10 Legal Risks of Poorly Drafted Bonus Plans
Introduction
Bonus plans are meant to motivate performance, retain top talent, and reward results. But when these plans are poorly drafted, they can backfire—leading to employee disputes, legal claims, or unintended financial exposure. Many businesses overlook the legal risks of poorly drafted bonus plans, which can include unclear language, conflicting terms, or missing clauses in bonus agreements.
In this article, we’ll break down ten legal risks of poorly drafted bonus plans—and show you how to avoid them.
Who This Is For / Why This List Matters
This guide is for:
- Business owners and HR leaders drafting incentive plans
- Legal professionals reviewing employment agreements
- Consultants advising on executive compensation
- Startup founders offering equity or revenue-based bonuses
It’s especially relevant:
- During company scaling or restructuring
- When offering variable compensation or commissions
- After legal or financial audits of employee compensation
1. Ambiguous Performance Criteria
If bonus triggers are vague—like “good performance” or “solid growth”—you’re opening the door to disputes.
Why It Matters: Employees may believe they’ve met the criteria, while leadership disagrees. This can lead to breach of contract claims or morale issues.
What to Do: Clearly define targets with measurable KPIs. Include formulas or scoring systems when possible.
2. No Discretion Clause
Some companies forget to include a clause stating that bonuses are discretionary, not guaranteed.
Why It Matters: Courts may interpret the bonus as an entitlement, especially if it’s paid regularly.
What to Do: Add language clarifying that bonus payments are subject to employer discretion and business conditions.
3. Contradictory Employment Contracts
Bonus terms in offer letters or contracts sometimes conflict with internal HR policies or bonus plan documents.
Why It Matters: Inconsistencies create ambiguity, and courts usually interpret unclear terms against the drafter.
What to Do: Ensure consistency across all employment documentation, especially in light of the legal risks of poorly drafted bonus plans.
4. No Forfeiture Clause
If you don’t specify what happens when someone leaves the company, it can lead to disputes about eligibility.
Why It Matters: Departing employees may claim entitlement to a prorated or full bonus.
What to Do: Clearly define forfeiture rules for resignation, termination for cause, and layoffs.
5. Poor Timing Definitions
Does “annual bonus” mean calendar year or fiscal year? Payment within 30 days or 90?
Why It Matters: Ambiguity around timelines creates confusion and legal risks of poorly drafted bonus plans.
What to Do: Define timelines precisely in the plan.
6. Missing Clawback Provisions
Without a clawback clause, your business may not be able to recover bonuses paid based on false data or misconduct.
Why It Matters: You may pay out large bonuses and then discover accounting errors or fraud.
What to Do: Include a clawback clause allowing repayment in defined situations.
7. Lack of Board or Shareholder Approval Language
Especially in startups or corporations, some bonuses need board consent. If you skip this, payments may be invalid.
Why It Matters: This can result in illegal distributions or shareholder disputes.
What to Do: Include conditions like “subject to board approval” in your plan.
8. No Tax Treatment Clarification
Failing to clarify how bonuses are taxed (as salary, equity, or deferred comp) may cause issues for both employer and employee.
Why It Matters: Tax misclassification can lead to penalties or disputes with tax authorities, increasing the legal risks of poorly drafted bonus plans.
What to Do: State how the bonus will be taxed and provide appropriate documentation.
9. Unclear Calculation Methodology
If your bonus structure uses formulas, those formulas must be unambiguous.
Why It Matters: Misunderstandings can lead to employee claims, especially for sales or revenue-based bonuses.
What to Do: Provide clear examples and calculation methods within the plan.
10. Overlooking Jurisdiction-Specific Laws
Some countries or states treat bonus pay differently in terms of labor laws.
Why It Matters: A compliant plan in one region may be illegal in another.
What to Do: Localize your bonus plan based on the jurisdictions where employees are based, minimizing the legal risks of poorly drafted bonus plans.
Mini Case Example: Legal Risk in Action
A growing SaaS company offered annual performance bonuses tied to revenue milestones. However, the bonus language didn’t include a discretion clause or define what revenue milestones meant. After a strong year, several employees demanded bonuses, but leadership believed only “net revenue” counted. Two employees filed legal claims, citing past communications as implied guarantees. The matter was settled, but cost the company legal fees and strained internal trust. Afterward, the company updated its plan with explicit definitions, discretion terms, and board approval requirements, reducing the legal risks of poorly drafted bonus plans.
Summary Checklist: Legal Risks in Bonus Plans
- Define clear, measurable performance criteria
- Include a discretion clause
- Align bonus terms with employment contracts
- Add forfeiture rules for different exit scenarios
- Specify timing and calendar references
- Include a clawback clause
- Require board/shareholder approval where relevant
- Clarify tax treatment
- Provide examples of bonus calculation
- Localize the plan for all applicable jurisdictions
Closing Thoughts + Call-to-Action
Poorly drafted bonus plans are a silent liability. They seem simple—until they create friction, cost you money, or invite legal trouble. With just a few thoughtful changes, you can turn your bonus structure into a powerful, protective tool for both your team and your business, reducing the legal risks of poorly drafted bonus plans.
Need help reviewing or drafting your bonus agreements? Contact us today for a custom consultation or download our legal risks of poorly drafted bonus plans checklist to start fixing yours.
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