Can a bonus ever be a ‘discretionary payment’ under the Holidays Act? The Court of Appeal says yes

The Court of Appeal today issued its judgment in the seminal Metropolitan Glass & Glazing Ltd v Labour Inspector case about the treatment of short-term incentives in holiday pay.  The case and its appeal have received a fair amount of attention from businesses and unions alike.  This is not unexpected given the implications the case has for payroll liabilities – which, for some businesses, could be significant.

It will be a relief to those businesses that the Court of Appeal has found in favour of Metropolitan Glass: its short-term incentive (STI) payments should not be included in the calculation of holiday pay.  The key point for employers going forward is that the assessment will hang on the wording of the scheme, whether the scheme clearly articulates any discretion, and how that discretion operates.

What was it all about?

The pivotal question in Metropolitan Glass was whether the company’s STI arrangement should be included in an employee’s gross earnings for the purposes of calculating holiday pay.

The statutory overlay of the case is section 14 of the Holidays Act 2003, which defines ‘gross earnings’ as:

  • meaning all payments required to be paid under an employee’s employment agreement, including (among other things) productivity or incentive-based payments; but
  • excluding any payments not required to be paid under the employment agreement, including (among other things) discretionary payments.

Under section 5, a ‘discretionary payment’ is any payment the employer is not bound by the employment agreement to pay to the employee.  It does not include, however, payments that are provided for under the employment agreement but that are variable in amount or conditional.

Here, Metropolitan Glass had STI schemes that were not referred to in its employment agreements.  The documentation for the STI schemes set out that any payment under them was conditional on the achievement of certain deliverables and, in any event, entirely at Metropolitan Glass’ discretion.

Metropolitan Glass argued that the STI schemes were discretionary payments for the Holidays Act’s purposes and therefore excluded from the calculation of gross earnings.  The Labour Inspector’s view, which the Employment Court agreed with, was that the payments were productivity or incentive-based ones and therefore included in the calculation.

Metropolitan Glass appealed, resulting in today’s judgment.

Where did the Court of Appeal land?

In determining whether the Employment Court erred in its judgment, the Court of Appeal broke the issue down into two elements:

  • Was the payment made under the ‘employment agreement’?
  • Was the payment a payment Metropolitan Glass was required to make?

What is the meaning of ‘employment agreement’?

The Court of Appeal agreed with the Employment Court that the formal written employment agreement will never constitute the entire contract between the parties.

The Court commented that it would be ‘nonsensical’ if an incentive payment was gross earnings where it was contained in the main employment agreement, but a discretionary payment where it was contained in a separate document albeit in exactly the same terms.  The mere fact that the Metropolitan Glass’ STI scheme was in a separate document did not preclude it from falling within the meaning of gross earnings.  Rather, whether a STI payment is discretionary or not (and excluded from gross earnings or not) turns on whether it is a payment the employer is contractually bound to make.

Was Metropolitan Glass contractually bound to make the payment?

It was here that the Court of Appeal departed from the Employment Court’s assessment, finding that conditional STIs will only be included in gross earnings where the employer has a contractual obligation to pay the bonus if the conditions are met.

Here, that was not the case.  The STI scheme’s documentation clearly set out that any payment under the scheme was entirely at the company’s discretion, even where all of the conditions were met.

The Court of Appeal considered in an aside whether a residual discretion not to make any payment at all was the same as a discretion as to the amount payable (in which case it would not be a ‘discretionary payment’ for section 14’s purposes).  The Court concluded that it was a prerequisite of the latter type of discretion that the amount not be specified in the employment agreement.  Here, it was included in the employment agreement (by way of the STI scheme documentation).

What can we take from this?

The judgment sheds clarifying light on one of the many complexities of the Holidays Act.  But while businesses may rejoice the result, we would advise taking some caution in effecting it into payroll practices:

  • The judgment should be read in its context and employers should be careful not to interpret it as saying all STI schemes are discretionary payments.  In Metropolitan Glass, while the STI schemes were part of the employment agreements, they were carefully worded so as to give Metropolitan Glass absolute discretion regarding payment.  The case could only be relied on, then, where a business’s bonus scheme similarly provides that payment is ultimately at the employer’s discretion, even where all the conditions for the bonus are met.  We note also that the Court stayed silent on whether a residual discretion would be the same as a discretion as to the amount in circumstances where the amount is not set out in the employment agreement.
  • The judgment could be appealed to the Supreme Court. Until the highest court has issued its view on the matter or the timeframe for lodging an appeal has lapsed, we should not take this as settled law.
  • Regardless of the position reached, we can expect legislation next year that will override the judicial developments in this area.  The Government has accepted all recommendations of the Holidays Act Taskforce, one of which is to change the definition of ‘gross earnings’ to mean all cash payments an employee receives except reimbursements for costs incurred.

If you have any questions about the implications of this judgment for your business, please do not hesitate to get in touch with one of our employment experts.

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