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In What Circumstances Can A Bonus Be Clawed Back Once Paid?

In this news alert, Partner Merrill April and Trainee Solicitor Rachael Parker explore the specific circumstances in which a bonus can be clawed back once paid, following the recent judgment in the Steel vs Spencer case and the lifting of the banker bonus cap as of 31 October 2023.

On 11 October 2023, Mrs Justice Bacon handed down her judgment in the high court in respect of Mr Steel versus his former employer Spencer Steel LLP (T/A the Omerta Group), a global Executive search firm.  

Like many recruitment consultants, Mr Steel’s package was a combination of base salary and commission. For the year in question, the commission was 3 times his base and whilst discretionary, had been paid every year for 5 years. Mr Steel’s employment contract contained bonus clawback provisions that required him to remain employed by Omerta (and not under notice) for at least 3 months following the payment of his bonus. The express rationale in the contract for this provision, was that was that the scheme was “intended to incentivise employees to remain in the employment of the Company.” The bonus was paid to him in January 2022. Mr Steel subsequently resigned on 22 February, giving 3 months’ notice.

The Firm then maintained that his bonus would be repayable “as a debt.” This is a common phrase in settlement agreements as well as employment contracts and can have serious consequences as it did here. Mr Steel had also given an indemnity in relation to the Company’s enforcement costs. Indemnities are also common in both settlement agreements and employment agreements and must be carefully considered by an executive negotiating their contract on the way into a company.

Statutory demand and proceedings before the ICC

Mr Steel disagreed that the bonus was repayable, forcing Omerta to issue a statutory demand. This is a powerful weapon in the hands of an employer who is owed money by a former employee, as the timescale for payment is short, and if the demand is not met or set aside, the employer can then proceed to bankrupt the former employee. Under the Insolvency Rules, such a demand can only be set aside where the debt is disputed “on grounds which appear to the court to be substantial.”

Mr Steel failed in his application to the Insolvency and Companies Court (ICC) to set aside the statutory demand and was obliged to repay the full bonus, plus costs (of £12,000) under the indemnity provisions, to avoid these consequences. He then appealed to the High Court in relation to the ICC Judge Mullen’s findings on the restraint of trade doctrine as it applied to his situation.

Mr Steel’s first argument before the ICC was that the clawback clause was an unreasonable restraint of trade and the second was that it operated as an unenforceable penalty.

Restraint of Trade in the ICC and the High Court

In the ICC, Judge Mullen reviewed Mr Steel’s application in the light of what he called the “weight of authority” and concluded that generally bonus clawback provisions are NOT within the restraint of trade doctrine (which would make them potentially unenforceable) because they do not operate to prevent an employee working for a competitor, they simply make it rather expensive to do so!  Judge Mullen relied on the High Court decision in Tullett Prebon v BGC Brokers, 2010 EWHC 484 (QB) and distinguished a later judgment by a Deputy High Court Judge in 20:20 London v Riley, 2012 EWHC 1912. The high court judge in Steel agreed with the ICC and dismissed the appeal.

Disincentive to resign or restraint?

The Riley case is interesting though because in that decision the Judge referred to EDS v Hubble (an unreported  1987 decision  of the Court of Appeal) and concluded that;-

 “there is no authority binding upon me which decides that a repayment provision can never through disincentive or “golden handcuff” effect amount to a restraint of trade requiring objective justification. Indeed [Electronic Data Systems v Hubble] appears to suggest the contrary.”

The 20:20 case in 2012 therefore provides a judicial indication that a financial disincentive to resign is, on the face of it a restraint of trade. Whether it is an unreasonable one and therefore unenforceable would then be a matter of fact to be determined in each case. Reasonableness in this context refers to the interests not just of the parties, but also the public interest.

 Judge Mullen alluded to that position again in his judgment in the ICC in March 2023, by saying that “there might be circumstances where the severity of the consequences were clearly out of all proportion to the benefit received.” In Mr Steel’s case however, Judge Mullen found that the conditions attached to the bonus payment were “very moderate” and it is not difficult to agree with that. In conclusion then, the judicial authorities to date, (especially the High Court in Tullett Prebon) are very clear that not every disincentive to resigning will be a restraint of trade, let alone an unreasonable one.

Penalty clause?

The ICC Judge also considered that the argument that the provisions operated as an unenforceable penalty clause was so weak as to have no real prospect of success and so this issue did not go to the high court in the Steel case.

What can we learn?

This case is a reminder that employees need to consider the potential effect of such clauses (and indeed other clauses, such as repayment of training costs) both when agreeing terms in a contract at the beginning (including any right for the employer to recover “as a debt” and any indemnities) and also when contemplating the timing and impact of resigning. A new employer might agree to compensate for lost bonuses, or for training costs reimbursement, but this is not a given and must be negotiated (including having regard to the impact on tax paid on the bonus or other incentive).

The fact that Mr Steel’s situation meant that he had to repay the bonus does NOT mean that an employee in different circumstances will also be in that situation. A more onerous contractual term may be challengeable.

This is because in the 2021 case of Quantum Actuarial v Quantum Advisory, 2021 EWCA Civ 227 the Court of Appeal makes it clear in the context of considering whether a particular contract operates as a restraint of trade, that the central question to be determined is “the practical effect of the restraint in hampering the freedom to trade.” The second part of the question, which may to a degree overlap with the first, is whether the particular restraint is reasonable, having regard to a number of factors, including the relative bargaining power of the parties.

Indeed in this case, Mrs Justice Bacon stated at para 35 “the law recognises indirect restraints of trade where the restraint derives from the loss of a benefit, rather than a direct prohibition on competing trade.”

What next?

 A disincentive to resign, such as in this case, where the employee had to remain employed for a short period, before giving notice is not considered to be a restraint of trade based on a line of authority which Mrs Justice Bacon considered to be the application of established precedent. However, she recognised that “the doctrine of restraint of trade continues to be applied and considered in new contexts.”

It may be therefore that bad leaver and rival leaver clauses (which are common in Private Equity for example) would fall into the category of a restraint of trade, where they operate to cut off payments of carry or other  benefits already earned by the employee having introduced investors, and to which the former employee would otherwise be entitled, rather than preventing them joining any rival at all. This may particularly be the case where certain rivals are specified, so there is an element of restriction on where an ex-employee can work (see the agency case of Marshall v NM Financial Management, 1997 EWCA Civ 1237 1997).

Bankers bonus cap lifted

This judgment comes only a few weeks before the FCA/PRA have lifted the cap on banker’s bonuses; effective from 31 October 2023. The original cap originated in 2014 as a response to the 2008 global financial crisis. The headline-grabbing decision has been met with great controversy considering the current economic climate and cost of living crisis. However, the FCA and PRA have justified their decision stating the cap was placing upward pressure on salaries and allowances that may not be linked to longer term performance. Therefore, the aim of removing the cap is to encourage more of bankers’ remuneration to be linked to performance and compliance rather than being fixed at a high level. There is also further argument that by removing the cap it brings the UK in line with the rest of the world, excluding the EU, encouraging a larger talent pool and stemming a potential exodus.  

Steel vs Spencer serves as a reminder for bankers and others that the contractual conditions surrounding such bonuses and the timing of any resignation, must be carefully considered, as in certain circumstances, such bonuses can and are being successfully clawed back.

If you would like to discuss bonus clawback further or if you have any questions arising from this article, please contact Partner Merrill April and Trainee Solicitor Rachael Parker, both of whom specialise in employment law issues for senior executives.