Termination Clauses and Restrictive Covenants in Employment Agreements

• 
  Sarah Low
  Lawyer

Avoiding and Fixing Drafting Errors

Note: This article written by Sarah Low of McKenzie Lake Lawyers was first prepared for and delivered at a talk for the Ontario Bar Association on September 30th, 2015 regarding “Key Updates in Labour and Employment”. 

It is increasingly common for employers to rely on written Employment Agreements.  The most important clauses in these contracts are termination provisions that seek to limit employee notice entitlements upon termination, as well as restrictive covenants used to protect the employer’s interests by restricting an employee’s employment and business activities for a period of time after separation.  Recent cases confirm the Court’s continued unwillingness to enforce termination provisions and restrictive covenants, especially non-competition clauses.  The purpose of this paper is to outline how to avoid and fix common drafting errors in such provisions, and increase enforceability.

TERMINATION PROVISIONS

Common Law reasonable notice is generous relative to the minimum requirements of employment standards legislation such as the Employment Standards Act, 2000 (“ESA”), and the Canada Labour Code, 1985 (“Code”).  There can be a substantial difference in the notice entitlements of a dismissed employee who has signed an employment contract that contains a termination clause limiting his or her entitlements to the ESA, and what that employee would receive if he or she was entitled to reasonable notice at Common Law.  By contractually limiting employees to their minimum entitlements under the legislation, employers can avoid the potentially enormous cost of lengthy Common Law notice periods.  However, the interpretation and language of these provisions is always a hot-button issue.  Historically, the Courts have generally found these provisions void, usually for failure to comply with employment standards legislation. (see Machtinger v. HOJ Industries, [1992] 1 SCR 986 (SCC), Wright v. The Young and Rubicam Group of Companies (Wunderman), 2011 ONSC 4720,  Stevens v. Sifton Properties Ltd., 2012 ONSC 5508)

Recent cases have followed this trend and confirm the tenuous nature of termination provisions:

Miller v. A.B.M. Canada Inc., 2014 ONSC 4062

Miller was employed by A.B.M. Canada Inc. as the sales development manager.  His compensation included base salary, car allowance, and pension contributions.  He signed an Employment Agreement prior to commencing employment.  The termination provision stated that he could be terminated “at any time without cause upon being given the minimum period of notice prescribed by applicable legislation, or by being paid salary in lieu of such notice or as may otherwise be required by applicable legislation.”  Miller was terminated after being employed for approximately a year and a half.  His termination letter stated that he was entitled to two weeks of base salary in lieu of notice, and he was offered an “enhanced” offer of four weeks of base salary plus his car allowance for that time.  Miller sued.

The Superior Court found that the termination clause was not enforceable and awarded him Common Law reasonable notice.  The employer appealed to the Ontario Divisional Court, arguing that the termination provision’s failure to reference benefit continuance should be treated as a presumption that those benefits would be continued.  The Court found that the clause was in fact not silent on the benefits since other clauses in the contract distinguished between base salary, pension and car allowance.  At best the termination clause was ambiguous and should be interpreted in favour of Miller.  The clause was struck and Miller, with 17 months of service, was awarded a notice period of three months.

Howard v. Benson Group, 2015 ONSC 2638

Mr. Howard had signed an Employment Agreement containing a five-year term.  The termination clause on the Agreement read:  “Employment may be terminated at any time by the employer and any amounts paid to the employee shall be in accordance with the Employment Standards Act of Ontario.”  Howard was terminated after two years and sued the company.  He argued that the clause was unclear as to whether the “amounts paid” would include benefits or other amounts, and the wording suggested it was discretionary whether he would be paid anything at all.  He also argued that he was entitled to be paid out for the remaining three years of his contract.  The Ontario Superior Court agreed that the provision was ambiguous, left question about his entitlements under the ESA, and that Common Law reasonable notice should apply.

Paquette c. Quadraspec Inc., 2015 ONCS 4179

Mr. Paquette had been employed by Quadraspec Inc. since 1983.  The parties entered into a new employment contract in 1998, which provided for a maximum notice period of six months of salary.  The clause stated that the employee waived any rights to any other amounts, excluding salary, vacation pay and other benefits unpaid at the time of termination.  He was dismissed in 2011, and was paid six months’ salary and all amounts owing to the date of termination.  He sued.  The Court found that the termination clause was in violation of the ESA in that it did not allow for the continuation of benefits until the end of the statutory notice period.  He was awarded Common Law damages.  What is most noteworthy about this case is that the Court also found that Mr. Paquette was entitled to severance under the ESA, even though Quadraspec’s annual payroll in Ontario was less than $2.5 million.  The Court held that the calculation of an employer’s payroll for the purposes of an employee’s entitlement to severance under the ESA is not necessarily restricted to payroll within Ontario.

Luney v. Day & Ross Inc., 2015 ONSC 1440

This case provides some much needed good news for employers, showing that it is in fact possible to draft an enforceable termination provision.  The decision demonstrates how a clear and properly drafted clause can help an employer limit notice and severance liability.  The Court in this case scrutinized a termination clause in the context of the Canada Labour Code, and the clause was upheld.

Luney worked for an inter-provincial trucking company and upon termination he was offered a severance package consistent with the termination clause in his Employment Agreement.  The provision read as follows:

“Your employment may of course, be terminated at any time for ‘just cause’, in which case you will not be entitled to any notice or severance payment.

If your employment is terminated for other than ‘just cause’, or if a competent tribunal should rule that your termination was ‘unjust’, you will be entitled to two weeks [sic] notice or pay in lieu of notice and a severance of one week’s regular pay for each full year of service, less statutory deductions. The payments are not to exceed the equivalent of 15 weeks [sic] pay.

It is understood and agreed that in the event the aforesaid notice and severance entitlements are not in conformity with the notice and severance provisions prescribed by the Canada Labour Code or other similar legislation, the statutory minimum’s [sic] shall apply and be considered reasonable notice and severance. Discussion of individual salaries may be grounds of dismissal.

The foregoing notice and severance payments will satisfy any and all obligations to you by Day & Ross Inc. or any affiliated company arising out of or in any way connected with the termination of your employment, including any obligations arising under the Canada Labour Code and similar legislation for notice, severance pay or reinstatement.”

Luney brought an action against the employer, asserting the termination provision was unenforceable on two grounds:  1) it was ambiguous and therefore did not rebut the presumption of reasonable notice at Common Law; and, 2) it violated the Code on the basis that it did not provide for benefits.  The motion judge dismissed the motion, finding that the language in the clause clearly rebutted the presumption of reasonable notice at Common Law.  Luney appealed to the Divisional Court, who agreed that this language was effective and enforceable.  The Divisional Court also found that the lack of reference to benefits did not render the clause void, since the employer had included wording to the effect that if the severance entitlements were not in conformity with the severance prescribed by the Code, the statutory minimums would apply.

Lessons for Counsel and Employers: Common (Fatal) Drafting Errors

1. Non-Compliance with the Legislation

• A termination provision that provides for less than the statutory minimum notice and severance required under the ESA or Canada Labour Code is void and unenforceable.  It is illegal for an employer to provide less than the minimum standards of the ESA or CLC, even if the employee has agreed to this lower amount.  Common Law reasonable notice will apply in these circumstances;
• It should be noted that an employer’s total (possibly global) payroll should be considered when determining severance entitlements for this purpose above;
• Any ambiguity will be interpreted against the interests of the employer;
• Where the termination provision contains a formula that is potentially greater than the legislated entitlements, ensure there is no point or circumstances under which the formula could provide for less than those entitlements.  It is also wise to include language to the effect that, where entitlements under the contract may be less than what is provided for by the ESA or CLC, the legislated standards will apply and be substituted for those contractual provisions.  If the language is deemed not to be in compliance with the legislated standards, those standards will apply.  Be clear that under no circumstances will the employee receive less than those minimum standards.

2. The termination provision does not specifically include benefit continuation for the ESA statutory notice period

• Under s.61(1) of the ESA, employers must maintain all regular benefits for the statutory notice period.  If a termination provision excludes the continuation, or even where the contract is silent but the employer does indeed provide the benefits, the provision will be deemed void and Common Law reasonable notice will apply.  See:
  • Wright v. The Young and Rubicam Group of Companies (Wunderman), 2011 ONSC 4720;
  • Stevens v. Sifton Properties Ltd., 2012 ONSC 5508;
  • Miller v. A.B.M. Canada Inc., 2014 ONSC 4062;
  • Howard v Benson Group, 2015 ONSC 2638; and,
  • Paquette c. Quadraspec Inc., 2015 ONCS 4179.
• Clauses should clearly communicate that ALL remuneration will continue for this statutory notice period.  This may include, but is not limited to, regular pay, commissions, group benefits and all other regular benefits, vacation pay accrual, any applicable allowances, and pension or RRSP benefits;

3. Ambiguity

• As previously mentioned, the clause must clearly reference all legislative requirements including statutory notice, severance, and benefits;
• Include clear language to the effect that the employee will not be entitled to any additional compensation beyond the statutory entitlements or whatever other entitlements for which the provision allows;
• When using a formula that provides compensation greater than the statutory entitlements, and that formula provides for a specific amount of pay or compensation “in lieu” of notice, that pay or compensation in lieu should be clearly defined.  List what will be included in the “compensation.”  All regular remuneration must continue for the statutory notice period.  If there are specific benefits or compensation which will not or cannot continue past the ESA notice period, make sure to exclude these.  These can include:
  • Base salary;
  • Bonus;
  • Commissions;
  • Benefits such as extended health, short and long term disability, life insurance, car or electronics allowance;
  • Reimbursement of professional fees, dues, professional education expenses; and,
  • Stocks or stock options.
• Include language which makes it clear that the entitlement described in the provision will constitute the entirety of the employee’s entitlement under all applicable legislation and that the Common Law principles of reasonable notice will not apply;
• Without such specificity, the Courts may find that the termination provision is ambiguous and that it should be interpreted against the interests of the employer.  In this case, the Common Law will apply and the Courts will require the employer to compensate the employee for the loss of all benefits and compensation during the contractual or Common Law notice period.

4. Relying on Dated Contracts – Obsolescence

• Courts will often find termination provisions (or whole employment contracts) void where the employee’s position or terms of employment have changed considerably since the original signing of the contract.  Often the rationale of the Courts is that where a restrictive termination provision may have been justified in imposing on a junior employee, a senior employee who has been promoted to a higher level position would normally be entitled to a much longer notice period;
• Changes in position, responsibility, geographic location of employment, or pay essentially dissolve the “substratum” of the Agreement, which should reflect the realities of the employment relationship.  Accordingly, consider including anti-obsolescence language, especially with respect to the most valuable and contentious provisions such as termination provisions and restrictive covenants.

Employment contracts should be updated regularly when hiring new employees, or if an employee’s position or terms of employment change in a material way.  Keep in mind that inserting a termination provision into an already existing contract creates a whole new host of potential issues.  The Courts will not enforce these unless additional conditions are met.  The Ontario Court of Appeal in Braiden v. La-Z-Boy Canada Limited, 2008 ONCA 464, set out what an employer must prove before a Court will enforce a termination provision placed into an already-existing employment contract.  An employer must prove that:

Employers should take advantage of the cost reducing strategy of including termination provisions in employment contracts.  They must be vigilant in ensuring these provisions remain updated and enforceable, otherwise they are unlikely to survive judicial scrutiny.

RESTRICTIVE COVENANTS

Employers often try and rely on restrictive covenants in employment contracts to protect their business interests by restricting an employee’s employment and business activities for a period of time after their employment has ended.  There are various kinds of restrictive covenants, including non-solicitation clauses, non-competition clauses, and confidentiality and non-disclosure clauses.  We know from cases such as RBC v. Merill Lynch,  2008 SCC 54, and KRG Insurance Brokers (Western) Inc. v. Shafron, 2009 SCC 6, that there is a legal presumption that restrictive covenants are contrary to public policy as being in restraint of trade and prima facie void, unless they are shown to be reasonable in the circumstances of the parties and business.  The onus of proving this rests on the employer.  Generally restrictive covenants are only enforceable if they are truly necessary to protect the legitimate business interests of the employer, and if they are drafted in a manner that imposes minimal restrictions and impairments on employees.  Courts are almost always unwilling to enforce the most extreme of these restrictive covenants, non-competition clauses, especially when a less restrictive non-solicitation clause would have been sufficient.

When a restrictive covenant arises in the context of an employment relationship, the Court will apply the following test:

1. Does the employer have a legitimate interest worthy of protection?
2. Does the covenant restrain trade (does it prevent the employee from working)?
3. Are there exceptional circumstances?
4. Is the restriction reasonable between the parties with regard to the extent of the activities that are prohibited and the extent of the temporal and geographic application?
5. Is the restriction reasonable when considering public interests?

See Eagle Professional Resources Inc. v. MacMullin, 2013 ONCA 639, and Mason v. Chem-Trend Limited Partnership, 2011 ONCA 344.

Besides the risk of unenforceability, there are other potential risks and drawbacks of restrictive covenants for an employer.  If a non-competition clause is in fact enforced (or if it simply exists), that can be a factor in extending the reasonable notice period.  In the case of Khan v. Fibre Glass-Evercoat, [2000] O.J. No. 1877, the Court awarded a three year employee an extra five months of notice in consideration of the fact that he had a five year non-competition clause in his contract.  This approach was affirmed in the more recent case of Ostrow v. Abacus Management Corporation Mergers and Acquisitions, 2014 BCSC 938, where an employee with less than one year of service was terminated after having signed a six month non-competition clause.  While the company never attempted to enforce it, the employee Ostrow testified that he believed it to be enforceable.  The Court held that the existence of the non-competition clause increased his period of reasonable notice and awarded it at six months.

The recent case of Rhebergen v. Creston Veterinary Clinic Ltd., 2014 BCCA 97 supports the historical rational behind invalidating non-competition clauses, although the Court of Appeal ultimately upheld the restrictive covenant in this case.  Rhebergen was a veterinarian who had signed an Associate Agreement containing a covenant which required her to pay a fixed amount if she set up a competing practice within three years of leaving the business.  After leaving the clinic she challenged the covenant.  The trial court confirmed that the clause was in fact a non-competition clause, and was unenforceable for various reasons.  The Court found the phrase “sets up a veterinary practice” to be ambiguous, and reiterated that courts cannot “fix” such a clause to make it enforceable.  The clause also imposed an unreasonable restraint on trade which was not justified by any exceptional circumstances, and the temporal application of three years was too long.   In a split decision, The Court of Appeal overturned the decision and found that the clause was in fact reasonable and not ambiguous, allowing the appeal and enforcing the clause.  The Court found that the amount to be paid was not a penalty, rather it was compensation for the costs incurred by the employer in training the associate.  They also felt the clause was unambiguous.  This case shows that courts may be more agreeable to putting a price on competing, especially in cases involving more sophisticated employees, but will still likely strike provisions which restrict it completely.

Lessons to Counsel and Employers: Drafting Restrictive Covenants:

1. Consider whether restrictive covenants are truly necessary to protect an employer’s interests.  Consider realistically what harm the employee can do and aim to prevent that harm.  Keep in mind the aim is to genuinely restrict the employee from competing or soliciting, not working;
2. It is rarely worthwhile to include a non-competition clause in an employment contract. Focus on the non-solicitation clause to protect a business’s interests;
3. The clause should reflect the true nature of the employee’s role and the circumstances of the business, and be no more restrictive than what is necessary;
4. Be reasonable.  Limit non-solicitation clauses to restrict solicitation of customers with whom the employee had contact during their employment.  Restricting contact with potential customers and suppliers will make the covenant harder to enforce;
5. Be specific in drafting and narrow the covenant to make it as least restrictive as possible.  Limit the temporal and geographic scope to what is reasonably necessary to protect the business.  Factors to be considered are the employee’s position, years of service and seniority, the relationship they had with customers, and the degree of customer loyalty in the respective industry;
6. If you have already used non-competition clauses or restrictive covenants and you are concerned about enforceability, when terminating an employee, consider communicating to that employee in the termination letter that they are not bound by the clause in looking for new employment and that it is essentially waived.