Legal pitfalls when offering a bonus scheme

A well-designed bonus scheme can effectively incentivise employees to go above and beyond in their work, rewarding loyalty. But disputes can also arise around bonuses. Getting it wrong can result in high-value legal claims; and in a recent Employment Appeal Tribunal case the employer had to pay out £500,000.

Bonus payments often form a significant part of an employee’s reward package, and they will scrutinise their payments. Disputes often arise where an employee challenges how a bonus is calculated, who it is awarded to, or the employer’s decision that it is not obliged to pay a bonus at all.

Legal risks arise not just from contractual claims, but also allegations of discriminatory treatment. Thinking through what the business wants to offer, ensuring this is reflected accurately in documentation and keeping to that position, will all help minimise the risk of a claim.

In this blog we outline the three types of bonus, and highlights the common legal pitfalls.

Types of bonus scheme

It is important to be clear about the type of bonus in operation:

• contractual – the contract or director’s service agreement sets out that the individual is entitled to take part in the bonus scheme. It may guarantee an amount that will be paid, or set out conditions for a bonus to be payable or how the bonus will be calculated;
• fully discretionary – the business can decide whether or not to pay any bonus or none at all; or
• partially discretionary – gives the individual the right to be considered for a bonus payment, and the way of calculating the amount is at the business’s discretion.

When does the employer have to pay?

Where the bonus is guaranteed in a contractual document, the employer must pay it. If the employer is obliged to pay depending on particular conditions, such as profit levels or personal targets, the employer will have to pay a bonus if those conditions are met.

Employers will only be able to decide whether or not to make a bonus payment, if it is genuinely at their discretion. The first port of call will be to look at the wording of a policy or contract.

However, even if there may be nothing in writing, this apparent flexibility may be misleading if consistent past practice has created an expectation of bonus payments. This can be incorporated into the contract through custom and practice.

A verbal agreement can also have contractual force, meaning the individual could be entitled to a payment.

Pitfalls to avoid and tips

Verbal agreement – this can create a binding agreement, such as through discussions before joining the business or via a staff announcement, so take care when putting something forward that could be interpreted as an offer. Bonus scheme documentation may specify that the employer is not bound by anything said in precontractual discussions.

In a recent case in the Employment Appeal Tribunal (Chandrashekarappa v Wipro [2026]), a commitment was made in a presentation to staff to pay a 1% bonus of invoicing over 12 months for new deals secured by sales staff. This was subject to the Sector Lead’s approval. Mr Chandrashekarappa completed a major deal and the payment of the bonus was approved by the Sector Lead, although the figures were not yet known. Before the revenue figures were known, the company applied a cap of $150,000 to the bonus and made the payment subject to a higher level of management approval. The EAT held that additional requirements of the cap and the higher level of approval could not be applied. The employee’s entitlement crystallised at the point the Sector Lead’s decision was communicated to him. He was entitled to the full, uncapped 1%, which was over £500,000.

Unclear terms – disputes can arise from not recording a verbal agreement or using unclear wording, especially in regard to eligibility and calculations. We can carry out the negotiations for you or work through the arrangements with you and draft clear, accurate agreements to minimise the risk of a dispute. We can also ensure the agreement covers areas that may not have been discussed, such as what happens when the employee leaves, and any clawback arrangements allowing the employer to recover the bonus in certain circumstances, such as misconduct or leaving within a specified time of receiving the payment.

Assuming the bonus scheme is discretionary – custom and practice may mean that bonuses have to be paid, even if nothing is in writing or contracts say the opposite. We can review your practices and any written agreements and advise on reducing risk and avoiding committing the business unintentionally to paying bonuses.

Unaffordable commitments – employers may bind themselves to a bonus that made business sense when the individual joined, but is no longer affordable or does not target any current business needs. Although the employer may be restrained from drastically reducing the entitlement, well-drafted contractual documents can give the employer the right to change the terms of the agreement, for example the performance targets on which the bonus becomes payable.

Assuming discretion is unlimited – while documentation may give the business a discretion whether to award bonuses or how to calculate these, how the discretion is exercised is limited by an implied obligation to do so in good faith and not arbitrarily or irrationally. Employers may also breach the mutual duty of trust and confidence in how they exercise discretion and this can allow the individual to resign and claim unfair dismissal. We can advise you on ensuring your decisions withstand any challenge.

Discriminatory decisions – this is a risk, particularly when bonuses are awarded based on subjective performance-related criteria, individuals may interpret different treatment as unfair and relating to protected characteristics. Employers should try to be consistent in their treatment of staff, unless there are non-discriminatory reasons for differences in treatment.

Discrimination risks also arise where payments are calculated differently for staff depending on their circumstances, such as not paying or reducing a payment due to absence on family-friendly leave or disability-related sick leave, or working part-time or on a fixed-term contract.

It may be possible to justify different treatment or to pro rate the bonus and we can advise you on this.  The decision-making process should be evidenced to defend any claims or allegations of discriminatory treatment.

How we can help

We can review your written documents, past practice and verbal agreements to assess what payments are likely to be due and when. We can draft clear contracts and bonus schemes to reduce uncertainty or retain flexibility.

For further information, please contact Neil Largan, Head of Dispute Resolution team.

This article is for general information only and does not constitute legal or professional advice. Please note that the law may have changed since this article was published.