season is now in full swing for companies with financial years ending in March. Although the general trend since the financial crisis has seen bonus payments shrinking in size, bonuses continue to constitute a significant proportion of total remuneration for many employees.
For HR practitioners navigating bonus season, it is important to understand the legal and regulatory framework for bonuses in Hong Kong, which is not without its pitfalls. The Employment Ordinance recognises two different types of bonus: contractual and discretionary. Contractual bonuses are usually fixed by reference to payment of a guaranteed sum, the achievement of specific targets, or a predetermined formula. Where they are paid on an annual basis, they are likely to fall under the “end of year payment” regime in the Employment Ordinance.
A consequence of this is that a pro rata payment of the bonus must be made if employment is terminated by the employer (other than summarily for gross misconduct) and the employee has been employed for at least three months of the relevant bonus year. Any provision in the employment contract which purports to prevent a pro rata payment will be void.
Discretionary bonuses, as the name suggests, are paid at the discretion of the employer. Such bonus schemes will often set out a non-exhaustive list of factors that may be taken into account by the employer when deciding whether a bonus is to be awarded and, if so, how much it should be. Typically, the factors might include individual performance, team performance, company performance or the employer’s strategic needs (e.g. retention of staff).
Whatever the structure of the scheme, it is important to ensure that its intended nature is clearly documented. This is because there is a presumption in the Employment Ordinance that a bonus scheme is contractual unless it is expressly stated to be discretionary.
The nature of the arrangement will depend not only on how it is described, but also on how it is operated in practice. If a bonus is paid automatically each year by reference to a predetermined formula, without any exercise of discretion, it is likely to be construed as an end of year payment, irrespective of how it is labelled.
The Limits on exercise of Discretion
Many Hong Kong employers, particularly in financial services, prefer to operate a discretionary bonus scheme because it gives them freedom to decide whether to pay a bonus and, if so, how much.
Although discretionary bonus schemes provide an employer with greater flexibility, it is important for employers to be aware that the exercise of discretion is not unfettered. The courts in Hong Kong have followed the approach of the English courts and it is now well-established law that discretion must not be exercised in a manner which is perverse, irrational or capricious, but rather rationally and in good faith.
Despite these limits on discretion, the good news for employers is that case law developments over the past 15 years have made it difficult for an employee to challenge an employer’s exercise of its discretion. The employee has the burden of proving that no reasonable employer would have exercised its discretion in the same manner. This is a high threshold and it is likely to require an overwhelming case to persuade a court to find that the level of a discretionary bonus payment (or even a “zero” bonus) is irrational or perverse. This is especially the case now that zero (or very low) awards have become much more prevalent since the financial crisis.
It is also important for employers to ensure that any exercise of discretion is by reference only to the parameters stated in the employment contract, and not to other factors. For example, if the contract states that bonuses will be determined based on the employee’s individual performance, but the employer takes something else into account when determining the award, this could expose the employer to the risk of a legal challenge.
The Banking Perspective
Employers in the banking sector should also ensure that they are familiar with the guideline on a sound remuneration system issued by the Hong Kong Monetary Authority (HKMA), which aims to ensure that banks’ remuneration arrangements are consistent with, and promote, effective risk management. The guideline is mainly concerned with senior management and employees whose duties involve the assumption of material risks.
The guideline is based on, and broadly reflects, the principles for sound compensation practices and implementation standards issued by the financial stability board. It recommends that the award of variable remuneration (i.e. discretionary bonuses) should depend on the fulfilment of predetermined and assessable performance criteria, including both financial and non-financial factors.
Bonus season is one of the most anticipated times for employees across the working world and a well-prepared rewards strategy can play a key role in engagement and retention. HR managers should make sure they have a thorough understanding of the relevant legal and regulatory framework to ensure this crucial period goes off without a hitch.
This article appeared in the Classified Post print edition as Watch out for the pitfalls of bonus season.
