DRAFTING BETTER BONUS POLICIES

Posted on May 27, 2011 in Consulting

To prevent disputes over bonus pay, employers should always thoroughly and meticulously explain their bonus policy in writing.  A written bonus policy not only tells an employee what is expected of them for an earned bonus, but is also the best defense against employee allegations concerning strictly oral promises.   

This post identifies the critical factors when drafting or reviewing a bonus plan.

Discretionary or non-discretionary plans

First, an employer should determine whether they are drafting a discretionary or non-discretionary bonus plan.  A bonus policy must fit one of these two categories, and the employer should clearly state which one it chooses. If discretionary, the policy can simply read, “Our Company may pay bonuses in its sole discretion depending on the overall financial performance of the business and the employee’s performance.”  In addition, a discretionary policy need not and should not contain a formula; a formula within a discretionary policy conveys an inconsistent message.  However, the policy could explain general factors that the company might consider in exercising its discretion, such as company profitability and individual employee performance.

Disclaimer of oral promises

In a written bonus policy, an employer should add the disclaimer that oral promises of bonus payment are not enforceable. On this note, every bonus policy should state that no oral promise by any officer, manager, or employee is enforceable and that the company will honor only written promises signed by both the President of the company and the employee. 

“Earned when paid” provisions

Employers rarely want to pay a bonus to a former employee. That being said, a bonus becomes an obligation of the employer (equivalent to wages) once it is earned.  Thus, a policy misses the mark if it simply states that an employee must be employed on the day a bonus is earned without further specifying the bonus has not been earned until paid.  To avoid such complications, employers should specify that an employee earns a bonus only if he is employed on payment day and has not indicated his or her intent to resign. In this circumstance, very specific language is critical to good policy writing.

Bonuses based on sales

Employers often pay employees a bonus based on sales.  Sales-based bonus policies require attention to a number of critical details: which or what type of sales are eligible for bonus payment, whether the employee must surpass sales thresholds and if those thresholds are reset at certain time periods, whether the employee’s bonus is dependent on collected revenue and not gross sales, and many other factors.  For example, an employer might restrict the bonus to sales that are attributable directly to the employee and are collected by the company within 90 days of the date of sale.  This example makes it clear that only revenue collected within a restricted time frame counts towards the employee’s potential bonus.  Whatever the policy, clarity is critical and is often achieved by providing a written example with hypothetical numbers.

Key terms and their definition

Employers should carefully define key terms in their bonus policy.  Sometimes common terms have unique meaning for a particular business.  Employers may assume that their unique meaning of a term is understood by its workforce.  The workforce and the employer are better served if the employer spells out precisely what it means by the key terms in its bonus policy. 

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