How discretionary are discretionary bonuses?

October 31, 2022

For employees who receive a bonus as part of their compensation, it is not uncommon for that bonus to be labelled as discretionary or for the employee’s contract to say that it will be paid “at the employer’s sole discretion”. Understandably, this language causes employees to feel uneasy, especially for those whose bonus accounts for the majority of their total compensation, since this language implies that the bonus can be set unilaterally or even withheld at the employer’s whim. Moreover, it is not uncommon for employers to attempt to use this language to their advantage when the employment relationship comes to an end, often relying on this language to argue that the employee is not entitled to a bonus for the period worked prior to termination or during the notice period. To be clear, that generally does not fly. If a bonus is a big part of an employee’s compensation, the default position is that the employee is entitled to a pro-rated bonus for any part year worked and to be paid in full over the notice period (contracts can change this default, but they often try and fail).

Employees can find significant comfort in the Court of Appeal for Ontario’s recent decision in Bowen v JC Clark Ltd., 2022 ONCA 614, which affirmed that an employer’s discretion in awarding a discretionary bonus is not unfettered. The two employees in Bowen had identical employment contracts that outlined the components of their total compensation, including a discretionary bonus provision, which read as follows: “At the total discretion of the Company, you may be eligible for a bonus at the end of each fiscal year depending on factors that include your personal performance and the profitability of the Company.”

The employees worked for the employer for approximately two years. They received a bonus in their first year of employment of $15,000 but were terminated without cause part way through their second year of employment. Despite the employer’s exceptional profitability that year, it did not remit a bonus to the employees for the period they worked prior to their termination. Instead, upon termination, it remitted a $577 payment to both employees, representing a “2-week pro-rata bonus” over their two-week notice periods.

The employees brought an action against the employer arguing, amongst other things, that they were entitled to their bonus for the partial year worked prior to termination. The employer took the position that the fact that the bonus was “discretionary” meant that it was solely up to the employer as to how that discretion was exercised. Presumably, this would mean that the employer had the power to unilaterally exercise its discretion not to remit a bonus at all.

The Court of Appeal for Ontario did not accept the employer’s position and instead held that “where an employment agreement provides for a discretionary bonus, there is an implied term that the discretion will be exercised in a fair and reasonable manner”.[1] It held that the employer’s analysis ought to have considered both bonuses paid to other similarly-situated employees for that year and the fact that the employer had a significant bonus pool that year. The Court ultimately held that, had the employer considered these factors in exercising its discretion, the employees would have been entitled to a bonus of $116,000 for the period worked in their second year of employment as well as the two-week notice period. It awarded each employee $115,000, since they sought this amount in their trial submissions and in their factum on appeal.

Even where an employment agreement stipulates that payment of a bonus is subject to the employer’s “pure” or “absolute” discretion, Bowen affirms the proposition that the employer’s discretion is not unconstrained and must be exercised reasonably. Where courts are unsure as to whether the employer acted reasonably, it will look to extrinsic evidence, including how similarly situated employees were treated at bonus time.

This is an issue that we handle again and again in our practice. We encourage you to contact one of our lawyers if your termination package does not deal properly with bonus income.

[1] Bowen at para 35