Podcast S3E1 | Employment: All About Bonuses

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TRANSCRIPT

00:01
Welcome to Series 3 of The HIP Talks podcast: a series of discussions on legal issues hosted by Hugill & Ip Solicitors. The firm provides high quality legal services with integrity, professionalism and respect for its clients and the community. An outstanding team of lawyers who have achieved exceptional results and recognition in the areas of Dispute Resolution – Corporate & Commercial – Private Client – Family – Employment & Business Immigration and Data Privacy.

Jacqueline Cheng  00:29
Hi, everyone, I’m Jacqueline Cheng from Hugill & Ip, and I’m here today with Adam Hugill to talk about Hong Kong bonuses. Hi, Adam.

Adam Hugill  00:38
Hi, Jackie.

Jacqueline Cheng  00:39
Hi, I understand that bonuses are a common feature in most employment contracts, and that about 90% of employees in Hong Kong expect to receive some form of annual bonus each year. What sort of bonuses are actually common in Hong Kong?

Adam Hugill  00:54
Bonuses can take many forms from be very simple to being very complex. The nature of the bonus depends on really what the purpose of the bonus is. The reason bonuses can become very complex, and certainly for high value bonuses, is that they must balance rewarding staff, maintaining your high earners with balancing the costs to a business. The most simple and standard form of bonus in Hong Kong is what we call the traditional end of year, or Chinese New Year bonus, it’s usually called a 13th month bonus. This tends to provide one month’s extra pay, usually at the end of the calendar year or at the lunar year. The timing of the bonus and the amount of the bonus is fixed and so it’s not really reliant on appraisal scores, KPIs of the performance or achievement metrics of the employee.

Jacqueline Cheng  01:39
Does this mean that all employees are actually automatically entitled to receive this 13th month bonus?

Adam Hugill  01:45
For employees unfortunately not. There’s no such thing as a mandatory bonus in Hong Kong, and entitlement to a 13th month bonus, or indeed any type of bonus depends on what’s written in your employment contract. Now it is possible to become entitled to a 13th month bonus or some other type of bonus through custom and practice. This means that something has happened consistently over a long period of time, and therefore becomes part of an employment contract or be it an unwritten part of the contract. Unfortunately, it’s very difficult for employees to prove that a customer practice exists, which gives them the right to receive a bonus.

Jacqueline Cheng  02:19
What is this high complex value bonus that you mentioned before?

Adam Hugill  02:23
Okay, so before we go on to consider complicated bonuses, we should talk about the form of bonus protection that’s included in the Employment Ordinance. The Employment Ordinance, of course, is the key piece of legislation that governs employment issues in Hong Kong. What the Employment Ordinance does include protections for what it calls the end of ear payment. Now, an end of year payment means an annual payment or annual bonus, which is of a contractual nature, but specifically does not include an annual payment of bonus that we call gratuitous, or that’s paid at the discretion of the employer. So, this definition obviously includes a 13th month payment. However, because it’s worded quite widely, it can cover many other types of bonuses, including the complex bonuses, or high value bonuses that we see associated with the financial services sector. It’s this part of the employment ordinance, which gives rise to disputes between employers and employees. In some cases, these disputes can run to multi millions of dollars.

Jacqueline Cheng  03:20
So what does the Employment Ordinance do that creates all of these multimillion dollar disputes you speak of?

Adam Hugill  03:27
Well, if a bonus falls within the definition of end of year payment, certain rules automatically apply to that bonus, whether or not similar rules or even conflicting rules are included in the employment contract. For an example, let’s assume the bonus period is a calendar year 1st of January to 31st of December. If an employee has worked for at least three months of the bonus year, and their employment is terminated by the company, but not for gross misconduct, then the employee is entitled to receive a pro rata bonus, the right to a pro rata bonus payment does not arise, however, if you resign, unless of course, it’s a constructive dismissal, which is a totally separate area. So, what this actually means for employers is if you were to terminate an employee on the 31st of March, no pro rata bonuses payable. However, if you wait for one day and terminate on the 1st of April, a pro rata payment would be payable. Doesn’t sound like much. But if you’re working for a major industry and you’re running an HR operation for large scale redundancies, the difference of one day could be a substantial business cost.

Adam Hugill  04:31
It’s also fairly usual for employers to pay bonuses during the first few months of the following year. So, the bonus year runs January through December bonuses might get paid end of the following January, February or March. One of the rules in Employment Ordinance is that if an employee has worked for the entire bonus year, the employee is entitled to receive that bonus whether or not the employment is terminated prior to it being paid. This even applies if the employee is dismissed for gross misconduct, or if the employee resigns.

Jacqueline Cheng  05:01
But Adam, isn’t it usual for an employment agreement to say that you must have worked for the entire bonus year in order to be entitled to receive any bonus, or that you must be in an employment and not serving your notice period in order to receive a bonus?

Adam Hugill  05:17
Yes, this is typical wording that appears in many employment contracts. However, provided you can establish that your bonus falls within the definition of end of year payment, the Employment Ordinance will automatically void any contractual term which is to the contrary. Going back to the definition of end of year payment and that is an annual payment or annual bonus which is of a contractual nature, but specifically does not include any bonus which is gratuitous or discretionary, we need to look at the key parts. That is the words “contractual nature” and “payable only”, as it relates to discretion of the employer.

Adam Hugill  05:53
Putting the simple 13th month bonus to one side, the obvious type of bonus that falls within the definition is contractual performance bonus. In particular, performance bonuses are paid with reference to a fixed criteria or key performance indicators. Such performance bonuses are common in sales executive contracts, where the sum of money is paid is directly referenced to the sales that the employee has made. And it’s often based on a very clear formula. Other professions for example, recruitment consultants receive performance bonuses upon achieving certain revenue targets and there’s a formulaic bonus that’s paid. Indeed, lawyers and other professionals also might receive contractual performance bonuses that reference billable hours, and fee revenues. In many ways, contractual performance bonuses are similar to commissions. Apart from the fact that commissions tend to be paid throughout the year, either monthly or quarterly, and annual performance bonuses are only paid once per year. The important thing with the contractual performance bonus is that part of the contract includes fixed or defined terms on how the bonus is calculated. Hopefully, the terms will be drafted very precisely and clearly so that everyone can apply the formula to arrive at the same figures. The reason for this is because lawyers hate doing math.

Jacqueline Cheng  07:06
So, I’m guessing that things start getting more complicated if the bonus isn’t of a contractual nature, or if it is payable only at the discretion of the employer.

Adam Hugill  07:15
Yeah, that’s right. Most issues come from discretionary bonuses, and whether or not the bonus is genuinely a discretionary bonus or not. To make matters more complicated, there can also be hybrid bonuses that include elements of both contractual and discretionary bonuses. As a starting point, under Hong Kong law, there’s a general presumption that a bonus is not a discretionary bonus, unless the employment contract specifically says that it is. Discretionary bonuses might simply state, your right to receive a bonus is entirely discretionary. We would call that a pure discretionary bonus. However, quite often, discretionary bonuses go on to set out factors that are taken into consideration by the employer when deciding if and how much the bonus to pay. Factors tend to mean things like the employee’s personal performance, the team performance, the overall profitability of the company and such like. This is where difficulties start to arise. Even if the bonus is stated to be discretionary. And often employers like to liberally pepper the bonus clause with the word “discretion” in every sentence, the Courts will look past the word and examine how the bonus actually operates.

Adam Hugill  08:21
There’s a famous case in Hong Kong way back in 2002, called Wong Huey Lam and Colgate Palmolive, often shorthanded to be the Palmolive case. And in this case, the Court of first instance said that a bonus that was described in the contract has been discretionary, was calculated with reference to achieving operational targets was not purely a discretionary bonus. In this case, it was accepted that a bonus could be contractual in nature, although it also has discretionary elements. This is what I mean when I refer to a hybrid bonus. The key question is whether the bonus can be described as being payable only at the discretion of the employer. It was on this question that the court answered no. Although the amount may be calculated with reference to some criteria that requires the exercise of discretion, the annual payment itself was payable by reason of the contractual provision in the contract, and provided the employees satisfied that contractual provision, then they were entitled to be considered for the bonus, it’s just that the amount had a discretionary element to it. The Court described such bonus to be a contractual benefit, the calculation of which involves exercise of discretion by the employer, rather than a discretionary benefit pursuant to a contractual formula. So if you understand it’s important that contract comes first, and then discretion second. The significance of this is that it made that the bonus was caught by the Employment Ordinance, and since that the rules of the Employment Ordinance prevail over any rules in the contract, a bonus was payable to that employee. Now in this case, I know we’ve been referring to multimillion dollar bonuses, but in this particular case, the employee and the employer were actually arguing over 15,000 Hong Kong dollars, but thankfully they work because it’s created some very useful case law for employers and employees going forward. And it stands at the foundation block for bonus claims that are worth 10 or even 100 times more than there was originally in that case.

Jacqueline Cheng  10:12
Okay. I can see why that is a hybrid bonus case, what about purely discretionary bonuses? Surely an employee cannot claim a bonus that is totally at the discretion of his employer.

Adam Hugill  10:24
Okay. Case law comes to the rescue again, and we need to go back a couple more years to the year 2000 and the English Court of Appeal case in Clark v Nomura. In that case, Mr. Clark achieved profits for Nomura that were in excess of 6 million GB pounds. Nomura exercised its discretion to decide how much bonus to pay him for that year and gave him nothing.

Jacqueline Cheng  10:44
Wow, that’s really harsh. I guess that’s why he sued.

Adam Hugill  10:47
Yeah. The Court decided that an employee’s discretion in deciding whether to award a bonus is generally subject to a test of – and wait for it – irrationality or perversity, referring to capriciousness as a good example. Very fortunately, in the last 20 years, the Courts have started to refer to this by the less flowery term of “reasonableness”. So, what they say is, would a reasonable employer have exercised his discretion in that way. If that discretion was exercised unreasonably, then it’s a breach of contract, and the Court would have to reach a conclusion as to what a reasonable employer would have paid to the employee in that position. So basically, the Court needs to step into the shoes of the employer and decide what a reasonable bonus would be. In Clarke to judge decided to award him 1.35 million GB pounds.

Jacqueline Cheng  11:36
I see that this is a UK case, but is this good law in Hong Kong?

Adam Hugill  11:40
Yep. The Hong Kong Courts have adopted this case. Actually, it was Nomura in Hong Kong that was one of the first to find themselves in the firing line, and the case is Post v Nomura and it was decided in 2001, so only one year later. However, Mrs. Post was not as fortunate as Mr. Clark. In that case, she was described as being a top employee, and was therefore expected to receive top performance. And the Courts when looking at what she did during the year couldn’t find any special or exceptional contribution on her part to merit a bonus award. So, the Court decided that it was not unreasonable for Nomura to have given her nothing.

Jacqueline Cheng  12:14
So, you have said that is common for bonus clauses to state that to be eligible for the bonus and employee must still actively be employed by the employer on the payment date. I understand that if it is a contractual bonus, an end of year payment, the Employment Ordinance will overrule this, but what happens if it is a purely discretionary bonus? Does that wording defeat an employee’s right to argue for discretionary bonus?

Adam Hugill  12:44
You’re right, if it’s not an end of your payment, the Employment Ordinance doesn’t kick in and come to the aid of the employer to create a payable bonus. But what the Courts have done in a very recent Hong Kong case, is create what we call the implied term of anti-avoidance. Now this came about in a case called Sunny Tadjudin v Bank of America. In that case, both the court and the Court of Appeal agreed that an anti-avoidance term could be applied into an employment contract, so that an employer cannot terminate an employment just to avoid paying a discretionary bonus. Now, in that case, the Courts were very careful to say that this does not mean that every contract has an implied term of anti-avoidance in it. That being said, in the few years since that case was decided, many lawyers arguing for employees and employers always addressed the anti-avoidance term. And so, whilst the Courts were careful to say it’s not implied into every contract. In reality, I think people have a pretty good shot of arguing anti avoidance if they can establish that their employment has been terminated purely to avoid paying on that bonus.

Jacqueline Cheng  13:53
It seems that there are many avenues available to employees to claim bonuses. What can employers do to protect themselves from such claims?

Adam Hugill  14:01
Good question. Well, we mentioned a little bit earlier that if you sack an employee within the first three months of the bonus year, then no pro rata bonus is payable, but there are a few other tips as well. So, if the employer intends for bonus to be discretionary, clearly and consistently state this in all documentation, if possible, don’t include reference to any factors, work on what we call the purely discretionary bonus. So, don’t refer to personal performance, company profitability, etc. Because that will be taken into consideration and start creating a hybrid bonus rather than a purely discretionary bonus. The problem we have with this is most employers want to hire the best employees. And the best employee is very reluctant to sign up to contract terms which don’t guarantee them or at least try and fix some criteria that relates to their bonus payment. And so, it’s a balancing act between giving the employees some satisfaction that they will receive a bonus and how much bonus they will receive, whilst not committing yourself to anything in writing. If you’re going to provide a contractual bonus to employees, then you need to be very transparent and methodical in how you draft the performance formula and the criteria that need to be applied. What I would recommend for this is that instead of writing it in the employment contract, you actually write the formula or the criteria or performance thresholds in a separate document. Now, you could add this as a schedule, or an appendix to the contract. And the reason I say this is because I would recommend including an express provision that an employer is able to change or vary the terms of the formula every year and reissue it on a year by year basis. If you do decide to do this, then the employer should make sure that they do actually reissue the terms each year, even if those terms are to remain unchanged. This will give the employer some flexibility to adjust bonuses, even though it’s a formulaic contractual bonus.

Adam Hugill  15:55
While I said that the traditional 13th month bonus is common in Hong Kong, because of the strict rules and the Employment Ordinance that governs such payments, employers are deciding to do away with it altogether. It’s just too much like hard work, so therefore, you have to change the contract terms for the employees. To change the remuneration terms such as this would require mutual consent by the employee. So, the question is who would actually seek to give up their bonus? Well, what we advise employers to do is to change this contract term at about the same time as you do salary review. So, you say to the employee, you will only get your pay rise if you agree this contractual term, which does away with a 13th month bonus. Now, if you’re a fair employee, what you would do is you would divide that 13th month bonus over 12 months and add that as part of the salary review. But some employers are much more harsh than that.

Jacqueline Cheng  16:46
This has actually been very informative, Adam, so how would you sum up this podcast?

Adam Hugill  16:51
Okay, in a nutshell, I would say that there’s a lot of opportunity for employees to pick fights with their employers. Usually they will only pick that fight to their employments ended, but you could in theory, pick a fight with your employer whilst you’re still an employee. From an employer’s perspective, with regard to bonuses, there are many pitfalls that they should be aware of.

17:13
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