Legal Insights

Commissions and incentive schemes: how to avoid costly disputes with employees and contractors

By Christopher Charalambous

• 13 December 2018 • 4 min read
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Developers commonly offer commission or bonus schemes as part of their contractual arrangements with sales employees and contractors.

The reasons are obvious: incentivised pay attracts high quality talent, drives and motivates the team, rewards success and fosters a healthy culture of competition and excellence.

The terms and conditions of such schemes vary significantly across the industry. However as a general proposition, commission arrangements provide for employees or contractors to be paid amounts in addition to their fixed or base salary in recognition of exceptional performance.

While bonus and incentive schemes are critical to driving productivity and results, they can be a real headache for developers when they are not well drafted. Often it is not until a person’s employment or engagement with a developer comes to an end, that problems with the interpretation of the wording of a scheme come to the fore.

The approach of the courts in Australia

There has been a recent trend on the part of Australian courts to take a beneficial approach to the interpretation of bonus clauses. That is, the courts have been prepared to interpret a clause in a way that is beneficial to the individual rather than the company, and this has resulted in the payment of significant damages to individuals for breach of contract claims.

The courts will often require a company to pay a bonus to an employee even in circumstances where an employer has purported to exercise its discretion not to pay a bonus, or has asserted that the relevant scheme is, on the wording of the clause, able to be withdrawn by the company at any time.

While a clause may expressly state that the payment of a bonus is entirely within the discretion of the company, the courts have imposed significant limits on this and found that such a discretion should not be construed as allowing an employer to withhold a bonus capriciously, arbitrarily or unreasonably. Where a developer has full discretion about whether or not to pay a bonus, they must still exercise their discretion in a way that is ethical and equitable.

Similarly, many bonus schemes contemplate developers setting key performance indicators (KPIs) or targets for their workers in order to determine whether or not a worker is entitled to a bonus. Such contracts often provide that the relevant KPIs will be determined at some point down the track, either by agreement with the worker (which is always problematic) or by another process, such as determination by the Board.

In practice, companies may fail to set clear KPIs or targets (often for a range of reasons), and consequently take the view that the entitlement never crystallises. But the courts have been critical of this conduct, saying that it will amount to a breach of contract to fail to set KPIs or targets if a contract provides for their identification and implementation.

Effect of termination

It is critical that developers draft bonus provisions with sufficient clarity to address the issue of payment of bonuses on termination. Too often, contracts are silent on this issue, which provides scope for employees to seek the assistance of a court to determine the position.

Confusion often arises in relation to the date from which someone ceases being eligible for bonus entitlements. Ideally, developers should ensure that a person’s entitlement to bonus payments ceases on the date they are given notice of the termination of their employment or engagement. Similarly, if an employee or contractor provides notice of termination in accordance with the contract, the agreement should stipulate that the entitlement ceases on the same date. If the contract is silent on this question, there will likely be an argument about whether the date of notice or the last day worked (assuming they are different) is the relevant date for calculating bonus entitlements.

While trailing arrangements are common, developers should be wary of commissions or bonus schemes that contemplate long-term or staggered payments to employees and contractors. They may be straightforward to administer while the relationship is going well, however things can get complicated on termination.

Lessons for developers

  1. The crafting of incentive schemes is a delicate balance between positioning an attractive arrangement that will appeal to top talent and protecting the company in the event of a soured relationship.
  2. Be mindful that although you may use language, which on its face, provides the company with maximum discretion and flexibility, in practice a court is likely to interpret the clause in favour of the worker. Relying on ‘carve-outs’, such as the right to exercise a discretion, or a failure to set any threshold KPIs as a basis for withholding bonus payments from the worker, will not stack up in court.
  3. It is critical for minimising your exposure to claims that you ensure your bonus and commission scheme provisions are drafted in a way that gives you maximum flexibility but minimises the risk of ambiguity, especially as to how the scheme will operate when an employee or contractor ceases to work for you.

Need guidance to draft bonus and commission scheme provisions?

Contact the Employment, Remuneration & Benefits team.

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