Implications for Incentive Payments/Bonuses

The Employment Court decision has significant implications for employers in respect of target-based incentive payments, and holiday pay entitlements over annual closedown periods.

The Labour Inspectorate and Metropolitan Glass jointly filed proceedings in the Employment Court as they were unable to agree on holiday pay calculations (Metropolitan Glass and Glazing Limited v Labour Inspector, Ministry of Business, Innovation and Employment [2020] NZEmpC 39).

Before their employment commenced, Metropolitan Glass provided employees by way of a letter with a short-term incentive scheme (STI Scheme), which was described as a "discretionary bonus scheme".  Employees who met their targets under the STI Scheme would be paid bonus payments by Metropolitan Glass. The question for the Court was whether the STI Scheme was part of "gross earnings" and therefore needed to be included for the purposes of calculating holiday pay in accordance with the Holidays Act 2003 ("the Act").

The Act defines "discretionary payments" as a payment that the employer is not bound by the employment agreement to pay the employee. Discretionary payments are expressly excluded from the definition of "gross earnings" and do not need to be taken into account when calculating holiday pay.  

This means if a bonus scheme meets the definition of "discretionary payments" then the payment could be excluded from holiday pay calculations, which was Metropolitan Glass's position.  If the STI Scheme payments were held to be "gross earnings" those payments would need to be included in the holiday pay calculations.

The STI Scheme

Metropolitan Glass's STI Scheme provided that if staff achieved three key deliverable targets they would be paid a bonus payment, weighted according to their annual base salary.  

The terms and conditions of the STI Scheme included:

          Any payments made under this Scheme are totally at the discretion of [Metropolitan Glass] and there is no
          guarantee of any payment in any year. [Metropolitan Glass] has the sole discretion not to make any
          payment even where the criteria in this Scheme are met. This Scheme is not a term and condition of your
          employment agreement.

          Accordingly, any bonus payments made under this Scheme will not come within the definition of "total gross
          earnings" for the purposes of holiday pay calculations under the Holidays Act 2003.

The payment was to be up to a percentage of base salary if certain targets were met.

The Decision

Metropolitan Glass said that the STI Scheme did not form part of the employment agreement, and that payment under the STI Scheme was discretionary. Therefore any payment made under the STI Scheme did not form part of employee's gross earnings, and did not need to be included in the holiday pay calculation.

The Court disagreed with Metropolitan Glass.  It concluded that an employment agreement can be comprised of different "components in more than one place". The STI Scheme had been put in place to incentivise employees to meet key targets, and the payments under the STI Scheme were for "remuneration for effort put in by the employee".  These productivity or incentive-based payments were captured under the definition of 'gross payments' under the Act. Consequently the Court held that the STI Scheme was not discretionary and should be included in the employee's gross earnings, and therefore part of the holiday calculation payment.

The Court also highlighted that a productivity or incentive payment that is conditional on several factors (eg meeting performance targets), will not make the payment a “discretionary payment" under the Act. Accordingly, Metropolitan Glass could not avoid responsibility by simply labelling the STI Scheme as "discretionary", and could not contract out of the Act.

Paying Holiday Pay During a Closedown Period

The Court was also asked to consider whether Metropolitan Glass's treatment of annual holidays during its closedown period complied with the closedown provisions of the Act.

Like many businesses, Metropolitan Glass has a closedown period each year over the Christmas holiday period.  For employees that had worked for Metropolitan Glass for less than one year, Metropolitan Glass provided them with an "annual holiday entitlement" proportionate to the amount of time the employee had been working with the company.  If the entitled leave was not enough to cover the closedown period, then Metropolitan Glass allowed those employees to take leave in advance or unpaid leave for the closedown period.

The Court found that Metropolitan Glass's approach did not comply with the Act.  The Act specifically states that in respect of the closedown period, an employee must be paid 8% of gross earnings since the commencement of their employment or since the employee last became entitled to annual holidays. Their service is then treated as commencing on the date on which the closedown begins.

This case has been appealed.

Takeaways for Employers

• Employers should review their incentive schemes, and seek advice if there are any concerns.
• Employers should ensure their calculation of holiday pay for their annual closedown periods complies with the Holidays Act 2003.

Please direct any enquiries to:

Melissa Johnston (Partner) on (09) 306 6729 (mjohnston@mcveaghfleming.co.nz)

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