Employers Rejoice – Court of Appeal rules discretionary bonuses to no longer be included in Holiday Pay

In 2020 the Employment Court in Metropolitan Glass & Glazing Limited v Labour Inspector[1] (“Metropolitan Glass”) turned settled understanding of employers obligations to quantify holiday pay on its head when it determined short-term incentive or productivity-based discretionary bonuses (“STIB” schemes) fell within the definition of “gross earnings” under s 14 the Holidays Act 2003 (“the Act”).

This decision significantly limited the scope of payments that fell outside the definition of “gross earnings”, exposing many New Zealand employers to additional financial liabilities. It meant discretionary payments made under incentive or productivity-based schemes must be included in calculation of an employee’s gross earnings when determining their holiday pay entitlements.[2]

This year, Metropolitan Glass appealed the decision to the Court of Appeal (“the Court”). It raised the following question: 

Did the Employment Court err in law by concluding that payments made by the  [appellant] from its short term incentive bonus scheme were “payments that the employer is required to pay to the employee under the employee’s employment agreement”, and therefore fell within the definition of “gross earnings” under s 14 of the Holidays Act 2003?   

THE COURT OF APPEAL DECISION

Meaning of “Employment Agreement”

The Court looked at the meaning of “employment agreement” and held that the formal written employment agreement was never the entire contract of service; it was only one source (albeit often the main source) of contractually binding terms.

The Court noted that if the meaning of employment agreement was limited, it would mean that an incentive payment would be regarded as gross earnings if it were contained in the main employment agreement, but a discretionary payment if it was in a separate document, even though the terms of the incentive payment were exactly the same. 

In this case, the Court found the source of the employer’s contractual obligation was irrelevant to the question of whether the SITB scheme was captured by the definition of “gross earnings”, which ultimately turned on whether such payments were “discretionary”, and were therefore payments the employer was not contractually bound to make.

Meaning of “Discretionary Payment”

The Court observed that the Employment Court had determined that productivity and incentive-based payments will always be “gross earnings” by virtue of s 14(a)(iv) of the Act. The Employment Court distinguished these incentive-based and productivity payments from “truly gratuitous payments” such as Christmas bonuses paid on the Employer’s own initiative.

The Court concluded that the Employment Court’s interpretation failed to consider whether the retention of a residual discretion to award a bonus under an STIB scheme took those payments outside the scope of “gross earnings”. The interpretation, the Court said, overlooked the key element of the definition of gross earnings, being that “the payment at issue must be one the employer is contractually bound to pay”. This contractual obligation is the defining line between discretionary payments falling outside the scope of gross earnings, and those payments which are captured by s 14.

Importantly, the STIB scheme set up by Metropolitan Glass contained an express provision that stated even if all the conditions of the STIB scheme were met; the employer retained the discretion to make any payment.

The Court has restored what has long been the settled understanding of employer’s obligations under the Act prior to the 2020 Employment Court decision.

WHAT DOES THIS MEAN FOR EMPLOYERS?

• Ensure discretionary incentive or productivity-based bonus schemes are truly discretionary.

Employers should ensure employment agreements and discretionary payment policies are robust and clearly understood. If an employer wishes to retain discretion to award a bonus, it should make that intention unequivocal in the wording of the scheme.

We recommend employers review not only their employment agreements, but also any separate company policies, circulars and other internal documents to ensure bonus schemes are appropriately defined.

If a discretionary incentive or productivity-based bonus scheme is vague, it could open the employer up to greater financial obligations to take those payments into account when calculating an employee’s holiday pay entitlements.  

• Understand (and clearly define) your contractual obligations.

Likewise, if an employer intends to be contractually bound to make a conditional payment under an incentive or productivity-based scheme, we recommend that intention be made clear. For example, automatic bonuses awarded when an employee achieves a certain KPI, will form part of that employees gross earnings (if reached) if that bonus is automatic. Productivity and incentive-based payments which equate to remuneration for effort are captured by the definition of s 14(a)(iv).

• Remember your obligations under s 103A.

Even when exercising discretion, employers are obliged to act fairly and reasonably. A failure to do so could form grounds for a personal grievance.[3]

• Amend policies and employment agreements carefully.

While the Court of Appeal has effectively restored the law prior to the by Employment Court decision, the Ministry of Business and Employment reserves the right to appeal to the Supreme Court within 28 days of the judgment for final determination. We recommend ensuring a review of your employment agreements and internal policies is undertaken carefully and thoroughly. We will be keeping a close eye on whether there could be further developments to the legal landscape in this area.

If you have any questions about ‘gross earnings’, discretionary payments or the Holidays Act, please contact Jaesen, Ruth, Jordan or Caylee.

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[1] Metropolitan Glass & Glazing Limited v Labour Inspector, Ministry of Business and Innovation and Employment [2020] NXEmpC39

[2] Details of the decision and an in-depth discussion of ‘gross earnings’ can be found here.

[3] Metropolitan Glass & Glazing Limited v Labour Inspector, Ministry Of Business And Innovation And Employment [2021] NZCA 560 [26 October 2021] at [41].