Court finds employers' discretion in awarding bonuses must be exercised fairly

by Rhonda B. Levy and George Vassos of Littler

In Bowen v. JC Clark Ltd., 2022 ONCA 614, the Ontario Court of Appeal (OCA) put employers on notice that their discretion in awarding discretionary bonuses is not unconstrained and must be exercised fairly and reasonably. 

The employees were portfolio managers (Portfolio Managers) of one of the employer’s hedge funds (Fund), whose employment was terminated without cause.  The OCA reversed the trial judge’s decision to dismiss their claims for a discretionary bonus.  In allowing the claims, the OCA stressed that an approach to awarding discretionary bonuses that is “purely subjective” and “unconstrained” is inconsistent with an employer’s obligation to exercise such discretion in a fair and reasonable manner.

In determining the quantum of the bonuses, the OCA took into consideration the returns of the Fund and the bonus awarded to the employer’s similarly situated portfolio managers in the relevant year.

Background

In 2003, two employees were hired in junior roles by a senior investment professional (Senior Professional), who created and managed the Fund through his investment firm. By 2012, the employees were Portfolio Managers under the Senior Professional’s supervision.

In 2012, the Senior Professional sold the Fund to JC Clark Ltd. (JC). He and the Portfolio Managers joined JC to manage the Fund. To complete the sale, the Senior Professional signed a combination agreement with JC (Combination Agreement), which provided that for four years after the Fund’s sale, the Senior Professional would receive 40% of the management fees and performance fees earned by the Fund.

The Combination Agreement required JC to offer employment to the Portfolio Managers on these terms:

2.6(e)(ii) [JC shall] offer employment … to each of [the Portfolio Managers] pursuant to an employment agreement … which … shall provide, among other things:

(i) for a base salary of $100,000 per annum;

(ii) for the potential (but not a guarantee) of [the Portfolio Managers] to be part of a discretionary bonus pool established by [JC];

(iii) …

(iv) for [the Portfolio Managers] to receive such portions of the Allocated Trailer Amounts and Allocated Fee Amounts as may be determined by the Senior Professional.

The Combination Agreement gave the Senior Professional the discretion to share his 40% of any fees earned by the Fund with the Portfolio Managers. The Senior Professional shared drafts of the Combination Agreement with the Portfolio Managers, but they did not receive the final signed version. Clause 2.6(e)(ii), above, was included in the drafts provided to the Portfolio Managers and in the final version signed by JC and the Senior Professional. Before the Portfolio Managers signed their employment agreements with JC (Employment Agreements), the Senior Professional told the Portfolio Managers that he would pay them 50% of the management fees and 100% of the performance fees allocated to him.

JC sent draft employment agreements for each of the Portfolio Managers to the Senior Professional in October 2012. The finalized Employment Agreements, identical for both Portfolio Managers, contained the following discretionary bonus provision:

At the total discretion of the Company, you may be eligible for a bonus at the end of each fiscal year depending on factors that include your personal performance and the profitability of the Company. 

This term was consistent with the language of the employment offer term in the Combination Agreement (clause 2.6(e)(ii)).

The performance fee payout provisions from the Combination Agreement were not referred to in the Employment Agreements, because the Senior Professional would control the payout of the 40% performance fee, and because referring to the performance fees would be inconsistent with the other employment agreements at JC, which did not mention performance fees.

The Senior Professional and the Portfolio Managers began working at JC in December 2012. The Portfolio Managers managed the Fund’s day-to-day activities. Because the Fund did not earn performance fees in 2012, there were no fees to allocate in 2013. In December 2013, each of the Portfolio Managers received a discretionary bonus of $15,000 from JC. By the end of 2013, the Fund earned performance fees of over $121,000. In January 2014, the Senior Professional directed JC to take his 40% of the performance fees under the Combination Agreement and share it equally between the Portfolio Managers (i.e., $24,000 to each). Accordingly, for 2013, each Portfolio Manager received a discretionary bonus of $15,000, and a performance fee sharing payment of $24,000 from the Senior Professional’s allocation.

In the first half of 2014, the Fund performed exceptionally well. In July 2014, JC terminated the Portfolio Mangers’ employment without cause after the employment relationship deteriorated.  In lieu of notice, the Portfolio Managers were each given two weeks’ salary plus a $577 bonus (i.e., the $15,000 bonus (paid in December 2013 for 2013) prorated for the statutory two-week notice period).

The Senior Professional remained at JC. He directed his entire 40% of the 2014 performance fees to be paid to the Portfolio Managers ($358,000 after tax for each). The Portfolio Managers claimed they were also entitled to be paid over $1.3 million in performance fees by JC (i.e., 40% of the performance fees) as a term of their employment for the portion of 2014 that they worked before their termination.

Trial Judge’s Decision

In the lower court, the Portfolio Managers claimed that their Employment Agreements and the performance fee sharing practices at JC entitled them to an additional 30% of the 2014 performance fees earned by the Fund, over and above the amounts they received because of the Senior Professional’s direction to JC in 2014.  In their final submissions at trial, the Portfolio Managers added claims for payment of discretionary bonuses at termination.

The trial judge dismissed the Portfolio Managers’ claims finding that they had two sources of remuneration: (i) JC paid them employment income and a discretionary bonus under the Employment Agreements.  The bonus provision referred only to the discretionary bonus payable at fiscal year-end.  The words “performance fees” did not appear in the Employment Agreements, and no definition described the calculation or fact of performance fees as part of their remuneration.  As the Employment Agreements were silent on performance fees, the Portfolio Managers were not entitled to a share of such fees directly from JC; and (ii) The Senior Professional could pay them a percentage of the performance fees of the Fund from his 40% share from JC, at his discretion. This arrangement was known to the Portfolio Managers when they signed their Employment Agreements, and their knowledge was further supported by their request and receipt of two signed side agreements with the Senior Professional, dated November 29, 2012 and December 1, 2012, in which he formalized his intention to share with them 50% of the Fund’s management fees allocated to him and 100% of the Fund’s performance fees allocated to him (Side Agreements).

The trial judge also found that the Portfolio Managers could not argue that they were entitled to a discretionary bonus under a specific term in their Employment Agreements for the portion of 2014 in which they worked because the claim was not sufficiently pleaded.

OCA Decision

On appeal, the Portfolio Managers claimed the trial judge erred in her findings.

Were the Portfolio Managers entitled to a percentage of the Fund’s performance fees as an implied term of their Employment Agreements?

The OCA did not interfere with the trial judge’s finding that the Portfolio Managers were not entitled to a share of the Fund’s performance fees beyond the share provided for in the Combination Agreement and the Side Agreements.  It noted that although the trial judge characterized the Portfolio Managers’ state of mind as “knowledge” or “awareness” that a share of the performance fees would be paid to them only through the Senior Professional, and not directly from JC as a term of their Employment Agreements, it was clear in the context of her reasons as a whole that she found that they agreed to these terms.  Indeed, the trial judge recognized that the Portfolio Managers knew they would be paid performance fees only through the Senior Professional, and with this knowledge, signed the Employment Agreements that did not provide for any performance fees. 

Did the trial judge err when she refused to consider whether the Portfolio Managers were entitled to a discretionary bonus on the basis that the issue was insufficiently pleaded and argued?

The OCA concluded that the trial judge erred in refusing to allow the Portfolio Managers to argue that they were entitled to a discretionary bonus under the Employment Agreements.  The OCA held that the issue was sufficiently pleaded in the amended statement of claim and raised in submissions and evidence at trial, and there was no unfairness to JC in allowing the Portfolio Managers to advance this claim.

Are the Portfolio Managers entitled to the discretionary bonus under the Employment Agreements?

The OCA found that the discretionary nature of the bonus provision did not mean that JC was entirely unconstrained as to how that discretion was exercised. Referring to judicial precedent, it emphasized that when an employment agreement provides for a discretionary bonus, there is an implied term that the discretion will be exercised in a fair and reasonable manner.  Accordingly, the OCA considered whether a fair and reasonable exercise of that discretion would result in the Portfolio Managers being awarded a discretionary bonus for the period they worked in 2014 (January 1, 2014 to July 16, 2014) plus the two-week notice period (until July 31, 2014), and, if so, how much they should be awarded.

The OCA concluded that it was not a fair and reasonable exercise of JC’s discretion to pay only $577 each (a “2-week pro-rata bonus” for the two-week notice period) and without paying a discretionary bonus for the period from January 1, 2014 until July 16, 2014.  It also concluded that the trial record was sufficient to enable it to set the quantum of the discretionary bonus.

At trial, JC’s presented evidence that two of its executives met every December to consider the allocation of discretionary bonuses from a pool of funds set aside for that purpose. They considered corporate performance, individual performance, attitude, teamwork, fund performance, raising assets for a fund, marketing a fund and, to some extent, how long individuals had been at JC and their position. The OCA described this allocation as “purely subjective” and discretionary and noted that no calculations were involved.  It stated that JC’s unconstrained discretion with respect to awarding bonuses was, “inconsistent with the obligation to exercise that discretion in a fair and reasonable manner.”

The Portfolio Managers argued that they were similarly situated to two other portfolio managers at JC (and who worked on funds that did not perform as well as the Fund the Portfolio Managers managed in 2014). The OCA accepted this assertion in considering the Portfolio Managers’ discretionary bonus entitlement and noted that the similarly situated portfolio managers each received $200,000 in discretionary bonus for all of 2014.

The OCA also observed that there was a significant bonus pool in 2014 based on the bonuses awarded to other portfolio managers; the Fund managed by the Portfolio Managers earned remarkable returns in 2014 prior to their terminations in July 2014 (and for 2014 as a whole, although less so after the Portfolio Managers’ terminations). In fact, JC’s Chief Operating Officer described the Fund’s returns in 2014 as “jaw dropping.”

In light of this factual context, the OCA concluded that a fair and reasonable exercise of JC’s discretion in setting a bonus amount under the Employment Agreements would involve consideration of the following objective evidence:

• The returns of the Fund; and
• The bonus awarded to the similarly situated portfolio managers for 2014, (pro-rated for the seven months they worked at JC in 2014, including the two-week notice period).

Based on $200,000 as the approximate bonus amount paid to similarly situated portfolio managers in 2014, this calculation amounted to $116,000.  Since the Portfolio Managers sought $115,000 in trial submissions and their factum on appeal, the OCA awarded $115,000.

Bottom Line for Employers

Bowen v. JC Clark Ltd. puts employers on notice that the discretionary nature of a bonus provision in an employment agreement does not mean the employer is entirely unconstrained as to how that discretion is exercised.  Employers are encouraged to avoid taking an approach that is “purely subjective” and “unconstrained” as to do so may be inconsistent with their obligation to exercise such discretion in a fair and reasonable manner. To determine entitlement to a discretionary bonus in a particular year and its quantum, the OCA’s decision in Bowen v. JC Clark Ltd. encourages employers to consider individual employee performance as well as whether discretionary bonuses will be awarded to similarly situated employees.