Hong Kong Court Clarifies the Application of Implied Terms in Employment Contracts

The recent case of Yang Zhizhong v. Nomura International (Hong Kong) Limited helpfully clarifies the applicability of Implied Term of Trust and Confidence, the Braganza duty and the Anti-avoidance Term in the context of contract termination and awarding bonuses in from a Hong Kong employment law perspective. 

In this noteworthy case, the Court dismissed a claim made by a former employee (Employee) against his former employer (the Company) for breach of contract of employment – seeking damages of over US$4 million comprising bonus award, annual base salary and loss of certain unvested bonus awards. 

At issue were the Company's decisions (i) to issue a warning letter (Warning Letter Decision); (ii) not award any bonus for the performance year 2016/17 (Bonus Decision); and (iii) terminate his employment (Termination Decision, collectively the "Decisions"). 

Facts

The Employee was employed by the Company as a Managing Director in its Investment Banking Division following the acquisition of certain assets from Lehman Brothers. Over time, he was promoted to Senior Managing Director and held dual roles as Head of China and Chairman of Investment Banking for the Asia ex-Japan region. 

The Company issued a warning letter to the Employee on 13 December 2016 following an internal investigation into the Employee's conduct, specifically in relation to his involvement in certain "three-way meetings" with equity research analysts and clients without proper compliance approvals.

The investigation was triggered by concerns raised by the Securities and Futures Commission during a routine inspection into the Company in May 2016.

Subsequently, on 21 April 2017, the Company discovered the Employee was at an advanced stage of interviews with a competitor – and was eventually made an offer.

On 10 May 2017 the Company met with the Employee to (i) communicate the Bonus Decision, and (ii) provide a written separation offer. The separation offer was not accepted by the Employee but separation discussions continued.

On 31 May 2017 the Company gave notice to the Employee that his employment would be terminated on the ground of redundancy with effect from 31 August 2017 (i.e. the Termination Decision). The Employee's outstanding deferred compensation awards (the "Unvested Bonus Awards") were forfeited because he did not sign a waiver and release, which the Company was entitled to require him to sign under the terms of the applicable award documents. 

The Employee sued the Company claiming it had breached various implied terms of the contract of employment by the Decisions and claimed damages. 

Legal Principles

The Employee claimed a number of implied terms applied to his employment. The Court narrowed them down to the following implied terms and elements for each: 

1. Braganza duty (named after the case of Braganza v. BP Shipping Ltd) - is implied into a contract insofar as it is necessary to prevent the abuse of an unfettered discretion by the employer. The Court will consider:

• whether the employer took into account all relevant considerations and excluded irrelevant ones; and
• whether the result was so outrageous that no reasonable decision-maker could have reached it.

2. Implied Term of Trust and Confidence – is implied by law as an incident of the contract of employment. An employer has the duty not to, without reasonable and proper cause, conduct itself in a manner calculated and likely to destroy or seriously damage the relationship of trust and confidence between them. This duty does not extend to an employer's decision to terminate employment. The Court will consider:

• whether the employer's conduct was likely to destroy or seriously damage the relationship of trust and confidence between employer and employee;
• whether there was reasonable and proper cause for the conduct; and
• whether the conduct was calculated to destroy or seriously damage the relationship.

3. Implied Term of Anti-avoidance (Anti-avoidance Term) – if implied into a contract of employment, restricts an employer's (apparently unqualified) right to terminate an employment where such termination is to avoid the employee becoming eligible for consideration or receiving a bonus award. When considering whether the Anti-avoidance Term ought to be implied into the contract, the Court looks at the contextual background to the contract, including but not limited to the competitiveness of the industry, purpose of the performance incentive programme, and whether the bonus formed a major part of the employee's remuneration; such that the employee's right to be eligible for the bonus was clearly intended and understood by both parties to constitute an important benefit to the employee and an integral part of their remuneration package. Where the Anti-avoidance Term is implied into the contract, the Court will consider:

• whether the Company exercised its right to terminate the Employee's employment in order to avoid the Employee being eligible for, or receiving a bonus award. 

The Decision

The Court held that the Implied Term of Trust and Confidence applied to the Warning Letter Decision and Bonus Decision, but that term cannot be used to apply to the Termination Decision and cannot water down an employer's right to terminate employment without cause.

The only plausible implied term that can govern the Termination Decision is the term that an employer would not do so for the purpose of avoiding payment of discretionary bonus (i.e. Anti-avoidance Term).

In respect of the Bonus Decision, the Court held that the Braganza duty applied alongside the Implied Term of Trust and Confidence. This means that in exercising the discretion to award a nil bonus to the Employee, the Company has a duty not to conduct itself in a manner calculated and likely to destroy or seriously damage the relationship of trust and confidence – and also a duty to exercise the discretion in good faith not arbitrarily, capriciously or irrationally.

(i) The Warning Letter Decision did NOT amount to a breach of contract

In respect of the Implied Term of Trust and Confidence, the Court found that the issue of the Warning Letter was not calculated to destroy or seriously damage the relationship of trust and confidence between the parties.

Cheng J considered that the Company's Employee Handbook provided that a written warning is a possible disciplinary measure; the Company had a reasonable and proper cause to issue the letter; the letter was a private and confidential document and not a measure to publicly embarrass him; and the Company assured the Employee that it intended to continue the employment relationship when delivering the letter.

The Court found that there was reasonable and proper cause for the issue of the Warning Letter, including (i) the Employee's insufficient awareness of the perception of conflicts of interest and his failure to take steps to manage such conflicts, and (ii) there was an obligation on the Company's management (which includes the Employee) to ensure fit and proper behaviour by analysts.

(ii) The Bonus Decision did NOT amount to a breach of contract.

In respect of the Braganza duty, the Court considered that the Company took into account all relevant considerations and excluded irrelevant considerations. Cheng J accepted that the Employee's misconduct and the gravity of that misconduct was a key consideration, whereas less important factors included the Employee's financial contributions and failure to complete compliance training on time.

In considering whether the result was so outrageous that no reasonable decision-maker could have reached it, Cheng J highlighted that the Court would only intervene if the decision-making process (of the Bonus Decision) was irrational without concentrating on the outcome, which is a matter for the Company's qualitative judgment rather than the Court.

Cheng J highlighted that rationality is not the same thing as reasonableness: the Court does not substitute its own view of what is a reasonable decision for that of the decision-maker.

It was decided that the positive factors (e.g. the Employee's contributions) were not sufficient to outweigh the negatives, with the most important one being the Warning Letter. The Court further noted that the Employee occupied a very senior position of responsibility in the Company and his conduct had to be viewed in that light.

In respect of the Implied Term of Trust and Confidence, the Court found that there was reasonable and proper cause for the decision (given the above findings in relation to the Braganza duty). Cheng J found that the Bonus Decision was not calculated to destroy or seriously damage the relationship of trust and confidence between the parties – taking into account that the Company's intention was to preserve an amicable relationship for the remainder of the Employee's employment, and the Company's discovery that the Employee was at an advanced stage of interviewing with a competitor on 21 April 2017, before the Bonus Decision was communicated to him on 10 May 2017.

(iii) The Termination Decision did NOT amount to a breach of contract.

In respect of the Anti-avoidance Term, the Employee pleaded that the Company terminated his employment not because of redundancy, as it claimed in the termination letter, but rather to prevent him from being eligible for, or receiving, bonus awards (including the discretionary bonus for 2016/17 and the Unvested Bonus Awards).

While the Court found that it was not a true redundancy, Cheng J considered that the Company called it a redundancy to save face for the Employee. But it does not follow that the Employee was terminated in order to avoid him being eligible for, or receiving, any bonus awards.

In particular, Cheng J took into account that the Bonus Decision was made before the notice of termination was given to the Employee – and the loss of Unvested Bonus Awards was not caused by the Company but by the Employee's decision to not sign the waiver and release, which the Company was entitled to require him to sign pursuant to the applicable bonus award documents.

Key Takeaways

This judgment reaffirms an employer's right to terminate an employee without cause unfettered by any Implied Term of Trust and Confidence.

While it may be possible for an employee to claim there is an Anti-avoidance Term implied into the contract of employment and applying to the termination decision – namely that an employer would not terminate for the purpose of depriving the employee of a discretionary bonus – this will be dependent on the facts of the case.

Where an employer has an unqualified discretion in relation to an employment decision – for example, not to award bonuses – employers should be careful to reach that decision rationally and not arbitrarily or capriciously.

This can be achieved by demonstrating a reasonable and proper cause for that decision.

• Employers should therefore ensure decision makers are aware of and apply the correct parameters when exercising discretion.
• Where a document confers discretion and sets parameters, employers should ensure that the parameters are sufficiently broad to capture different scenarios, so that the decisions are consistent with such parameters.
• When terminating employment close to bonus time, employers should be careful to navigate the risks around any potential Anti-avoidance Term and take steps to mitigate that risk; such as having in place sufficient policies and setting clear conditions for eligibility to bonuses.

The judgment is available here.