A little mixed up there.
Assuming adequately competent pilots, the most senior & qualified FO will be offered the upgrade vacancy. Yes, there might be a more senior but unqualified FO who will not get it. This is irrelevant. When that unqualified FO becomes qualified, start reading again from the beginning of this paragraph.
Bypass pay only applies if the most senior & qualified FO does not get the vacancy, for a reason that is subsequently determined (by the lawyers) to be inadequate. E.g. because a manager said he/she was incompetent, but actually the written records did not substantiate that judgement.
I wouldn't say it's a good system, but lots of experienced people say it's better than the alternative. A little like democracy, perhaps?