Litigation around discretionary bonus claims is rapidly becoming a big fee earner for employment lawyers. With the introduction of new race discrimination laws, further contentious work is set to take off

With mandatory provident fund (MPF) work tailing off and a depressed economy, employment lawyers in Hong Kong have seen a big shift in their workload towards cost-cutting related exercises. The more popular projects include restructuring retirement schemes and the adoption of more flexible contracts.

'On a global level, there are fewer and fewer defined benefit schemes,' says Duncan Abate, head of the employment practice at Johnson Stokes & Master's Hong Kong office. 'Hong Kong is following the global pattern, moving from defined benefit to defined contribution schemes. The advent of the MPF was an obvious trigger for a lot of people to wind up their defined benefit schemes.'

He points to certainty of cost as a driver. Defined benefit schemes are directly tied to market volatility and - with the current state of the equity markets - the reasoning is, at least in the short term, that it's cheaper for companies to lock themselves into defined contribution schemes, where the same percentage of an employee's salary is paid in each month.

'To a degree, a lot of it is actuarial crystal ball gazing,' says Abate. 'If the stock market rebounded 200%, it may be that it would have been cheaper to use defined benefit. They make a best guess.'

Employers are also looking to cut costs by introducing more flexibility into pay packages. Flexibility is minimal with the basic salary and MPF obligations more or less set in stone, but benefits and how and when they kick in are not. The goal once again is to cut costs, but also to turn remuneration into an incentivisation tool and therefore boost productivity.

The idea of using benefits to incentivise has been around for a while (The Institute of Human Resource Management has pushed it for years), but lawyers say more companies than ever are now taking it on board.

'More clients are looking at making more of their remuneration discretionary, particularly bonuses,' says Robert Lewington of Simmons & Simmons. 'In the past, Chinese New Year bonuses were seen as automatic. Where they automatically gave two months [as a bonus], now perhaps one month is automatic and the second is discretionary. It can be a big saving and perhaps less painful than a straight pay cut.'

Companies will naturally want to define 'discretion' as loosely as possible. Employees, of course, will fight for the reverse and lately, lawyers say, when push comes to shove the two sides will often battle it out in court.

'There have been a number of disputes about how you exercise your discretion,' says Cynthia Chung of Deacons. 'Whether something is under discretionary bonus would be a matter of substance rather than form. We're seeing more local cases establishing limits on how you exercise your discretion. Reasonableness is the benchmark, but it varies depending on the facts of the case. Both the UK and Australia have similar standards now.'

In light of this spate of lawsuits, lawyers are telling corporates to pay special attention to the wording of the discretionary bonus clause and, on the whole, the advice is not to specify any sort of criteria at all.

Employment law-related litigation is on the rise, say lawyers. A few years ago, work was largely non-contentious and advisory while now as much as half of Hong Kong's employment lawyers' work is derived from litigation. The fees are 'substantial', says one lawyer, and of course certain firms are far better resourced than others to handle such litigation. It is rumoured that not just one magic-circle firm in Hong Kong is rushing to play catch up with the market leaders. Needless to say, their recently hired employment specialists may have some apprenticing to do before they see any of the profitable litigation-based work.

The increase in litigation is the result of two forces, say lawyers. The first is higher unemployment. When jobs are plenty, few people will bother with suing an old boss. But when possibly facing months without work, pursuing a claim can suddenly seem attractive.

The other reason for this increase is the unprecedented levels of employee confidence and 'sense of empowerment', says Baker & McKenzie's Siobhan McKeating.

'Looking back over my seven years of practising employment law in Hong Kong, I would say that now is the time of greatest awareness of employee rights,' she says. 'It's awareness across the spectrum - discrimination, harassment, termination - in relation to data privacy. They're more willing to pursue a claim.'

But why now? What has happened to make employees in Hong Kong more legally aggressive?

In a word: Enron. As the media has widely reported, shareholders and politicians are pushing companies to adopt more stringent codes and honour their commitments to existing ones since the Enron debacle.
To date, the Sarbanes-Oxley Act is the most significant result of the resurgence of corporate governance. It is big, complex and far-reaching and, despite the fact it is primarily addressed to the securities side of US-listed companies, even employment lawyers in Asia-Pacific are feeling its effects.

The pressure is on throughout organisations, including how a company manages its employees. Employment lawyers are seeing new directions emerging from where corporate governance and human resources intersect. And firms like what they see.

'In the US, Baker & McKenzie has been active in developing its skill set to deal with corporate governance within its employment practice. They have a specific cross-department group,' says McKeating.

'It's something we're not yet doing a significant amount of work on but we anticipate doing a lot of work on it in the future. We have to develop our own skills. We work with our US securities lawyers, particularly developing how new laws affect the industry here. We're seeing the cross-over point in multinationals with operations in Asia.'

What concerns Hong Kong employment lawyers more than the corporate governance reform, however, is incoming race discrimination laws. 'Corporate governance is interesting and it will impact on certain employment contracts in Hong Kong, but race goes throughout every organisation from the grassroots up,' says Fiona Loughrey of Simmons & Simmons. 'We don't expect there to be any material exemptions.'

Putting race discrimination laws on Hong Kong's books has been under consideration for almost a decade. Hong Kong already has sex, disability, and family status discrimination ordinances, established between 1995 and 1997, with the Equal Opportunities Commission administering all three.

The government has been a signatory since 1969 to the International Covenant on Elimination of all Forms of Racial Discrimination, which obliged it to enact the legislation. Recently, interest groups have argued that all developed countries should entrench a protection against the discrimination and victimisation of minorities so race is regarded irrelevant, in the same way that family status or gender is, or should be.

The details of the new race discrimination laws have yet to be released, but they will be based on three existing pieces of legislation in Hong Kong. Lawyers disagree as to the expected passage date with some saying late next year and others putting it several years away. Nearly all, however, say that too much energy has been invested so far for the laws not to pass.

'We've seen a lot of lobbying and discussion on the issue,' says McKeating. 'It looks like there has been sufficient time for the commitment to be given that it would pass through. We've already seen the first roadblock - the exclusion of Mainland Chinese - and that has since been looked at and reviewed. I don't envisage there will be too many others. The government has tabled the bill, so I would be surprised if it didn't go through probably some time next year.'

Chung is more skeptical. 'The government is under a lot of pressure to get it through, but I think there'll be a lot of resistance from employers. Remember that it took them a long time to get the current three sets of laws through. The argument is the more restrictions you introduce, the more it'll scare employers away. A lot of people think the three are more than what Hong Kong can handle.'

Lawyers are generally reluctant to give an opinion on whether the laws are necessary, but they do anticipate the race discrimination laws will have a big impact on their practices. Certain companies will need to take preventative measures, and an increased number of discrimination-based lawsuits are a real possibility, they say.

'We already spend a lot of time emphasising the need to prevent claims of this nature,' says Lewington. 'The big companies - multinationals and large local corporates - already have the anti-discrimination policies in place, so they won't find it terribly difficult to extend that to race. It's the same procedures but on different grounds. But the smaller local companies will likely be asking for legal advice on the new laws.'

Aside from compliance, lawyers say, companies face unnecessary claims and protracted terminations. 'Of course there are genuine cases, but it's very easy for a sulky employee or a mischief maker to say, "You didn't like me because I took six months off to have a baby or because I have a bad back." That's already a problem. Now it's going to be because the employee is Chinese or not Chinese. It's going to be very problematic,' says Loughrey.

Employment lawyers are most likely to advise in situations of a departing employee though the new laws could also be used in relation to promotion or the selection of redundancy. 'We could see the sort of threat like "You better not select me or I'll have a go at you",' says Lewington.

Precedents for discretionary bonus claims

• The employment ordinance (EO) contains rules governing the making of end of year payments. These rules apply to both "13th month salary' (and similar payments) and any annual contractual bonus that is not discretionary
• EO rules state where an employee, who is entitled to an annual contractual bonus, is dismissed during the course of the bonus year he shall be entitled to receive a pro rata payment, provided that he has been employed for not less than three months of the bonus year and has not been dismissed for gross misconduct
• It is not possible to contract out of the EO rules
• As mentioned, the pro rata payment rules do not apply to discretionary bonus. An annual bonus will be presumed not to be discretionary unless there is a written term or condition in the contract of employment to the contrary
• Recent case law (Wong Huey Lan -v- Colgate-Palmolive (HK) Limited) suggests that - for the purposes of the EO - an annual bonus will only be treated as discretionary where the employer has discretion on whether or not to pay a bonus and not where the discretion goes only to the amount of the bonus
• Employers looking to avoid the application of the EO rules should ensure contracts describe a bonus as discretionary, and that their discretion extends to a right to decide whether or not to pay it
• Any conditions to the payment of bonus (eg if payment is conditional upon the employee being in employment at the end of the bonus year) should be included in the contract. Inclusion of such conditions will assist the employer on any argument as to whether or not bonus is payable
• The inclusion of conditions on payment of bonus will only allow an employer to avoid payment obligations in cases where bonus is discretionary (and so the rules in the EO do not apply)
• Employers may believe if a bonus is stated to be discretionary that specifying any pre-conditions to payment is unnecessary. However their discretion with regard to bonus awards is not absolute. The Hong Kong case of Wood -v- Jardine Fleming Holdings Ltd confirmed that employers cannot exercise discretion in an 'arbitrary' manner. Courts will overturn bonus awards if they conclude the decision was one that no reasonable employer could have reached (see the UK case of Clark -v- Nomura International plc)
• Employers sometimes list the factors to be taken into account in assessing bonus entitlement. Where this is the case, employers must remember they are obliged to follow the factors listed and cannot consider other factors unless the contract gives them an express right to do so
• There is no need for employers to list the factors relevant to the assessment of bonus. Employers who want to avoid being bound by specific criteria can simply state that bonus entitlement is in the absolute discretion of the company

The Sarbanes-Oxley Act and its effect on employment law

Sarbanes-Oxley Act

The US recently enacted Federal legislation to deal with audit reports of SEC-registered companies and related matters. It is known as the 'Sarbanes-Oxley Act'.

From an employment law perspective, there are two key provisions in the Act.

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  Should a CEO or CFO receive a special payment (being a bonus, incentive-based compensation or equity-based compensation, or a profit realised from the sale of securities) and the company's accounts subsequently need to be revised because of a failure to comply with SEC accounting requirements, then any special payment received within 12 months of issue of the inadequate accounts must be paid back to the company
• It has new whistleblowing provisions, which provide for criminal sanctions against those who "knowingly with the intent to retaliate' act against a whistleblower (including interfering with the whistleblower's lawful employment or livelihood)

The Sarbanes-Oxley Act is very broad in its application and it remains unclear to what extent its provisions will apply to overseas companies