Is an employee entitled to incentive compensation as part of their “reasonable notice” damages when terminated from employment? That is often the $1 million (or even $10,000) question.

Background

It is well established at common law that an employee who is terminated without cause is entitled to be provided with reasonable advance notice and, failing that, is entitled to damages in lieu of compensation that would have been received over a “reasonable notice period”.

Notwithstanding this established principle, employer’s often include language in their incentive compensation agreements intended to “oust” the common law by making clear that incentive compensation will not be included in reasonable notice damages so that they do not need to pay out bonuses to dismissed employees.  Over the years, courts across Canada have considered whether various attempts at this language are drafted sufficiently to limit employees’ rights to incentive compensation on termination of employment. However, the court decisions have produced seemingly inconsistent results, leaving employers with the difficult task of drafting contracts without clarity around the legal test they must meet and, in many cases, resulting in employers being required to issue big post-termination incentive pay-outs despite their contractual intention otherwise.

Decision

That’s where the Supreme Court of Canada’s October 9, 2020 decision in Matthews v. Ocean Nutrition[1] comes in, providing a long awaited national framework for the assessment of whether incentive compensation will be included in the calculation of damages in lieu of reasonable notice.

In this case, it was undisputed before the SCC that the employee, Mr. Matthews, had been constructively dismissed from his senior management position with Ocean Nutrition and that he was entitled to damages equal to 15 months’ notice. The main dispute before the SCC was whether Mr. Matthews was entitled to a long term incentive plan (“LTIP”) payout that was triggered by a sale of Ocean Nutrition 13 months after Mr. Matthews’ termination, and therefore within the 15 month notice period. At trial, the Judge had determined Mr. Matthews was entitled to the LTIP payment. However, the Nova Scotia Court of Appeal overturned the trial decision on this point, finding that the LTIP agreement was sufficiently clear to oust Mr. Matthews’ entitlement during the notice period.

The SCC disagreed, and found Mr. Matthews was entitled to damages for his lost LTIP payment, which had previously been calculated at just over $1 million. The issue for the SCC was not, as the Court of Appeal suggested, whether Mr. Matthews was entitled to the LTIP itself, but whether his damages for breach of the employment contract should include an amount to compensate him for the loss of the LTIP entitlement. Framing the issue this way, the SCC held that two questions must be answered in determining whether an employee is entitled to damages for the loss of incentive compensation:

1. Would the employee have been entitled to the bonus or benefit as part of their compensation during the reasonable notice period?

2. If so, do the terms of the employment contract or bonus plan unambiguously take away or limit that common law right?

Following these questions, the SCC held that Mr. Matthews’ had a prima facie right to the LTIP payment since it would have been awarded during his reasonable notice period and he would have been entitled to payment under the LTIP. Notably, previous decisions have suggested that, in order for incentive compensation to be considered as part of the notice period, it must first be demonstrated that the incentive compensation forms an “integral component” of the employee’s compensation. The SCC held that the concept of “integral component” will only be relevant in assessing whether a discretionary incentive would have even been paid over the notice period. In the case of an incentive like the LTIP, where it is established that it would have been paid over the notice period, this analysis is unnecessary and the common law presumes the employee will receive the payment as part of damages in lieu of reasonable notice.

Second, the SCC addressed whether the language of the LTIP agreement addressing termination of employment was sufficient to rebut the prima facie presumption that LTIP would be included in the notice period damages. Specifically, the SCC was asked to consider language in the LTIP agreement providing that Mr. Matthews would not be entitled to an LTIP payment unless on the applicable triggering date he was:

…a full-time employee. For greater certainty, this Agreement shall be of no force and effect if the employee ceases to be an employee of [Ocean Nutrition], regardless of whether the Employee resigns or is terminated, with or without cause.

The LTIP agreement further provided:

The Long Term Value Creation Bonus Plan does not have any current or future value other than on the date of a Realization Event and shall not be calculated as part of the Employee’s compensation for any purpose, including in connection with the Employee’s resignation or in any severance calculation.

In finding that the above language did not preclude Mr. Matthews’ entitlement to reasonable notice damages which include the LTIP payment, the SCC set out the following:

1. For language of an agreement to rebut the common law presumption of entitlement, the language must be “absolutely clear and unambiguous”, at least in circumstances where the employer unilaterally drafts the language.

2. Requiring an employee to be “active” or “full-time” is not sufficiently clear and unambiguous to rebut the common law presumption. Similarly, providing that a limitation on entitlement applies when the employee is terminated “without cause” does not suffice. An employee terminated without cause is presumptively entitled to be compensated as if they remained “active” or “full-time” throughout the notice period.

3. The fact that the agreement specifically stated that LTIP is not to be included in calculating any severance calculation does not preclude Mr. Matthews’s claim as severance is a distinct concept from damages in lieu of reasonable notice.

Lessons for Employers

While, not unexpectedly, the SCC did not provide any example of language that will be sufficiently clear to limit an employee’s common law right to incentive compensation on termination, the SCC’s decision provides notice to Canadian employers that they will be held to a high standard of clarity in their drafting. Further, the decision provides important guidance on the types of language to avoid in drafting and reminds us of the importance of well-drafted termination clauses in employment contracts.

As with any major decision in employment law, employers are well advised to take a close look at their incentive agreements and determine whether changes may be needed. As always, Cox & Palmer’s Employment & Labour teams stands ready to assist with this.

[1] Matthews v. Ocean Nutrition Canada Ltd., 2020 SCC 26