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Bankers’ Bonuses – how the divorce capital of the world treats the rewards reaped from the financial capital of Europe

Lois Rogers, solicitor at Vardags, and Lily Mottahedan, barrister at 1 Hare Court, examine the court’s treatment of bonuses in financial remedy claims in light of the recent decision of Mrs Justice Eleanor King in H v W [2014] EWHC 4105 (Fam) and pre-existing case law.

 










Lois Rogers, solicitor at Vardags, and Lily Mottahedan, barrister at 1 Hare Court

Introduction
In the last few months, bankers' bonuses have occupied centre stage in both the international business and the political press and in the recent judgment of Mrs Justice Eleanor King in the High Court in H v W [2014] EWHC 4105 (Fam).

George Osborne may have lost his campaign against the EU cap on bankers' bonuses (which will limit bonus payments to no more than one's fixed salary or twice that with shareholder approval), but a banker husband, in the context of an appeal of a financial remedy order ancillary to divorce, has persuaded the High Court that his wife's share of his future bonus should be capped. This was undoubtedly welcome news to the residents of the Square Mile and Canary Wharf and will provide much needed clarity for litigants and their legal teams going forward.

H v W raises two inextricably linked areas of legal principle:

a) The principles underpinning maintenance awards (in particular needs versus sharing) and;

b) The principles guiding the court's treatment of post-separation acquest in bonus cases;

In terms of the principles underscoring maintenance orders, key cases include:

• B v S (Financial Remedy: Marital Property Regime) [2012] EWHC 265, Mostyn J

• Hvorostovsky v Hvorostovsky [2009] EWCA Civ 791, Court of Appeal

• VB v JP [2008] EWHC 112 (Fam), [2008] 1 FLR 742, Sir Mark Potter (President).

In terms of the principles specifically discussing bonuses as post-separation acquest, key cases include:

• Lawrence v  Gallagher [2012] EWCA Civ 394, Court of Appeal

• R v R (Financial remedies: Needs and practicalities) [2011] EWHC 3093 (Fam), Coleridge J

• B v B [2010] EWHC 193 (Fam), Moylan J

• H v H (Financial provision) [2009] EWHC 494 (Fam), Singer J

• P v P (Post-separation accruals and earning capacity) [2007] EWHC 2877 (Fam), [2008] 2 FLR 1135, Moylan J

• S v S [2008] EWHC 519 (Fam), Singer J

• H v H [2007] EWHC 459 (Fam), Charles J

• Charman v Charman [2007] EWCA Civ 503

• Rossi v Rossi [2006] EWHC 1482 (Fam), Mr Nicholas Mostyn QC (as he then was)

• M v M (Ancillary relief: Division of assets accrued post-separation) [2004] EWHC 688 (Fam), Baron J

H v W: The key facts
The husband and wife were 43 and 55 respectively. This was a 19 year marriage (including cohabitation) with one (now adult) child of the marriage.

From 2010 the husband was the managing director of a Russian bank whose income was comprised of a basic salary and a discretionary bonus made up of cash and shares.

In the year ending April 2012, he received a total of c.£450,000 per annum comprised of:

a) A basic salary of £250,000 gross.

b) A discretionary bonus and deferred cash of £195,750 gross plus an award of £18,000 of shares vesting over three years from April 2013.

Until the 1990s the wife was a legal secretary but had not worked for the last 15 years and was thus dependent on the husband's income.

While the husband painted a pessimistic picture of the future of bonus payments, the bonus level was broadly consistent with the pattern he had enjoyed over the last three years.

The wife's open position in relation to maintenance was periodical payments of £4,500 pcm together with 35% of all net bonuses on a joint lives basis.

The first instance decision
District Judge White awarded the wife a substantial proportion of the equity in the former matrimonial home, joint lives periodical payments of £3,750 pcm, and 25% of the husband's net annual bonuses on a joint lives basis.

In his explanatory judgment, the judge emphasised the difficulties facing practitioners and the court in setting the appropriate level of maintenance in circumstances where a significant proportion of the payer's remuneration is not guaranteed, or is deferred, or is paid in options and/or shares:

"As is common in the financial world this husband's income has historically comprised both basic salary and bonus. This immediately poses a problem for a Judge at first instance, trying to make an order which is both realistic in terms of past household income and affordable in respect of future income". (para.28 of H v W

The husband appealed.

The appeal
The husband brought an appeal against two aspects of the final order:

i) The order for periodical payments on a joint lives basis, seeking its substitution by a non-extendable term of maintenance until the husband attains the age of 60; and

ii) The order providing for the payment of 25% of the husband's net annual bonus to the wife, which he sought to be removed in its entirety. On his behalf it was argued that the first instance judgment had adopted the language of 'sharing' in relation to the bonus, not 'needs'.

Permission to appeal
At the permission to appeal hearing, Mr Justice Mostyn gave permission only in relation to ii) above. The judge found that the award of 25% of future net bonuses engaged important points of legal principle in relation to maintenance awards. In particular, he found that there was a tension in this case between the following interpretations of the judgment (para.7 of H v W):

i) If, per the husband, the percentage bonus award granted by the District judge were formulated solely on a sharing basis, then an important point of legal principle would arise warranting appellate review.  Mostyn J himself had sought to clarify this in B v S (Financial Remedy: Marital Property Regime) [2012] EWHC 265 (Fam), namely, that maintenance claims should be needs-based only. In that case, he found that:

"Of course needs are elastic in concept and there is much room for sharing the exercise of discretion in their assessment. But to allow consideration of the concept of sharing to intrude in the assessment of a periodical payments award seems to be based on a doubtful principle and is replete with problems of quantification by any sure standard" (para.79, B v S).

ii) If, alternatively, per the wife, the percentage bonus award had been determined by the district judge on the basis of needs "generously interpreted", then the only aspect to be advanced on appeal is whether there should have been a numeric or monetary cap on the sums received. Mostyn J made his view clear on this point when he said that the district judge would have been "plainly wrong" to award the wife a share of the husband's bonuses to meet her needs without such a cap.

The outcome in H v W
Allowing the appeal and imposing a cap of £20,000 pa on the wife's 25% share of future bonuses, Mrs Justice Eleanor King held that District Judge White had not erred in his application of the relevant principles as he had not in fact sought to apply the sharing principle to future bonuses. However, she found that in making a needs-based award that included a percentage of the husband's future bonuses, the correct approach would have been to impose a monetary cap on the wife's needs "generously assessed".

In finding that the judge at first instance had in fact applied the needs principle to the bonus portion of his maintenance award, her ladyship gave particular weight to the comments the judge made in his explanatory judgment:

"I refer in my order to the wife's "basic" needs being met. This is far from needs being "generously interpreted". I would certainly have made a higher periodical payments order had the husband not denied the probability of future significant bonuses. The fairer solution was to give the wife a modest proportion of the husband's future bonus if he received any. If not then both would have to live more frugally than would otherwise be the case" (para.28 of H v W). 

Her ladyship however found that (own emphasis):

"The proper approach would be for the district judge to calculate a total figure for maintenance … Having carried out this exercise the court will then make a monthly order to be paid from salary at whatever rate the district judge feels to be fair, and for the balance to be expressed as a percentage, or the net bonus up to a stated maximum each year" (para.39 of H v W)

Discussion
The importance of a cap on periodical payments funded from bonuses
Mrs Justice Eleanor King approved of the percentage mechanism used in allocating a proportion of bonus payments in maintenance, remarking that "given the intrinsic uncertainty of bonuses, [it] can only be expressed in percentage terms" (para.38, H v W).

However, she agreed with Mostyn J's strong "steer", expressed at the permission to appeal hearing, that the wife's entitlement to the husband's future bonus payments must be capped with reference to a maximum figure equal to the amount by which the wife's needs, "generously determined", would be met.

This percentage approach with a cap was also adopted by Coleridge J in the earlier case of R v R (Financial Remedies: Needs and Practicalities) [2011] EWCH 3093 (Fam) when he made an award of spousal maintenance of £55,000 pa with an additional 20% of any sum paid out of the husband by way of bonus, capped at £20,000 pa and to terminate upon the wife's receipt of a deferred lump sum.

In the authors' view, confirmation of the importance of a cap on bonus payments goes some way to alleviating an inevitable tension specific to bonuses: intrusion into the future income of a spouse which is directly attributable to his or her efforts during a period of post-separation and which does not involve trading or increasing/decreasing the value of a matrimonial asset.

The risk of reward must be shared
This case also confirmed that the inherent risk latent in bonus payments should be shared by both parties.

The risky nature of bonuses comes into play in two ways: i) on the overall quantum of the bonus and, indeed, whether there will be one at all (hence the % approach); and ii) its make-up (cash plus shares).

Thus, Eleanor King J found that any percentage share of future bonuses should apply pro rata across all elements of the paying party's remuneration package as it would not be fair for the wife to benefit from the cash element in priority to the husband, leaving him to take the risk on share price movements and the consequences of deferred cash payments.

This judgment thus gives recognition to the current reality that city workers' packages are generally more weighted towards deferred bonus schemes and share options than they used to be, and that discretionary awards in current financial conditions may not be guaranteed.

Context: post-separation bonus cases
The special place of bonuses in post-separation asset cases
In Rossi v Rossi, Mostyn J summarized the competing arguments vis-à-vis post-separation bonuses in the following way:

"Similar controversy arises in relation to bonuses earned in the period of separation. The earner of such bonuses can validly argue that he did his work outside of married life and without the support of his spouse. But the other can equally and validly argue that the ability to earn was generated during the marriage; that she was maintaining the family infrastructure pending dissolution of the marital partnership and division of the assets; and that during the period of separation the parties were financially linked." (para.15, Rossi v Rossi)

However, despite the tension between these two lines of argument, it appears that bonuses have a special place in post-separation asset cases. Indeed, in cases dealing with an increase in the value of capital assets during the period of post-separation e.g. the matrimonial home, shares (CR v CR [2007] EWHC 3206 (Fam), [2008] 1 FLR 323), or a company that was created or developed during the marriage, it appears that ring-fencing arguments carry less weight than in bonus cases.

In M v M for example, Baron J elucidated the difference between the two:

"[62] In this case, the post-separation accrual does not arise from the trading of capital that existed at separation; rather it has accrued from the husband's own hard work post-separation, albeit that part of his bonus is referable to a scheme which was 'invented' during the marriage.

[63] Moreover, the bonus is also due to the husband's personal work in fulfilling ABC Co's current policy of developing its overall business. This takes 50% of his time albeit that is not currently profitable. Such undefined part of his bonus as is referable to this aspect cannot be seen as relating to his earlier 'invention'".

What is the cut-off point for sharing?
H v W
demonstrates the application of the needs principle in post-separation bonus cases, but the permission hearing in that case also raised the question of whether there could be an element of sharing of post-separation bonuses. This point was brought to light by Singer J in H v H when he asked:

"When does the clock (or the meter) stop in a case where one spouse continues, once cohabitation has ceased, to accrue savings or wealth from earnings or elsewhere?" (para.79)

While the case law demonstrates a fact-specific and discretionary evaluation to achieve fairness, generally the courts have applied a restrictive approach to allowing one party to share in the post-separation income generated by the other (unless needs determine that he/she should as in H v W).

In Rossi v Rossi, Mostyn J introduced a post-separation cut-off point of 12 months:

"[24.4] If the post-separation asset is a bonus or other earned income then it is obvious that if the payment relates to a period when the parties were cohabiting then the earner cannot claim it to be non-matrimonial. Even if the payment relates to a period immediately following separation I would myself say it is too close to the marriage to justify categorisation as non-matrimonial unless it related to a period which commenced at least 12 months after the separation".

This "rule" was part-approved by Singer J in S v S but was rejected by Charles J in H v H when he said: "an approach that is acknowledged to be arbitrary, and which therefore does not have regard to the realities and circumstances of a given case is not correct" (para.57, H v H). So too was a trial date cut-off rejected by Moylan J in B v B "as a matter of policy" (para 47, B v B), as it would fail to give sufficient weight to the husband's endeavours post-separation. In H v H, Singer J excluded discretionary bonuses earned between 12 and 33 months after separation.

However, the recognition of a more intuitive dividing line, being the point of the parties' separation, has not prevented the court from allocating a share of post-separation bonuses to achieve fairness between the parties, for reasons such as the disparity in future income, one party's earning potential and the parties' respective contributions.

In H v H, Charles J ruled that the matrimonial property should be assessed at the date on which the marital partnership came to an end but made a "run-off" award so that the wife could make a smooth transition to independent living by awarding her with 1/3rd of the husband's income in the year following separation, 1/6th in the following year, and 1/12th in the third year. Whilst recognizing the wife's continuing contribution to the family in caring for the children (for which she is in receipt of child maintenance), the judge found that the post-separation bonuses were predominantly the product of the husband's "talents, energy and good fortune" (para 85).

In P v P, Moylan J, while acknowledging the argument that the partnership of mutual support ends at separation, found that "we are not engaged in the rigid application of any specific formula with a requirement to find clear and precise boundaries" (para.117), and he awarded the wife a share of the post-separation bonuses which on one hand reflected the fact that a significant part of the wealth had been earned by the husband since separation (two bonuses and deferred shares totalling £7m), but also that the husband had a very substantial future earning capacity:

"I … could not ignore future earning capacity when it is one of the express factors listed in paragraph 25(2) of the Matrimonial Causes Act. …. In my view, a fair outcome might not be achieved unless the court takes into account the different times and the different forms in which financial resources can accrue during the course of a career. In reaching my decision, therefore, I take into account both the fact that a significant part of the wealth has been earned by the husband since the separation and the fact that he has a very significant earning capacity" (paras124 and 125).

In B v B, Moylan J awarded the wife 15% of certain future deferred bonus instalments, confirming that the overall division was fair by according "proper weight to all the relevant factors in the case, including the contributions each party has made and will make to the welfare of the family and to the fact that a significant part of the wealth has accrued from income [post separation]"(para.51). 

Treatment of bonuses as capital is wrong?
As an aside, in the context of discussions on the treatment of bonuses, practitioners may also wish to note the Court of Appeal's comments in Lawrence v Gallagher [2012] EWCA Civ 394 that future bonuses should not be treated as capital:

"Apart from the factual errors these were annual bonuses' deferred in collection and conditional on performance. They were not capital assets but part of the appellant's income stream upon which he is taxed at top rate. I can see no principled basis upon which the respondent should be awarded 45% of that as though it were a present capital asset. I would delete this element of the judge's award entirely.

"No doubt in those cases where the applicant seeks a joint lives periodical payments order the frequent replacement of cash bonuses by deferred bonuses presents a problem for practitioners and for judges. Should future projections be variable upwards if the bonus is paid at the end of the three year deferment or should the order be variable downward if the bonus does not become due for payment? No submissions were made as to what the general approach is or ought to be. We are not in the present appeal concerned with a continuing periodical payments order and the appellant's hope or expectation of future receipt does not to my mind have much bearing on the present division of the available assets."
 [paras 53 and 54] 

Conclusion: A move towards an analytical approach?
In the authors' view, Mrs Justice Eleanor King's judgment vis-à-vis caps on bonuses sits neatly with the principles and methodology adopted in non-matrimonial asset cases such as Jones v Jones [2011] EWCA Civ 41 and N v F [2011] EWHC 586 (Fam).

Practitioners will have noted, and indeed participated in, the many incisive commentaries on the 'broad-brush' versus 'mathematical' approach in financial remedy claims involving non-matrimonial assets in the last few years and the tension between these two lines of judicial decision-making (see for instance Jones v Jones [2011] EWCA Civ 41, Robson v Robson [2010] EWCA Civ 1771, N v F [2011] EWHC 586 (Fam), GS v L [2011] EWHC 1759 (Fam)).

Subsequent to the aforementioned cases, the analytical approach has found favour with the Law Commission in its recent report Matrimonial Property, Needs and Agreements where the Commission concluded that:

"We believe that the better method is that which identifies the non-matrimonial property, disregards it, and shares the remainder equally (subject to the parties' needs being met), exemplified in the case of Jones v Jones. This is in preference to the more broad brush approach which shares the couple's property in proportions which the court considers to be fair, taking into account the presence of non-matrimonial property …We consider the former approach to be clearer and more conducive to promoting financial settlement'.(Introduction para)

Thus it appears, in light of H v W and the recent Law Commission report, that in the marathon of the 'broad-brush' team versus the 'mathematical' team, the latter approach is presently taking the lead.

17/4/14