Holiday pay decision on discretionary incentive bonus schemes overturned

In a recent decision, the Court of Appeal confirmed that payments under discretionary incentive bonus schemes do not fall within the definition of gross earnings under the Holidays Act 2003 (“the Act”).

Holidays Act 2003

When calculating payment for holidays under the Act, employers must take into account “gross earnings” as defined in section 14(a) of the Act. The greater the amount of “gross earnings”, the greater the potential calculation for payment for holidays.

Under section 14(a) of the Act, gross earnings are defined as all payments that the employer is required to pay to the employee under an employment agreement, including productivity or incentive-based payments. Therefore, any payments that the employer is not bound to pay are excluded from the employee’s holiday pay calculations. This includes any “discretionary payments”.

Metropolitan Glass & Glazing Limited v Labour Inspector, Ministry of Business and Innovation and Employment [2021] NZCA 560

In 2016, Metropolitan Glass introduced a short term discretionary bonus scheme for senior employees. The terms and conditions of the scheme expressly stated that Metropolitan Glass retained the discretionary right to make or withhold payment, even if the employee met the targets. As with other employers, Metropolitan Glass calculated payment for holidays on the assumption that discretionary incentive bonus schemes fall within the meaning of “discretionary payment”. The Ministry of Business, Innovation and Employment (“MBIE”) challenged this assumption.

The Employment Court agreed with MBIE, and held that all incentive or productivity based payments would be considered gross earnings under the Act, and therefore had to be included in the calculation of payment for holidays. The Court also held that a term does not have to be included in the formal written employment document to be binding under an employment agreement. Rather, contractual obligations could arise from sources outside of the formal agreement. This decision contradicted general commercial practice and would have resulted in employers having to backpay millions of dollars’ worth of holiday pay to employees.

In a win for employers, the Court of Appeal reversed this decision. They held that the Employment Court’s interpretation of the Act misinterpreted the key distinction that gross earnings are compulsory under an employment agreement, whilst discretionary payments are not. The Court of Appeal agreed that the fact the bonus scheme was not incorporated in the original written agreement did not of itself render the payments discretionary. Rather, the key question of whether something is or is not part of “gross earnings” is whether it is compulsory.

Given that Metropolitan Glass retained the discretion to decide whether to pay the bonus, the scheme fell within the definition of discretionary payment.

What does this mean for employers?

This decision affirms that discretionary bonus schemes are not to be considered in calculations for payment for holidays where the employer expressly retains a discretion to withhold incentive payments. If an employer’s discretion is limited to when payment will be made, or how much, then it will be considered gross earnings. Thus, the key for employers is that the scheme is neither conditional nor guaranteed. Notably, however, the employer is still under a legal obligation to exercise its discretion fairly and responsibly.

The decision was also significant in its confirmation that the meaning of “employment agreement” will differ depending on context. Binding payment obligations can arise from sources other than the formal written agreement, which are then considered “gross earnings” for the purpose of calculating payment for holidays.

Is the law settled?

This decision highlights, once again, the glaring need for reform of the Act. Greater clarity and certainty is needed for employers.

It is yet to be determined whether the Labour Inspector will appeal this decision to the Supreme Court. However, significant policy concerns were raised in the Court of Appeal, perhaps hinting at a desire to appeal. These concerns were based around fears that this outcome would enable an employer to pay an employee a deliberately low salary and top it up with discretionary payments, meaning holiday pay would be less than regular remuneration. Further uncertainty exists in light of the current Holidays Act Review and planned overhaul. Nevertheless, the law as it currently stands has landed in a satisfactory place for employers.

If you would like more information or advice on any relevant calculations for payment for holidays and your obligations as an employer, please do not hesitate to contact us.