But ill-prepared employers can find themselves on precarious footing when it comes to the distribution of bonuses during the holiday season. What may seem like an innocuous gesture of goodwill to alleviate pressure at a festive time of year can unintentionally give rise to an implied term of employment for years to come.

Unbeknownst to many, implied terms of employment through an employer’s conduct can create an unwritten entitlement equally as enforceable as the payment of salary.

In the absence of an enforceable employment contract that clearly and unequivocally establishes bonus awards as discretionary, employees may contend that the historical payment of bonuses establishes a guaranteed component of their annual compensation. This means that companies who face an economically depressed year run the risk of exposure to significant unexpected expenses across the board, as employees who consistently received bonuses can assert an entitlement to their annual payment. This, of course, compounds the adverse impact of a poor year for employers.

To minimize the risk, employers must ensure that employment agreements include language expressly communicating that the payment of variable incentives is truly discretionary, subject to change (including nonpayment), and that any award in one year shall not be construed as creating an entitlement in the future.

As a matter of best practices, contracts should, either expressly or by reference to an existing policy, include objective assessment of at least a portion of employees’ variable compensation. By having this framework in place, employers are better positioned to justify volatility in variable pay.

Communication is key

When awarding bonuses in any given year, employers should reiterate that the award was discretionary and contingent on various factors, including individual and/or company performance. The employer should also underscore that past practices do not create binding obligations for potential future awards.

This clear communication at the time of granting an award reinforces the contractual framework in the event of future disputes, such that the recipient will be unable to reasonably allege that the award was intended to be guaranteed each year.

Actions speak louder than words

Although many employers include the necessary language in contracts, often their actions are inconsistent with these contractual provisions, complicating matters. For example, where a similar dollar amount or percentage of compensation is provided annually irrespective of individual or company performance, the courts may look to the conduct of the parties to determine whether or not the payment of bonuses was truly discretionary. If the employer has, year after year, provided its staff with bonuses through good times and bad, the company may be on the hook for the payment of bonuses consistent with these amounts, regardless of contractual provisions.

How to offset a precedent

There are two primary approaches that employers rely on to shed unintended bonus liabilities.

First, employees can be presented with an updated employment agreement which includes the contractual provisions necessary to amend an existing bonus policy. Given that the new contract will be removing an existing entitlement, it is imperative that employees are compensated for their execution of the new agreement, typically by way of a raise to their base salary or a one-time signing bonus. Absent this consideration, the company runs the risk that the new contract is unenforceable, and the existing terms of employment remain in place.

The other option is by advance notice. An employer is entitled to amend its employees’ terms of employment in any way it desires, as long as it provides sufficient notice before the change comes into effect. What level of notice is appropriate will depend on the circumstances and is a function of a number of factors (i.e., age, position, tenure) and the nature of the change. While minor tweaks, such as the introduction of a new policy, may not require any notice, others like the overhaul of a bonus plan will more generally require more time.

Generally speaking, due to the “one size fits all” approach of executing new contracts, most employers tend to prefer the former approach to the latter. In my experience, the second approach is more common where an affected employee refuses to execute the new agreement and is willing to forego the signing bonus or raise to preserve their existing terms of employment.

As we head into 2024, now is a prudent time to review and, if necessary, revise employment contracts to address the discretionary nature of variable compensation. By incorporating carefully crafted language and implementing consistent communication, employers can ensure a clear understanding for all by this time next year. In the realm of employment, the true value of clarity is often underappreciated.