Will the new clawback rules trigger unlawful deduction from wages claims?

From 1 January 2015, new clawback rules will come into force that will require financial services organisations to clawback employees’ bonuses awarded on or after 1 January 2015 in certain situations.

October 31, 2014
5 min read

1. The new clawback rules

Clawback should be applied where the individual concerned:
- participated in/was responsible for conduct which resulted in significant losses for the firm; or
- failed to meet appropriate standards of fitness or propriety.
A firm should also make reasonable efforts (depending on the individual’s level or responsibility) to recover bonuses already paid/vested where:
- there is reasonable evidence of employee misbehaviour or material error; or
- the firm/relevant business area suffers a material risk management failure.

The clawback period is at least 7 years from the date of the award.

A particular issue that arises from this is whether the clawing back of bonuses that relate to the 2014 performance year, before the new clawback rules actually came into force, will constitute an unlawful deduction from wages. The unlawful deductions legislation will be relevant whether the clawback is achieved by making deductions from future salary/bonus payments or requiring a payment from the employee.

2. Unlawful deductions from wages

Under the Employment Rights Act is It is unlawful for an employer to make a deduction from a worker’s wages or to receive a payment from a worker.

“Wages” include “any fee, bonus, commission, holiday pay or other emolument referable to the worker’s employment, whether payable under their contract or otherwise”. The position regarding discretionary bonuses is not 100% clear, not least because in order to bring a claim under the unlawful deductions provisions, an employee must be able to claim a quantified amount. However, it is established law that once a discretionary bonus has been awarded (even if it has not yet been paid) it falls within the definition of “wages”. This would apply to both the cash and non-cash elements of a bonus award.

A “deduction” happens when the total wages paid on any occasion by an employer to a worker is less than the net amount of the wages “properly payable” on that occasion.

3. Exceptions to the general rule

The Employment Rights Act sets out some specific exceptions where an employer can make deductions. These include:

deductions made in order to reimburse the employer for an overpayment of wages or an overpayment in relation to expenses incurred by the worker in carrying out their employment;
deductions required or authorised by statute or a provision in the worker’s contract; or
deductions where the worker has given their prior written consent to the deduction.

It is extremely unlikely that, if a bonus/part of a bonus had to be clawed back, the initial award would be viewed by an Employment Tribunal as an overpayment. Therefore, the key issues to consider are:

Is the claw back required or authorised by statute?

The new claw back rules will form part of an updated Remuneration Code, which itself forms part of the FCA handbook. The power of the FCA/PRA to make provisions in the handbook derive from FSMA 2000 and FSA 2012 and, therefore, there is a strong basis for employers to say that there is a statutory obligation to comply with the Remuneration Code.

Is there a contractual provision allowing the deduction?

A deduction will not be unlawful if it has been required or authorised by a relevant provision of the worker’s contract, i.e. a provision that is set out in a written contract which has been given to the worker before the deduction was made, or an express or implied term, the existence and effect of which have been notified to the employee in writing before the deduction is made.

The provision must make it clear that the deduction may be made from the worker’s wages and the employer must also be able to demonstrate that the event justifying the deduction has occurred.

Depending on the drafting of particular employment contracts, employees may already have authorised the clawing back of bonuses. This should be checked. If not, a variation to the contract could be agreed with the employees – this could be done as part of the annual pay cycle.

Has the employee given prior written consent to the clawback?

A deduction will not be unlawful if the employee has previously signified in writing his agreement or consent to the making of the deduction. Crucially, the written consent must be given before the event giving rise to the deduction, not just before the deduction itself.

Therefore, if the employee has previously given written consent (for example as a part of pevious pay awards) that allows his/her bonuses to be clawed back in certain circumstances, the employee will not be able to claim that he/she is being subjected to an unlawful deduction from wages.

4. Remedies

The remedy for an unlawful deduction from their wages or an unlawful payment to the employer is payment (or repayment) of the sum unlawfully deducted (or received) by the employer, and in some cases compensation for further financial loss.

A claim must be brought within three months of the deduction or, in the case of a series of deductions, within three months of the final deduction.

5. What should employers do?

Based on the legal position summarised above, there is a risk that the clawing back of bonuses earned in the 2014 performance year, but paid in 2015 following the introduction of the new rules will be held to be an unlawful deduction from wages.

In order to avoid this employers should first check if employees’ contracts contain broad enough wording to allow the deductions or if employees have previously consented to deductions for claw back or, more broadly, as required to ensure compliance with the Remuneration Code. If neither of these avenues proves fruitful, there are three further options:

a) simply rely on the fact that the Remuneration Code, which is derived from statute imposes a statutory obligation to claw back, which allows the company to recover previously paid bonuses and/or to make deductions from future salary/bonus payments;

b) make the 2015 bonus award subject to a contractual variation to inserts the required wording into the employment contract to allow for deductions. Provided that a deduction is not made immediately afterwards, this will ensure that one of the exceptions above is met without having to get written consent; or

c) as part of the 2015 bonus award, require the employees to provide written consent to allow for deductions if a clawback scenario arises. This is similar to option b), but includes the employees signing a consent form. Again, this will work provided that a deduction is not made immediately afterwards.

There is potential scope for employees to argue that, despite the statutory nature of the Remuneration Code, claw back cannot actually be applied to awards for the year preceding 1 January 2015. Therefore, simply relying on option a) carries some risk. Option c) creates administrative obligations in terms of securing employees’ signatures. Therefore, the most prudent course of action is option b), with option a) as a back up.