|Legal Effect of a Retention Bonus (Signing Bonus)
A company can use several methods to retain highly-skilled workers for a long time, with two representative examples. One is through a non-compete clause in the employment contract or rules of employment, whereby the employer prevents capable workers from transferring to competitive companies, and the other is through a signing bonus, where the employer tries to restrict the transfer of workers through financial means. A non-compete clause is hard to validate as it restricts the freedom of a worker’s occupation. The Supreme Court has argued that "even if there is a non-compete agreement between the employer and the employee, if such an arrangement excessively restricts the constitutionally-guaranteed freedom of occupation, or the right to work or free competition, an action contrary to good social order, such as good customs as set forth in Article 103 of the Civil Law, should belong to invalidity.” For this reason, many companies prefer signing bonuses, which have a direct effect on the reduction of turnover by good manpower.
I recently received an inquiry from a company about the effectiveness of a retention bonus clause . For this company, 30% of the annual salary is set as bonus, with 50% paid with the 1st year's salary in January, and the remaining 50% paid in January of the following year. In return, the worker must work for three years. The employer wants to include the following clause: "If the employee resigns prior to the agreed three years, the retention bonus shall be returned." The company asked for a legal review of the validity of this. In this case, I concluded that for the retention bonus to be set for three years would be no problem, considering related matters such as the nature of the related wage, the prohibition of forced labor, the Prohibition of Predetermination of Nonobservance, etc.
In this article, I would like to deal with this issue in more depth, reviewing (ii) the characteristics of a special bonus and violation of the Labor Standards Act; (iii) the legal effect of a signing bonus; and (iv) the criteria for a signing bonus.
II. The Characteristics of a Special Bonus and Determining Whether it Violates the Labor Standards Act
1. The Characteristics of a Special Bonus
The term "wages" as defined in Article 2 of the Labor Standards Act refers to “wages, salaries and any other money and valuable goods an employer pays to a worker for his/her work, regardless of how such payments are termed." Regarding the wage status of bonuses, such bonus can be regarded as wage if payment conditions and payment timing are set in a collective agreement or employment rules, etc. and if the payment of such bonus is customary for all employees. If the above conditions are satisfied, such special bonus can be recognized as having the characteristics of wages. Concerning the legal characteristics of a "Retention Bonus", the Ministry of Employment and Labor judged that this bonus could not be considered as wages under the Labor Standards Act if payment was not stipulated in a collective agreement or rules of employment, etc., and if the employer temporarily or voluntarily paid it on condition of securing longer employment. Therefore, it is not included in the average wage for the calculation of severance pay.
2. Determining Whether a Special Bonus Violates the Labor Standards Act
“Prohibition of forced labor” as stipulated in Article 7 of the Labor Standards Act means that “No employer shall force a worker to work against his own free will through the use of violence, intimidation, confinement or any other means which unlawfully restricts mental or physical freedom.” It is forced labor to cause workers to carry out unwanted work. However, it is not forced labor for an employer to direct, supervise or legally sanction workers to fulfill their obligation to provide work under an employment contract. The penal provisions of Article 7 (prohibition of forced labor) impose a penalty of imprisonment of not more than 5 years or a fine of not more than KRW 30 million, while the penalty for violation of Article 20 (Prohibition of Predetermination of Nonobservance) is a fine of less than KRW 10 million. Therefore, in the application of the signing bonus case, Article 20 of the LSA Act, which includes the voluntary intentions of the employees, is more appropriate than Article 7, which governs only direct physical and mental restraint, such as assault, intimidation and confinement.
The prohibition of predetermination of nonobservance prescribed in Article 20 of the Labor Standards Act stipulates that "No employer shall enter into a contract by which a penalty or indemnity for possible damages incurred from breach of a labor contract is predetermined.” This is to prevent an employee from being forced to continue to work against his/her will by previously agreeing to pay a certain amount of money without determining the type and degree of the actual damage to the employer because of non-fulfillment of the employee’s employment contract. In order to guarantee performance in a contractual relationship, the Civil Act may apply penalties or damages for default in advance at the conclusion of a contract (Article 398 of the Civil Code ‘Liquidated Damages’). However, while a penalty for non-fulfillment of work is a means of securing long-term employment of good manpower for the employer, it does prohibit employees from resigning, because of the burden of penalty payment. As concerns provisions for the prohibition of ‘Liquidated Damages’, labor contracts in the form of penalties for existing wages are not allowed, but reimbursement of training costs and bonuses with reasonable and valid content is permitted, because it does not unduly limit freedom of resignation.
III. Legal Effectiveness of a Signing Bonus
1. Situations where the return commitment of the signing bonus is valid
(1) Suwon regional court ruling on May 13, 2013: 2002gahap12355: An employee agreed that he would receive KRW 150 million as a retention bonus for 3 years’ compulsory stay, which he would repay if he left the company prematurely. After 7 months of service, he moved to a competitor company. The court ruled, “The retention bonus does not belong to the wage and can be excluded from application of Article 20 of the LSA (Prohibition of Predetermination of Nonobservance), but the company paid the bonus for the purpose of retaining the employee for 3 years. Therefore, the employee should repay the retention bonus.”
(2) Seoul regional court ruling April 29, 2013: 2013kahap231: An employee received a signing bonus of KRW 50 million, which he agreed to repay if he left the company before two years after receiving this money. He then left the company after 7 months. The court ruled, “This signing bonus to retain the employee for a certain period of service cannot be translated as forced labor, and it also does not violate Article 20 of the LSA (Prohibition of Predetermination of Nonobservance).”
(3) Changwon District court ruling on November 17, 2007: 2007na9102: According to a mutual agreement between a company and an employee, the company was to pay a special bonus to the employee in accordance with the length of service, ranging from 12 months to 41 months of the normal wage, in return for which the employee would stay for two years from the date on which the employee was paid. The agreement stipulated that in the event that the employee resigned from the company, the special bonus would be returned to the company for a period not exceeding two years. The employee who received the compensation from the company submitted a resignation letter and resigned on the day after the receipt of the compensation. In this case, returning compensation based on two years of obligatory work does not restrict the freedom of choice of the workplace or freedom of retirement. The court agreed with the company’s rule that the special bonus should be returned.
2. Instances where the return commitment of the signing bonus is invalid
(1) Supreme Court ruling on Oct. 23, 2008: 2006da37274: When an employee joined the company, he signed a retention bonus agreement whereby he would receive KRW 500 million and serve the company for 10 years. If he resigned before 10 years, he would repay a penalty of KRW 1 billion. In this case, the court ruled that this retention agreement violated Article 20 of the LSA (Prohibition of Predetermination of Nonobservance) and became null and void.
(2) Inchon regional court ruling on April 29, 2013: 2013gahap3994: An employee promised to stay in the company for at least 5 years, and received KRW 50 million as a retention bonus. In the agreement, the employee agreed to repay 3 times the value of the retention bonus received if he did not fulfill the agreement. After 5 months of service, the employee resigned. The company claimed KRW 150 million, three times the amount of the retention bonus. In this case, the court rejected the employer’s claim.
3. The Supreme Court ruling on Signing Bonuses
(1) Case details: A company that manufactures robot doctors (ROBODOC) hired an experienced engineer in the field of fuel cells at S company on January 13, 2009 for a period of four years. The company made a recruitment agreement to pay KRW 100 million as a signing bonus separate from the salary. The recruitment agreement contained a stipulation that the company guaranteed employment for seven years, and the employee would work for the company for seven years. The employee resigned on April 12, 2010 for personal reasons. The company sued for return of the signing bonus, but the district court dismissed the plaintiff’s (company’s) claim (Dongbu District Court, 2010kahap13266). The company appealed, and the Seoul High Court partially accepted the claim that the employee should pay a prorated amount of the signing bonus, stating that the signing bonus was: 1) a special incentive to join the company, 2) a full down payment for 7 years of pre-emption, and 3) a special bonus to expect 7 years’ service (Seoul High court 2011na22827).
(2) Decision of the Supreme Court: The Supreme Court dismissed the plaintiff's claim, saying, "As the company concluded labor contracts as a way of hiring experienced professional personnel, the so-called “signing bonus”, the following points should be taken into consideration: ① Whether or not they have the characteristics of compensation for job turnover or the conclusion of a labor contract; ② Whether to pay for the prohibition of resignation during the compulsory working period; ③ Whether or not there is a written statement concerning returning the bonus upon retirement or turnover in the middle of the period.” Based on the aforementioned premises, the signing bonus was judged to have the characteristics of a reward because there was no description of a specific method of payment or any return obligation. In other words, the signing bonus for this case is an instance in which the nature of the reward for employment is judged to be stronger than the nature of the mandatory working period of seven years.
IV. Conclusion (Criteria for a Signing Bonus)
The judging criteria for a signing bonus must adhere to the following principles:
(i) If there is a disagreement over the interpretation of the contract between the parties: ① The contents of the document, ② The motivation and the manner in which the agreement was made, ③ The purpose of achieving by agreement, and ④ The true intention of the parties should reasonably be interpreted according to logic and empirical rules.
(ii) It is effective for the employer to stipulate a return of the employee's bonus, which is provided separately from the employee's wage, for the special purpose of preventing the employee from transferring to another company. In principle, these return arrangements are required to ① balance the amount of the signing bonus award and the duration of the contract of employment, and the degree of the former restriction; ② not infringe on the essential condition of the employee's freedom of changing occupation; ③ the bonus should not have the characteristics of a wage, and ④ there should be no reason related to the employer for the employee’s transfer to another company.
In other words, it must be made clear that the signing bonus is awarded on the condition that the bonus is to be paid for a period of mandatory service; the duration of such obligatory service should be as short as possible and; the returning amount should be the same or less than the amount that the employee received for the mandatory service period. In addition, a contract for returning the bonus award is valid only if the employee voluntarily resigns.