Hong Kong Court of Appeal rules withholding of bonus and set-off for gross misconduct was unlawful

Save for certain exceptions as provided for in section 32 of the Employment Ordinance (Cap. 57) (the “EO”), it is well-known that deductions made from wages due to an employee are unlawful. Are bonuses due to an employee also subject to the same restriction against deductions from wages? Does an employer have the right to set-off any sums owed to it by an employee or will this violate section 32?

These were the questions considered by the Hong Kong Court of Appeal in the recent case of Xu Yi Jun v GF Capital (Hong Kong) Ltd [2020] HKCA 663 (6 August 2020). In its judgment, the Court held that:

1. the wording used in a bonus clause will be strictly construed;
2. bonuses due to an employee are subject to the section 32 restriction against deductions; and
3. equitable set-offs are prohibited by section 32.

Facts

The underlying dispute involved a former employee, Xu Yi Jun (the “Employee”), bringing a claim for payment of a HKD7,800,000 guaranteed bonus from her former employer, GF Capital (Hong Kong) Ltd (the “Employer”) pursuant to her employment contract. The employment contract contained the following bonus clause:

“6. Guaranteed Bonus

In addition to the annual bonus and sign-on bonus referred to in clauses 4 and 5 above, we will grant you a guaranteed bonus of HKD7,800,000 (2016 Guaranteed Bonus) for the calendar year ending 31 December 2016. The 2016 Guaranteed Bonus is payable to you irrespective of your performance or the performance of the Group during the calendar year. Any annual bonus in excess of the 2016 Guaranteed Bonus shall be calculated and payable to you in accordance with clause 4 above. The 2016 Guaranteed Bonus will be vested in the following calendar year and payable in full on the payment date of your monthly basic salary in March 2017 (the “Due Date”). If your employment with the Company is terminated voluntarily by you without cause or you have been found guilty of any gross misconduct, in either case before the Due Date, any outstanding payments of the 2016 Guaranteed Bonus will be forfeited.” (emphasis added)

The due date for payment of the bonus fell on 31 March 2017 (Due Date). However, the Employer had delayed payment pending the completion of an investigation into allegations of the Employee’s serious misconduct. The allegations had arisen out of a deal, proposed by the Employee, that related to a company in which the Securities and Futures Commission had ordered to cease trading.

The Employer’ internal investigation subsequently found the Employee guilty of certain counts of misconduct. On 14 June 2017, the Employee resigned by giving 2 months’ notice and commenced proceedings in the Labour Tribunal claiming payment of the bonus with interest.

The Employer denied the claim on the basis that the bonus had been forfeited due to the Employee’s gross misconduct which had occurred before the bonus Due Date, in accordance with Clause 6. The Employer also brought a counterclaim against the Employee for the loss and damage it claimed to have suffered as a result of the Employee’s gross misconduct, and which it said gave the Employer a defence of equitable set-off.

How should Clause 6 be Interpreted?

The Court first had to consider how to interpret the phrase “If…you have been found guilty of any gross misconduct…before the Due Date”.

The Employee argued that the plain and natural meaning of this phrase was that it was necessary for there to be a “finding” of gross misconduct before the Due Date. The Employer, on the other hand, argued there was no need for such a finding to have taken place, so long as the gross misconduct itself had occurred before the Due Date.

The Court sided with the Employee’s interpretation. It held it was clear that if the bonus was to be forfeited, there must have been a finding of gross misconduct before the Due Date, and that gross misconduct merely having occurred (and not having been found) before the Due Date was insufficient.

In arriving at this conclusion, the Court reiterated the existing position that where the language of a clause is very clear, it will be difficult for a party to argue that a clause was intended to operate in another way as a matter of “business common sense”.

Will set-offs from / deductions to a bonus violate section 32 of the EO?

Regarding the Employer’s defence of equitable set-off, the Employee argued this was contrary to section 32(1) of the EO which provides that:

“No deductions shall be made by an employer from the wages of his employees or from any other sum due to the employee otherwise than in accordance with this Ordinance.” (emphasis added)

The Employee drew attention to the words in emphasis and claimed the effect was that the restriction applied to sums other than wages (which it was accepted the bonus did not amount to). This was notwithstanding that the heading of section 32 is “Deductions from Wages” and the section itself is headed “Restrictions on deductions from wages”. The Court agreed with this interpretation and indeed it was not disputed by the Employer.

The Employer, however, argued that:

1. An equitable set-off does not extinguish or reduce any claim by an employee for wages, but merely precludes the exercise of a right to claim where the connection between the claims would make this manifestly unjust, and thus this does not fall within the “deductions” prohibited by section 32(1).
2. A distinction should be drawn between an equitable set-off in the context of legal proceedings (which should not be precluded by section 32) and an equitable set-off deployed by an employer outside legal proceedings (which should fall within section 32).

The Court disagreed with the Employer’s arguments on both counts. It held it could not be the legislature’s intention to temporarily remove an employee’s right to payment of a sum until after a determination by the courts of an employer’s claim for damages against an employee for their negligence during work. It also found that while the practice of set-off by judgment is permissible, this does not in and of itself support the contention that section 32(1) does not preclude an employer from exercising an equitable set-off in an action by raising a claim for unliquidated damages.

Accordingly, setting-off of the Employee’s claim for the bonus if due and payable with the Employer’s counterclaim is prohibited by section 32 of the EO.

Implications for employers

It is not uncommon for employers to want to withhold incentive payments from employees in circumstances where they have caused damage to the business, particularly where the incentive is a significant sum and the employee has committed (or is suspected to have committed) gross misconduct. However, the decision in GF Capital serves as a warning to employers that they need to carefully consider whether this is lawful in light of the wording of the employment contract and section 32 of the EO.

In particular, employers should be mindful of the following:

1. The risk of future disputes can be mitigated with clear drafting that gives the employer greater flexibility over the award of any payments.
2. Lump sum bonuses that are guaranteed come with inevitable risk and the conditions for vesting need to be clearly specified. As an alternative, employers should consider offering discretionary bonuses or making payments by way of instalments rather than as a lump sum. However, this increased flexibility needs to be balanced against the desire to attract talent and incentivize performance.
3. Employers should exercise caution before withholding or making deductions from sums that may have already vested. The decision confirms that the ambit of section 32 of the EO is broad and applies to sums other than “wages”. This will include not only bonuses but also other sums including, for example, retirement scheme contributions, gratuitous commissions, travel expenses, and gratuities payable on termination.
4. Employers should generally not apply any set-offs against sums due to an employee unless this falls within one of the permitted exceptions under section 32 of the EO. Even if the employer has a strong claim against the employee (whether for gross misconduct or otherwise), unless expressly provided for in the EO, the proper practice in such circumstances should be to first pay the applicable sum to the employee and then bring legal proceedings against the employee for damages. While this can be a frustrating, time-consuming and expensive process, applying deductions from the outset will likely amount to a breach of section 32 which can give rise to criminal liability – both for the employer and personally for its directors and officers in certain circumstances.

Please contact Helen Colquhoun or David Smail if you have any questions on the impact of the decision in GF Capital. We would be happy to assist with the drafting of bonus clauses or reviewing your practices on deductions from wages/other sums due to employees.