Court of Appeal overturns decision on discretionary payments

Employers nationwide will be breathing a sigh of relief that the Court of Appeal has reversed a controversial decision which found that incentive payments attracted holiday pay.

The Court of Appeal’s decision in Metropolitan Glass & Glazing Limited v Labour Inspector, Minister of Business and Innovation and Employment[1], released yesterday, confirmed the Employment Court got it wrong when it held  Metropolitan’s incentive payments fell under the definition of “gross earnings” in the Holidays Act 2003.

Business New Zealand, who appeared as an intervener, said if the Employment Court decision had been upheld, businesses across the country could have been forced to back pay a minimum of $500 million in holiday pay.

The decision

The decision essentially turned on whether the incentive payments were discretionary or not.

Under the Act, an employer must pay holiday pay on an employee’s gross earnings. Gross earnings includes payments that the employer is required by the employee’s employment agreement to make, but excludes any discretionary payments. The Act is clear that a payment will not be discretionary just because the amount isn’t specified or can be determined by the employer, or if conditions have to be met for the payment to be paid.

Metropolitan’s incentive scheme was not actually under an employment agreement, but contained in a separate document. It stated that the payments under the  scheme were totally at the discretion of the Board of Directors and that there was no guarantee of any payment, even if the performance targets were achieved.

Despite this, the Employment Court held that the incentive payments were required to be paid under the employment agreement. The Employment Court further found that the payments were not discretionary, as the definition of gross earnings under the Act was intended to capture productivity and incentive based payments. Such payments were contrasted with truly gratuitous payments such as a Christmas bonus.

In the Court of Appeal, Metropolitan argued the payments were not made under an employment agreement, and the employer was not required to make the payments since they were stated as being discretionary.

Metropolitan were unsuccessful on the first argument. The Court of Appeal agreed with the Employment Court that a contract of employment may comprise terms arising from a number of different sources, and the formal written employment agreement will never be the entire contract of service. Regardless of the fact that the incentive clause was not actually in the written employment agreement, it still formed part of the wider employment agreement.

Importantly however, the Court of Appeal agreed with Metropolitan on the second argument. It criticised the Employment Court for not considering whether the existence of a residual discretion to not make any payment at all, even if the conditions were met, took the payment “outside the scope of gross earnings and into the territory of a discretionary payment”. That error overlooked the key element of the definition of gross earnings: that a payment must be one the employer is contractually bound to pay.

The Court of Appeal went on to say Metropolitan did more than just label it’s incentive scheme discretionary. It included an express term that even if all the conditions were met, it retained the discretion not to make any payment. On the basis, holiday pay was not payable on the incentive scheme payments.

Key takeaway

To ensure bonuses or incentive payments are truly discretionary, employers should ensure that any provision clearly states that the employer has the discretion not to make payment at all, even if certain conditions are met. It will not be sufficient to simply state that certain criteria or conditions have to be met, or that the amount payable is at the discretion of the employer.

Further potential changes?

It remains to be seen whether the Labour Inspector will appeal the case to the Supreme Court. And while employers may be celebrating the successful appeal, if proposed changes to the Holidays Act go ahead, the decision may be moot. The Holidays Act taskforce recommended that the definition of gross earnings be amended to include all cash payments received by the employee, except direct reimbursements. This would remove the discretionary payments exception and any incentive or bonus payments would fall under the definition of gross earnings. The Government has accepted the Taskforce’s recommendation, but we are yet to see whether this change will form part of the new Act. The Government has signalled it expects to introduce legislation in early 2022.

[1] Metropolitan Glass & Glazing Limited v Labour Inspector, Minister of Business and Innovation and Employment [2021] NZCA 560 (“Metropolitan”)

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