In what is welcome news to many employers, the Court of Appeal has overruled the Employment Court’s judgment regarding discretionary incentive payments under the Holidays Act 2003.
The Court of Appeal held that where incentive schemes reserve a discretion for an employer not to make payment, such incentive payments are discretionary under the Holidays Act. This means that the payments would not form part of “gross earnings” upon which annual holidays are calculated.
In 2016 and 2017, the employer sent a letter to certain employees inviting them to participate in a discretionary bonus scheme. The scheme contained conditions that were attached to performance targets, but also stated that any payments made under the scheme were entirely at the employer’s discretion, and that it had no obligation to make any payment even when all the specified criteria were met.
The Labour Inspector considered that the payments made under the schemes were “gross earnings” for the purposes of the Holidays Act 2003 and should have been taken into account in calculating holiday pay. The employer disputed this and argued that they were discretionary payments, which the Holidays Act does not require to be included in “gross earnings”.
The Employment Court found in favour of the Labour Inspector, and the case was subsequently heard by the Court of Appeal.
The question for the Court of Appeal was whether payments made under the discretionary bonus schemes were payments the employer was required to make to its employees under the employment agreement and therefore within the definition of “gross earnings” under section 14 of the Holidays Act.
The Court of Appeal distilled the case down into two threads. The first thread considered whether “employment agreement”, for the purpose of the definition of “gross earnings”, should be interpreted narrowly as meaning only the formal written employment agreement.
The Court of Appeal concluded that the meaning of “employment agreement” will differ depending on context. It was noted that under the Holidays Act, the essential difference between a “discretionary payment” and “gross earnings” is whether the employer is contractually bound to make the payment. If a contractual obligation exists, the source of the obligation is irrelevant. It is well established that contractual obligations between an employer and employee can arise from different sources outside of the formal written employment agreement. Therefore, the fact that the bonus scheme was not contained in the formal written employment agreement did not of itself render the payments discretionary.
Is the employer required to pay?
The second thread considered whether the payment was in fact discretionary.
The Court of Appeal disagreed with the finding in the Employment Court that any incentive or productivity based payments will always be “gross earnings” under the Act, and can never be discretionary payments. That approach was considered to be an error, because it overlooks the key element of the definition of “gross earnings”, which is that the payment at issue must be one the employer is contractually bound to pay. Conversely the definition of “discretionary payment” is a payment the employer is not contractually bound to pay.
As a result, the Court of Appeal noted that the Employment Court never considered whether the existence of the residual discretion in the schemes not to make any payment, even if all conditions were met, took it outside the scope of “gross earnings” and into the territory of a “discretionary payment”, as defined under the Holidays Act.
Further, it was observed that although Metropolitan Glass has a legal duty to exercise its discretion fairly and reasonably, the fact that the bonus payments under the scheme were neither conditional nor guaranteed meant it still retained its character as a discretionary payment for the purposes of the Holidays Act.
The Court of Appeal’s judgment is strongly favourable for employers.
The Court of Appeal’s judgment means that the Authority and the Court must now consider one overriding factor above all else – is the employer contractually bound to make a payment? If the employer has a discretion not to make a payment, despite the criteria having been met, then that payment would not form part of “gross earnings” for the purposes of the Holidays Act.
Where to from here
For now, employers can breathe a sigh of relief. Provided the employer has the discretion not to make a payment, then the payment is discretionary, and it is not part of gross earnings. The dividing line, as drawn by the Court of Appeal, is clear and favourable for employers to apply.
If the Labour Inspectorate wishes to seek leave to appeal to the Supreme Court, it is highly likely to be granted – because this is a matter of statutory interpretation. In that scenario, all employers would have to wait with baited-breath for the Supreme Court to weigh in on this matter.
There is, however, a countervailing consideration. The Holidays Act taskforce deliberated with the Employment Court’s decision in mind – and their recommendation, if enacted into law, would mean that gross earnings will be expanded to include all cash payments received (discretionary or not), except direct reimbursements for costs incurred, from an effective date (prospective only).
In light of this countervailing consideration, there may be some pressure not to press on with an appeal – because the certainty helps to bury the issue of retrospective liability.
In our view, the Court of Appeal’s judgment affirms the correct approach in calculating holiday payments and provides employers with some much-needed certainty in this area.
However, the Holidays Act 2003 overhaul could leave employers in the lurch again. While we agree the current definition of gross earnings is overly complex which often leaves employers in the dark regarding their legal obligations, the current proposed definition swings too far the other side. We consider that the Holidays Act taskforce’s recommendation of the proposed expanded definition of gross earnings is too broad and runs counter to the well-established concept of discretionary pay.
If you need advice or assistance in relation to your payroll practices, we encourage you to contact us.