What was this case about?

Hewlett Packard (HP) asserted broad discretionary rights over the payment of commissions to a sale representative (Ms Subasic), to the extent that HP:

• denied the terms of the sales incentive program were binding in contract; and
• in the alternative, argued that HP had a right to retrospectively cap the amount of commission payable.

This case demonstrates the court’s willingness to:

• provide an aggrieved party recourse at law to enforce a private commercial arrangement; and
• fetter broad discretionary rights with an implied obligation to act in good faith.

Case study

HP is the Australian limb of a global information and communication technology business.

Ms Subasic was employed by HP as a sales representative and, after she left her employment, commenced proceedings against HP to recover $309,750.39 in underpaid commissions. Her claim related to a six-month period during which Ms Subasic exceeded her sales quotas to such an extent that she was 500% over budget (the measure period).

What happened?

Ms Subasic was offered employment with HP by letter (Offer Letter), which attached ‘General Terms and Conditions’ (collectively, the Employment Agreement). Also attached to the Offer Letter was an overview of HP’s policies and procedures, which did not form part of the Employment Agreement.

The Offer Letter referred to 2 components of earnings:

• a Total Remuneration amount per annum (TR); and
• a Target Incentive Amount per annum (TIA).

During the measure period, Ms Subasic achieved a level of sales that, in the ordinary course, would have resulted in her receiving an incentive payment of $446,250.39. Instead, she was paid $136,500.00 being an amount equivalent to 350% of her TIA in the measure period.

HP’s decision to pay the lesser amount was made upon a review of Ms Subasic’s performance, and 11 other employees who also exceeded their sales quotas, conducted after the measure period expired. On review, Ms Subasic’s sales target was not altered nor were any other metrics that constituted the incentive payment formula. Instead, HP applied a blanket cap on incentive payments to all 12 employees of 350% of the employee’s TIA. However, in Ms Subasic’s case, the cap reduced the payment by 800% of her TIA, whereas in the case of another employee, the reduction represented 59% of the relevant TIA. Moreover, the capping was purportedly imposed retrospectively, such that Ms Subasic received no incentive payment at all for all sales made after a point in the measurement period.

The Employment Agreement

The Offer Letter stated (emphasis added):

You will be paid a Total Remuneration amount… Your TR amount includes, the payments and benefits set out in HP’s General Terms and Conditions of Employment, but does not include any applicable profit share, employee share plan and other benefits.

The [sales] Program and the TIA are subject to change or cancellation at Hewlett-Packard’s discretion.

The General Terms & Conditions relevantly provided (emphasis added):

3. REMUNERATION

Your Total Remuneration has been set at a competitive market rate and as such includes all payments and benefits HP is legally obliged to make to you, to make on your behalf or make in relation to any amount or benefit provided to you (including overtime, loadings, allowances, superannuation as prescribed by law and Fringe Benefits Tax).

7. POLICIES

HP has a number of policies, procedures, practices and benefits which apply to its employees.

You agree to abide by any policies, procedures, practices and the criteria that govern any benefits that HP implements, as varied from time to time by HP at HP’s discretion. To the extent that the contents of policies, procedures, practices or benefits refer to obligations on HP, you agree that they are guides only and are not contractual terms, conditions or representations on which you rely.

The terms of the sales program and methodology for calculating incentive payments were set out in a document titled ‘HP Global Sales Compensation Policy’ (GSC Policy), which referenced a number of other documents including a Sales Plan to be issued to Ms Subasic in each measure period. The highly prescriptive documents form a part of what was aptly described in submissions as ‘the elaborate machinery’ by which incentive payments were to be calculated and paid.

The TIA was one of a number of metrics within the incentive payment formula, along with sales targets for different product types expressed in dollar figures, a weighting ascribed to different types of products sold, and a payout figure that included an accelerator, such that the greater the sales, the greater the multiple of TIA that may (in the ordinary course) be paid.

The GSC Policy contained the following statements (emphasis added):

• None of the contents in this policy, HP Sales Plans, nor regional sales compensation guidelines shall be construed to imply the creation or existence of a contract between HP and any participant, nor a guarantee of employment for any specified period of time
• HP reserves the right to adjust Sales Plans as necessary to address changing business conditions or correct administrative error
• HP reserves the right to change or discontinue this policy, with or without notice, at any time.

Clause 10 of the GSC Policy, titled ‘Management Incentive Performance Review (MIPR)’, relevantly stated:

HP has implemented a management review policy to evaluate sales performance significantly above target or for evaluation of credit for ‘large’ deals… When a sales employee reaches an identified performance threshold, a management review occurs. As a result of these reviews, management may adjust various components of the employee’s Sales Plan, may hold incentive payments until review is complete or may recover unapproved payments to ensure fair measurement of performance. For plans with discretionary metrics, MIPR can only make adjustments to the formulaic portion.

The claim

The GSC Policy was not contractually binding

HP submitted that the sales program set out in GSC Policy was a “policy” or a “benefit” and so had no contractual force because clause 7 of the General Terms and Conditions expressly evinced an intention that HP not be bound by policies, procedures, practices and benefits.

Moreover, HP submitted that clause 3 of the General Terms and Conditions was an exhaustive statement of the money to which Ms Subasic was legally entitled under the Employment Agreement; that is, the extent of her entitlement was the TR amount and, conversely, any incentive payment did not fall within the TR and was a payment that HP was not legally obliged to make.

Ms Subasic claimed she was entitled to have the sales program implemented in accordance with its terms, in which event a payment may or may not be owing depending upon her performance.

HP had a discretion

If HP was legally obliged to implement the sales program, HP submitted that the calculation of the incentive payment was subject to the proper performance of HP’s contractual powers of review in accordance with clause 10 of the GSC Policy.

HP submitted that Ms Subasic had reached the performance threshold under the MIPR which automatically triggered a review, and that any incentive payment to Ms Subasic above that threshold was not payable unless or until it was approved on review. HP further submitted that the decision-maker conducting the review did not approve any further incentive payment above 350% of TIA and thereby capped any further incentive payments to Ms Subasic.

Ms Subasic claimed in reply that HP did not have a discretion to cap the amount payable to her at all or, in any event, could not do so with retrospective effect after the measure period had expired. Alternatively, she argued that if HP did have a discretion to retrospectively cap the payment, it had done so in breach of an implied term requiring that the discretion be exercised in good faith.

The judgment

The GSC Policy was binding

The court held, in the first instance and on appeal, that, when construed as a whole and understood in its proper commercial context:

• the Employment Agreement created a legal obligation on HP to adhere to the terms of the sales program for so long as it remained in place – regardless of whether HP’s performance of that obligation resulted in any payment to Ms Subasic; and
• the GSC Policy (which the court found was not legally binding) did not operate so as to deprive Ms Subasic of that entitlement, merely because the method for calculating the amount of payment (if any) was contained in that ‘policy’ which conferred discretions for HP to exercise.

The discretion could not be exercised retrospectively and/or must be exercised in good faith

The trial judge found, and the Court of Appeal upheld, that HP did not have the discretion to retrospectively impose a cap on the amount of incentive payments owing to Ms Subasic under the terms of the sales program. The courts reasoned that:

• the express terms of the sales program were detailed and prescriptive, explicitly limiting HP’s discretion to adjusting specific components of the incentive payment formula, which went against the existence of an implied general discretion to arbitrarily cap the amount of payment;
• such a power would defeat the commercial purpose of incentivising high performers; and
• in the alternative, if such a power existed, the exercise of it in such an arbitrary manner (i.e. taking a blanket approach without regard to varying degrees of performance of the affected employees) was in breach of an implied term to act in good faith.

Key takeaways

You may wish to have a broad-ranging discretion over the way commercial arrangements operate but, even if the other party to your transaction is willing to accept such a bargain, it is important for you to objectively consider the fairness of that arrangement and explicitly address in the express terms of your agreement the extent and manner of operation of your discretionary rights.

In the absence of clear and unambiguous terms, the courts will search for a construction that limits the exercise of discretionary rights; particularly in cases where the parties’ inherent bargaining power appears unequal. They may also impose an obligation of good faith. That will require that, although the discretion may be exercised having regard to the party’s own legitimate interests (Burger King Corporation v Hungry Jack’s Pty Ltd [2001] NSWCA 187), the interest must be legitimate, and within the ambit of the contract.

This might be pertinent for government entities seeking to partner with private enterprises to deliver public services while retaining strong control over the delivery of those services and a free choice as to whether that partnership continues. This is even more so as previous cases, and commentators, have expressed the view that an obligation of good faith is to be implied into all government contracts.

You should always take the opportunity to ensure your contracts are drafted in clear and express terms that accurately and comprehensively communicate the intended meaning of each provision. This should be done not only in pre-contractual negotiations but whenever the term of a contract is varied or extended, or when there is any other cause to review the contract (such as frequent or significant disagreements between the parties over its intended meaning).