Court of Appeal Comments on Rights to Severance Pay Following a Sale of Business

The Ontario Court of Appeal recently explored whether an employee’s statutory right to severance pay can be eliminated through the use of a full and final release signed during a share sale.

What Happened?

The employee in question was hired in 1980 by his original employer. The original employer was eventually purchased by a successor employer for $45 million in 2008. The employee received more than $17 million for his one-third share of the company.

The Share Purchase Agreement (the “SPA”) which governed this transaction stipulated that no “Key Employee” (a term that included the employee) had provided their notice of “an intention to cease being employed with the [c]orporation” and that “the [c]orporation does not currently intend to terminate the employment of any officer, Key Employee, or group of Key Employees”.

A release (the “Release”) in favour of the original employer and its successors was executed at the same time as the SPA and provided that the employee released the original employer and its successors from any claims.

Relevant Employment Agreements

2008 Agreement

The employee signed an Executive Employment Agreement in 2008 (the “2008 Agreement”) indicating that his employment would continue following the share sale. Among other things, the 2008 Agreement stipulated that:

  • the employee was to be employed as General Manager with a base salary of $250,000, and annual bonuses of $200,000 for the first three years;
  • the employee agreed to work for the original employer for a minimum of three years;
  • the agreement would be for an indefinite period of time, unless terminated;
  • the original employer could terminate the employee’s employment at any time, without cause, with written notice;
  • if the employee was terminated without cause on written notice, he would be entitled to 12 months of annual base salary, including Employment Standards Act, 2000 (ESA) entitlement, as well as defined “basic payments” and continued protection under group insurance benefits for 12 months; and,
  • the terms of the 2008 Agreement replaced and superseded all terms in previous agreements and the employee released any and all “claims” related to previous agreements.

The 2008 Agreement also included restrictive covenants.

2011 Agreement

An Executive Employment Agreement signed in 2011 (the “2011 Agreement”) was virtually identical to the 2008 Agreement, except that it:

  • purported to create a fixed-term contract (taking effect August 6, 2011 and terminating August 6, 2014 unless earlier terminated);
  • reduced the employee’s base salary and bonuses;
  • reduced the amount payable after termination without cause to 6 months of annual base salary inclusive of ESA entitlements, along with basic payments and continued protection under group insurance benefits for 6 months; and,
  • included a clause requiring the successor employer to advise the employee, in writing, at least 6 months before August 6, 2014 if the successor employer intended not to renew the agreement.

The 2011 Agreement continued to permit termination without cause, so long as notice was provided.

2014 Agreement

A new Executive Employment Agreement was signed in August 2014 (the “2014 Agreement”). Some key changes included:

  • a 2-year fixed term, subject to early termination; and,
  • a reduction in annual base salary to $185,000, and reduction in annual bonus to $46,250;

The 2014 Agreement continued to require notice of intent not to renew the agreement, in writing, but the notice was reduced to 3 months. Early termination on a without-cause basis continued to be permitted and, in such an instance, the employee would receive 6 months of annual base salary inclusive of ESA requirements, along with basic payments and continued protection under group insurance benefits for 6 months.

The Termination

In 2015, the successor employer was acquired by another company (second successor company) in an asset sale and the employee’s employment contract was assigned to the second successor company.  Six months later, the second successor company terminated the employee with one week’s working notice.

In accordance to the terms of the 2014 Agreement, the employee was offered six months’ salary and continuation of benefits for 6 months. At the time of the termination, the employee was 58 years old.

Wrongful Dismissal Application and Alleged Breach of Restrictive Covenants

The employee filed a wrongful dismissal application seeking 24 to 30 months’ pay in lieu of notice on the basis that he had 35 years of continuous employment with the original company, successor company, and second successor company.

The second successor company argued that the employee’s entitlement to compensation was limited by the terms of the 2014 Agreement.

Within 2 months of his termination, the employee obtained employment at a direct competitor of the second successor company, and subsequently became president of and purchased that company.  The second successor company counterclaimed against the employee based on an alleged breach of the restrictive covenants in the 2014 Agreement and his alleged breach of fiduciary duty. The second successor company invoked its right under the 2014 Agreement to suspend or terminate the remaining payments and benefits protection and refused to pay the employee under the termination clause.

Original Decision

The original matter proceeded via summary judgment motion. The judge found that the SPA and the Release released the second successor company from all claims related to the employee’s employment prior to the 2008 sale. Moreover, the 2008 Agreement, 2011 Agreement, and 2014 Agreement constituted a series of fixed-term contracts rather than a period a continuous employment. As such, the employee’s right to termination and severance pay under the ESA was limited to employment from 2008 onwards. Since the termination clause in the 2014 Agreement exceeded the minimum notice requirements under the ESA, it was held to be enforceable.

The employee appealed.

The Appeal Decision

The Court of Appeal concluded that:

  • the employee’s ESA entitlements could not be waived;
  • the termination clause was invalid and unenforceable; and,
  • the employee had been employed on an indefinite basis.

ESA Entitlements Could Not Be Waived

The employee argued that:

  • 9 of the ESA provides for continuity of accrued service in the event that an employer sells a business and the purchaser of that business then employs an employee of the seller. On this basis, the employee’s employment continued without interruption following the sale of the original employer in 2008, and the second successor employer was required to include his pre-2008 years of service when calculating his ESA entitlements;
  • 5(1) of the ESA invalidates any provision that seeks to contract out of ESA entitlements, and that the exception in s. 5(2) did not apply in this case; and,
  • 65 of the ESA prohibits setoff of an employee’s statutory entitlement to be paid severance pay, except in limited circumstances, none of which were applicable in this case. In any event, there was no evidence that the Release was ever intended to be a waiver. The evidence presented established that the Release related to the sale of the employee’s shares rather than the termination of his employment, and that the 2008 Agreement contemplated indefinite employment.

In contrast, the second successor employer argued that:

  • the employee waived his pre-2008 common law and statutory termination entitlements by signing the Release in exchange for substantial consideration as part of the SPA; and,
  • the Release was an all-encompassing settlement agreement which the parties had been free to enter into in the context of a share sale.

The Court of Appeal concluded that the second successor employer’s position must be rejected, noting that:

Regardless of whether the Release is a stand-alone agreement or part of a “package deal”, it must comply with the ESA. The relevant provisions of the ESA are neither ambiguous nor vague. Section 9(1) is mandatory: employment is deemed not to have been terminated or severed by the sale of the employer’s business in whole or in part, and employment with the seller is deemed to be employment with the purchaser for the purpose of calculating the employee’s length or period of employment. Moreover, s. 5(1) prohibits contracting out of or waiving any statutory obligations and voids any agreement purporting to do so.

In short, the ESA is designed to preclude the very thing that AIM argues occurred in this case. There could be no valid waiver of the appellant’s ESA entitlements.

The employee’s pre-2008 service could not be waived or released for the purposes of calculating his ESA entitlements, and the second successor employer was required to count this service in calculating his ESA entitlements upon termination.

The Termination Clause was Invalid and Unenforceable

The motion judge held that the termination provision of the 2014 Agreement would violate the ESA only if the employee had not released his pre-August 2008 service. Since this service could not be waived, it followed that the termination provision (which limited the employee to six months’ notice) violated the ESA because it provided a lesser benefit than the 34 weeks’ termination and severance to which he was entitled to under the ESA.

The Court of Appeal concluded that the termination provision in the 2014 Agreement, which sought to limit the employee’s entitlement to six months’ salary and benefits, was void.

The Employee was Employed on an Indefinite Basis

The Court of Appeal noted that the motion judge erred in law by failing to consider all relevant factors in concluding that the employee was employed for a fixed term rather than indefinite basis. There was significant evidence indicating that, despite the fixed-term language in the 2011 and 2014 Agreements, the employee was employed on an indefinite basis.

The Court noted:

Plainly, the 2008 Agreement contemplated indefinite employment.  But so too did the 2011 and 2014 Agreements: despite their fixed terms, both agreements specifically required the employer to provide written notice if it intended not to renew or continue the agreements. The 2011 Agreement included recitals specifically recognizing the appellant’s continued employment, and in particular stated that the parties desired to enter into the agreement “for the continuation of the employment of the [appellant]”. The 2014 Agreement recognized the appellant’s current employment.

While the motion judge had acknowledged the renewal notice provision, he failed to analyze its effect.

Employers should not be able to evade the traditional protections of the ESA and the common law by resorting to the label of ‘fixed term contract’ when the underlying reality of the employment relationship is something quite different, namely, continuous service by the employee for many years coupled with verbal representations and conduct on the part of the employer that clearly signal an indefinite term relationship.

The Court noted that this was, in essence, what had happened in this case, and concluded that the employee had been employed for an indefinite term from 2008 onwards and was therefore entitled to common law notice for the period of August 2008 to September 2015.

What Amount of Notice Was Appropriate?

The Court concluded that the reasonable notice period in this case was seven months, given the fact that the employee was 58 years old when he was terminated, had held a senior position, and had managed to obtain similar employment in a short window of time following his termination. The seven months’ pay in lieu of notice was to be reduced by all amounts received in mitigation of loss during the notice period (i.e. the payments he received from his new employer).

The employee was found to be entitled to the maximum termination and severance pay permitted under the ESA (i.e. 8 weeks’ termination and 26 weeks’ severance pay). An employee’s ESA entitlements, including the value of unpaid benefits, would normally be deducted from common law damages; however, in this case, the employee’s ESA entitlements exceeded his common law damages.

As such, the court concluded that the employee was only entitled only to his ESA termination and severance pay, in addition to any amounts owing in respect of unpaid benefits.

The employment law team at Duncan, Linton LLP regularly advises employees of their rights and obligations following a dismissal or termination. We provide employees with timely advice and practical guidance on all issues of employment law. We also help employers in preparing for dismissals or termination in order to minimize risk and ensure that the legal obligations owed to an employee are being met. To make an appointment with one of our lawyers, please contact us online, or call 519-886-3340.