In short, the Court of Appeal judgment confirms that where an STI scheme expressly gives the employer a discretion not to make STI payments (even if relevant targets are met), those payments are discretionary payments under the Holidays Act. This judgment is therefore likely to be welcomed by employers, because it means that those payments can be excluded from “gross earnings” calculations.
Please click here for our previous article for more details regarding the Employment Court decision in May last year.
The Employment Court decision was the first time the Employment Court had interpreted the definition of “discretionary payments” in the Holidays Act. In this case the Court considered whether payments under Metropolitan Glass’ (Metro Glass) STI scheme fell within the definition of “gross earnings” for the purpose of calculating holiday pay.
The definition of “gross earnings” under the Holidays Act includes “all payments that the employer is required to pay to the employee under the employee’s employment agreement”, but excludes “discretionary payments”. Metro Glass treated the STI payments as “discretionary payments” (and therefore excluded the payments from holiday pay calculations).
Metro Glass’ STI schemes were set out in standalone documents and were not specifically referred to in any employment agreements. Key aspects of Metro Glass’ STI scheme, as set out in those standalone documents, included:
- Terms setting out certain payment conditions, including the basis on which payments would be calculated (a percentage of the employee’s base salary), specific targets (and the weighting of those targets), and health and safety performance requirements needing to be met.
- Clear wording giving the company discretion not to make payments under the STI scheme even if the relevant payment targets were met.
In essence, the Employment Court found that any incentive scheme that is recorded in writing and includes performance-based metrics is likely to be considered “non-discretionary”, even when the scheme rules describe it as discretionary. In other words, any payments that have an incentivising nature in relation to an employee’s performance were required to be included in “gross earnings” calculations under the Holidays Act.
In deciding that Metro Glass’ STI scheme formed part of the participating employees’ employment agreement, and therefore had to be included in “gross earnings”, the Employment Court found:
- The term “employment agreement” in the “gross earnings” definition should not be interpreted narrowly to mean just an employee’s written individual or collective employment agreement. An employment agreement “may be comprised of components in more than one place”.
- A standalone policy or scheme may be incorporated into an employment agreement by reference, and “where it is reasonable to infer from the circumstances that the parties must have intended the relevant terms to have contractual force, those terms may be incorporated by inference”.
- The inclusion of productivity and incentive payments in the definition of included payments in the “gross earnings” definition “clearly contemplates that such payments are captured” in the meaning of an employment agreement and “that is so whether those payments arise out of provisions in the written individual employment agreement or from policy documents, or are contained in a separate, standalone document".
Court of Appeal upheld Metro Glass’ appeal
The Court of Appeal upheld Metro Glass’ appeal, finding that payments made under its STI scheme were “discretionary payments” and, accordingly, could be excluded from “gross earnings” calculations.
In our view, the Court of Appeal’s decision is consistent with how “discretionary payments” had generally been understood and interpreted prior to the Employment Court decision. It therefore “restores what has always been the settled understanding” of employers about how “discretionary payments” should be interpreted3.
The Court of Appeal stated that the Employment Court was in error as it overlooked the fact that the key element of the definition of “gross earnings” is that the payment must be one that the employer is contractually bound to pay. Conversely, the definition of “discretionary payment” is a payment that the employer is not contractually bound to pay.
The Court of Appeal’s decision placed appropriate reliance on Metro Glass’ express reservation of discretion, holding that4:
Metropolitan did more than just label its scheme discretionary. It included an express term that even if all of the conditions were met, it retained the discretion not to make any payment. It would of course be under an obligation to exercise that discretion fairly and reasonably, and a failure to do so could be grounds for a personal grievance, but in our view being neither guaranteed nor conditional the payment would still retain the character of a discretionary payment for the purposes of the Holidays Act.
The Court of Appeal did, however, agree with the Employment Court that the phrase “employment agreement” is broader than an employee’s written individual or collective employment agreement. In other words, standalone documents can also form part of an employment agreement. Specifically, the Court held5:
...a contract of employment (service) between employer and employee may comprise terms arising from a number of different sources…To put it another way, the formal written employment agreement is never the entire contract of service. It is only one source (albeit often the main source) of contractually binding terms.
Given its conclusion on the meaning of “discretionary payment”, the Court of Appeal’s decision did not ultimately turn on whether or not the STI scheme formed part of Metro Glass’ employment agreements.
What does this decision mean for employers?
Based on the Court of Appeal’s decision, provided an employer expressly retains a discretion to withhold incentive payments in any relevant STI (or similar) scheme (even if specified targets are achieved), such payments will not need to be included in “gross earnings”.
However, an incentive scheme which simply reserves a discretion as to the amount to be paid, or conditions to be met for payment, would not be discretionary. Rather, the key discretion an employer would need to reserve is whether to make a payment at all, regardless of whether conditions for payment have been met.
We are aware that many employees have raised claims in reliance on the Employment Court’s decision; those claims will now need to be reassessed in light of the Court of Appeal’s decision.
While this highly anticipated decision may come as a relief to employers, it remains to be seen whether the Labour Inspectorate will seek leave to appeal this decision to the Supreme Court.
In November 2021, the Supreme Court issued a judgment on another matter regarding the Holidays Act (Tourism Holdings Limited v A Labour Inspector of the Ministry of Business, Innovation and Employment).6 In particular, the Supreme Court determined that payments are a “regular part of the employee’s pay” if they are of a kind made regularly when assessed against the previous four-week period before an annual holiday is taken. The earlier Court of Appeal judgment had significantly broadened the scope of what might be described as a “regular” payment, while the Supreme Court decision (which you can read more about here) was consistent with case law prior to the Court of Appeal judgment.
Our employment team will publish updates on any potential further appeal regarding the Metro Glass case.
If you have any questions about the matters raised in this article, please get in touch with the contacts listed, or your usual Bell Gully adviser.