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Limits on employer discretion

When interpreting a contract of employment which contains terms which are expressed to be subject to the exercise of an element of discretion on the part of the employer (for example, bonus or commission clauses), are there limits on the employer’s ability to freely exercise its discretion and therefore limits on its decision-making power?
Until recently, the legal position was that:
  • Primarily the contract itself would set out the extent of the discretion.  In this regard, the specific words of the contract are all important.  There is a rule that “express mention of one thing excludes another”, meaning in general terms that provided a matter is dealt with clearly in a contract it should not be open to qualification by means of implication of supplementary or contradictory terms.  
  • In respect of the exercise of an employer’s discretion there was no obligation on the employer to act reasonably when doing so.  There was however, as established in various case law, the principle that an employer's discretion must be exercised in good faith, for proper purposes and not in any arbitrary, capricious or irrational manner. This did not mean the employer’s decision making had to be reasonable as such, it did not have to cause a result that was objectively correct or fair.  The decision was unlikely to be considered unlawful unless it was so outrageous, no reasonable employer would have made it, giving employer a wide band of potential outcomes in any particular situation in which the exercise of a discretion was required.  
In an ideal world all contracts would be perfectly worded and the extent of any discretionary element would be entirely clear.  However, if a contract is unclear or open to more than one interpretation, then disputes arise in which the Courts can examine matters such as intention, reasonableness and whether there is any legal basis for implying terms into the contract, and may in the process, develop the law through their judgment.
In the last 12 months, inroads have been made in this way, which may have the effect of limiting employer discretion.
The key case was Braganza v BP Shipping (2015), in which the Supreme Court determined whether the exercise of a contractual discretion by an employer was lawful, by looking not just at whether the final decision was arbitrary, capricious or irrational, but also at the decision making process.
It was stated in the judgment that although it is not for a court to substitute its decision on a discretionary matter for that of the decision-taker, courts can exercise some control over the manner of exercising that power.  When assessing whether an employer has exercised a discretion lawfully, the court is entitled to review whether: 
  • the decision-taker had taken into account relevant factors and ignored irrelevant ones (looking at the process behind the decision); and
  • that the actual decision must not be so outrageous that no reasonable decision-taker could have come to it (looking at the result of exercising the power).
In Braganza itself, a case involving a decision by an employer to refuse to pay an employee’s widow death benefits (as the employer had determined the employee had committed suicide) the court decided that the employer had, when forming the relevant decision, failed to take into account relevant factors and ruled the decision was unlawful.  
This is an extension to the law as it relates to employment contracts.  Commentators have stated that Braganza is a case that turns on its own particular and unusual facts and is not applicable to employer discretion in general terms.  Furthermore it has also been stated that it inappropriate to import a public law concept of correct exercise of discretion (i.e. looking at the process behind the decision) into the private arena.
Braganza has however, been followed in the Court of Appeal in March 2016, in the case of Hills v Niksun Inc.  The case involved the assessment of Mr Hills proportion of sales commission.  The court decided that the employee had provided sufficient evidence to suggest the decision as to his share was irrational, thereafter the employer had failed to demonstrate the decision making process was reasonable and the court therefore found in favour of the employee, increasing his commission.
Employers are reminded, that when exercising contractual discretion they should, as has been the case historically, ensure that the decision is made honestly and in good faith in a way that is not arbitrary, capricious or irrational. But additionally, it is recommended that employers document the considerations made during the decision making process in order to be able to demonstrate that all relevant factors have been taken into account and irrelevant factors have been ignored, in order to ensure that the decision is lawful.  
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