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Strategies to reduce severance obligations

By Daniel Chodos

Canadian companies express grave concerns about the enormous expense of terminating employees. These complaints are understandable: long-term workers are typically awarded substantial “reasonable notice periods” by the courts, and even short-service employees may become entitled to surprisingly generous severance obligations in some circumstances.

The resulting cost to companies looking to reduce their workforce can be astronomical.

This concern is particularly pressing in the wake of the Ontario government’s new legislation, which seeks to increase minimum wage by approximately 30 per cent – a policy that has led observers to predict the elimination of some 50,000 jobs in the province.

Unfortunately, smaller businesses are often the least knowledgeable about their severance-related obligations. Because the courts rarely differentiate between businesses based on their size and resources, the companies that suffer the brunt of Canada’s relatively generous severance obligations are often those that can least afford it.

However, there is hope. While the cost of staff reductions might seem daunting, companies frequently forget that there are ways to minimize these obligations – in some cases, rather substantially.

Termination provisions

First of all, employment agreements with enforceable termination provisions are a must-have for companies seeking to reduce their severance costs. The purpose of a termination provision is to replace an employee’s far greater “common law” entitlement with a lesser contractual amount – which can be as little as the minimum payment required by employment standards legislation. Although these provisions will not completely eliminate the cost of terminating most employees, they can nevertheless reduce severance payouts to a small fraction of what would otherwise be owing.

For example, whereas a 65-year-old employee with 10 years’ service in a small company might be entitled to 10 to 15 months of “reasonable notice” under the common law, that same employee could receive as little as eight weeks pay in lieu of notice under a well-drafted termination provision.

Even more significantly, an employee who is terminated shortly after being lured away from a secure, long-term job might be entitled to months or even years worth of severance under the common law. That same employee could be entitled to only a few weeks of notice – or even less – by executing a contract with a well-drafted termination provision.

The cost savings on that one employee could constitute a six-figure credit on the balance sheet.

Employers concerned that these clauses are not fair to the worker or that they will make it difficult to attract good candidates should bear in mind that there is no one-size-fits-all approach to termination provisions.

While some companies offer only the employment standards baseline in their contracts, this is not the only option. There is a vast middle ground between the bare minimum and the common law maximum. Contracts can be drafted to provide for an appropriate severance arrangement that balances the employer’s need to reduce its financial exposure with the employee’s desire for a “buffer” between jobs.

The key for many companies is not necessarily reducing their severance obligations to the lowest possible figure, but rather creating certainty as to their potential liabilities, thereby decreasing risk and legal costs.

Structuring severance arrangements

Many companies mistakenly assume that severance packages must be presented in a lump sum form. Barring a contractual promise to the contrary, many employers offer a more limited salary continuation, which ends if the employee finds work elsewhere. The idea is to avoid paying unnecessary windfalls to employees who might “mitigate” their legal claims by quickly reemploying elsewhere.

Moreover, businesses may not be aware that they have the right to provide for “working notice” in lieu of severance payouts. As the name suggests, this sort of arrangement requires an employee to continue working for the company during their notice period – instead of receiving a series of cheques without providing any value whatsoever. Working notice is absolutely permissible, provided that certain minimum statutory entitlements are otherwise paid out, the work is essentially unchanged in all fundamental respects, and the employee is given a reasonable opportunity to engage in their job search.

Aside from the additional production this arrangement may provide for, there are two additional monetary advantages to this approach. First, when employees resign during a period of working notice, they are either completely disentitled from receiving any further payments from the company, or limited to only a certain maximum amount.

Secondly, because many employees would prefer to receive payments in lieu of working notice, they will often hire lawyers to contact the company in the hopes of negotiating a discounted severance payment as a substitute for being require to “work out” their notice period.

In the right circumstances, this strategy can result in significant cost savings.

The impact of bonus plans

The other big question that arises in the context of employee dismissals is the treatment of bonuses upon termination. The rule of thumb is that an employee must be “made whole” during their period of reasonable notice. That means if an employee typically earns a bonus from year to year, that employee has two specific bonus entitlements upon termination:

a) A payment for the portion of the fiscal year in which they actually worked; and

b) A payment during the period of reasonable notice itself.

The financial consequences of these rules can be enormous. In fact, particularly where bonuses are an integral aspect of the remuneration structure, bonus payments may even outstrip the remainder of an employee’s severance-related entitlements.

To counter the significant financial risk associated with this default legal rule, businesses are well-advised to put in place carefully drafted bonus plans – or better yet, consider putting language right into employment agreements regarding the treatment of bonuses on termination.

By using the right language and properly implementing it, an employer may be able to ensure that employees will only be allowed to receive bonuses when they are actively employed on the day a bonus is paid out – thus avoiding the usual bonus payouts required on termination. To accomplish this objective, the bonus language must be very specific; among other things, it cannot violate employment standards legislation and it must define exactly what constitutes “active employment” for the purposes of the clause.

The issue of bonuses has become a hot-button topic for the courts over the past couple of years, so a qualified employment lawyer should be consulted to ensure the right wording is used in a bonus plan or employment contract.

By implementing these strategies, human resource specialists may become local heroes within the management structure of their organizations.

Daniel Chodos is a partner at Whitten & Lublin Employment Lawyers.

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