Holidays Act – Discretionary bonuses and “gross earnings”

27 October 2021

In a significant decision issued yesterday, the Court of Appeal has overturned an earlier judgment of the Employment Court regarding the treatment of discretionary bonuses under the Holidays Act 2003 (“the Act”). In Metropolitan Glass and Glazing Limited v Labour Inspector, the Court of Appeal held discretionary bonuses do not form part of an employee’s “gross earnings” under the Act and therefore should not to be taken into account when calculating payment for annual holidays

“Gross earnings” and “discretionary payments”

The Act defines “gross earnings” as:
“…all payments that the employer is required to pay to the employee under the employee’s employment agreement”
The Act gives examples of what constitutes gross earnings, including salary and wages, overtime and productivity incentives.
Discretionary payments are expressly excluded from gross earnings. They are defined as:
“…a payment that the employer is not bound, by the employee’s employment agreement, to pay the employee”

However, a payment is not discretionary if it is one an employer is required to make under the applicable employment agreement, but the employer has a discretion as to the amount payable, or if the payment is only payable if certain conditions are met.
Inclusion of discretionary bonuses in the calculation of gross earnings could impact on the amount payable to employees during annual holidays and on the termination of employment.

Metropolitan Glass invited senior employees to participate in a bonus scheme. Its scheme provided that if staff achieved three key deliverable targets, they would be receive a bonus payment. The payments were calculated as a percentage of base salary where the targets were met. The terms and conditions of the scheme included:

  • There was no guarantee of payment.
  • Metropolitan Glass had “the sole discretion not to make any payment”, even where the criteria were met.
  • Any payments would “not come within the definition of “total gross earnings” for the purposes of [the Act]”.

Metropolitan Glass considered payments under its bonus scheme were discretionary payments for the purposes of the Act and therefore not included when calculating the payments for annual holidays. The Labour Inspector took a different view. They said the payments were gross earnings and not discretionary.

Employment Court decision
The Employment Court convened a full Court to hear the matter due to its potential significance. It found in favour of the Labour Inspector.

The Court concluded that the terms and conditions of the bonus scheme formed part of the employees’ employment agreement. It noted that an employment agreement can be compromised of different “components in more than one place”. Policies may be incorporated into an employment agreement by express reference and by inference. As regards incorporation by inference, the Court held the test to be applied was whether it is reasonable to infer from the circumstances that the parties must have intended the relevant terms to have contractual force.  In this case, the Court held the scheme had been put in place to incentivise employees and the payments were remuneration for effort put in by the employees.

The Court went on to hold that these productivity or incentive-based payments were gross payments under the Act.  It held the Act contemplated that such payments are captured whether the payments arise out of a written individual agreement or from policy documents or contained in a separate document.

As a result, the Court held that the payments under the scheme were not discretionary and should be included in employees’ gross earnings. Therefore, they formed part of the calculation of payment for annual holidays.

The Court of Appeal
Dissatisfied with that outcome, Metropolitan Glass sought and obtained leave to appeal to the Court of Appeal. The Court of Appeal also granted leave to BusinessNZ to participate in the appeal hearing as an intervenor. BusinessNZ was concerned about the wider implications of the Employment Court decision. If allowed to stand, the decision was likely to result in backpay obligations amounting to hundreds of millions of dollars for New Zealand employers throughout the country who believed they were acting lawfully and in accordance with the Act.

The Court of Appeal agreed with the Employment Court that the mere fact that the scheme was in separate documents to the applicable employment agreements did not of itself take them outside the category of gross earnings.

However, the Court of Appeal noted that the hallmark of a discretionary payment and what distinguishes it from gross earnings is that it is a payment the employer is not contractually bound to make. If the employer was contractually bound to make the payment, then subject to a limited number of specified exceptions, it is gross earnings.  Conversely, the definition of discretionary payment is a payment the employer is not contractually bound to pay.

The Court noted Metropolitan Glass did more than just label its scheme discretionary. It included an express term that even if all of the conditions were met, it retained the discretion not to make any payment. As a result, the Court held that the scheme was discretionary and should not be included in employees’ gross earnings.

This judgment should provide some clarity for employers who offer discretionary bonuses. Where payments are genuinely discretionary and treated as such, they will not result in greater liability for holiday pay.

However, care still needs to be taken when implementing bonus schemes. To fall outside the scope of gross earnings, the payment must be genuinely discretionary. There must be a clearly expressed conditions that bonuses are awarded at the sole discretion of the employer. We recommend that appropriate wording to reflect this is included in the employment agreement or in the terms and conditions of the incentive or bonus scheme.

The other area for caution is deciding whether to pay discretionary bonuses or not. Any discretion must be exercised fairly and reasonably. This means there should be a good reason for not paying a bonus. They should not be withheld arbitrarily. This does not directly impact on holiday pay calculations, but withholding a bonus without good reason could give an employee grounds for an arrears claim and/or a personal grievance.

If you have any questions regarding your incentive or bonus scheme, please do not hesitate to contact us.

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