Termination Clauses

The purpose of a termination clause in an employment contract is to rebut the legal presumption that the employee will be provided with reasonable notice of dismissal and replace that entitlement with another notice period that has been agreed to by the parties.¹Machtinger v. HOJ Industries Ltd., 1992 CanLII 102 (SCC); The termination clause will typically provide the employee with either a fixed notice period or a formula for calculating the notice period based on the employee’s years of service. The termination clause will also specify what benefits and variable compensation (in addition to base salary) will be continued during the notice period.

It is now common for employers to insert termination clauses into their employment contracts to reduce their cost of terminating the employment of their employees. Typically, the termination clause will allow the employer to terminate the employee’s employment by providing the employee with a severance package that is significantly less than if the employer was required to provide the employee with reasonable notice of dismissal. That said, a termination clause does have the benefit of providing certainty regarding an employee’s entitlements upon dismissal.

A termination clause will not be enforced by a court unless it provides the employee with at least the minimum statutory entitlements upon dismissal as required by the Ontario Employment Standards Act, 2000 (“ESA”) or, for federally regulated employees, the Canada Labour Code (“CLC”). It is illegal for an employer to provide less than the minimum standards of the ESA or Code, even if the employee has voluntarily agreed to accept a lower amount.

In Ontario, a significant percentage of employment contracts contain termination clauses that will not be enforced by a court because the clauses have not been properly drafted. Given the significant percentage of void termination clauses, employers are advised to have their termination clauses reviewed by an experienced employment lawyer. It can be a costly mistake to have employees sign employment contracts containing termination clauses that have not been properly drafted.

Employees should also not presume that the termination clause in their employment contract is enforceable.

Wrongful dismissal cases often involve disputes as to whether the employee’s entitlement to notice of dismissal is limited to that set out in the termination clause or if the former employee is entitled to significantly greater entitlements because the termination clause has breached the ESA and therefore the employee is entitled to reasonable notice of dismissal.

It is normally to the employee’s benefit if the employment contract does not contain a termination clause. The exception to this general statement would be employees, such as senior executives, who have the power to negotiate termination provisions that provide superior entitlements to that offered by the common law presumption that the employee is entitled to reasonable notice of dismissal.

A termination clause may also not be enforced by a court if it has been inserted into an existing employee’s contract of employment (discussed in detail below) if the employee has not been given fresh consideration in exchange for the revised contractual terms.

An employee whose employer is federally regulated and therefore governed by the CLC may be able to avoid being bound by the provisions of a termination clause by initiating an unjust dismissal complaint under the CLC rather than a civil action before a court. It is well established that a Tribunal appointed pursuant to the CLC is not bound the terms of the termination clause.²Luney v. Day & Ross Inc., 2015 ONSC 1440 at para. 15

The difference in the notice and severance payments available to a dismissed employee who has signed an employment contract that contains a termination clause limiting his or her entitlements to the ESA and what the employee would receive if he or she is entitled to reasonable notice can be substantial. The most extreme example in Ontario of the possible difference between the ESA and reasonable notice would be an individual who is only entitled to 8 weeks’ notice pursuant to the ESA but who would have been entitled to 24 months reasonable notice if not for the termination clause in his or her employment contract.³{[(|fnote_stt|)]}Employers in Ontario with annual payrolls of less than $2.5 million are only required to provide dismissed employees with statutory notice (which is limited to 8 weeks notice if the employee has 8 or more years of service). Employers will payrolls in excess of $2.5 million must also provide an employee with 5 or more years of service with statutory severance pay.  See s.64(1)(b) of the Employment Standards Act, 2000{[(|fnote_end|)]}

Dismissed employees are often devastated when they learn that they are only entitled to weeks of notice pursuant to the ESA, rather than months or years of reasonable notice. It is not unusual for a dismissed employee to have forgotten that he or she signed an employment contract that limits their notice entitlement upon termination to the minimum standards of the ESA.

The key is for an individual reviewing an offer of employment to carefully review and understand the employment contract before accepting the offer. He or she may be in a position to negotiate a better termination provision with their potential employer (or have the termination provision removed entirely from the employment contract) before agreeing to join the company. Another option is to have the employment contract reviewed by an experienced employment lawyer to determine if the termination clause is enforceable. If the individual decides to accept an offer of employment that contains an enforceable termination clause the individual should at least understand what he or she is signing up for.

A Termination Clause that Has the Potential to Violate the ESA is Void

The Supreme Court of Canada held in Machtinger v. HOJ Industries Ltd.⁴Machtinger v. HOJ Industries Ltd., [1992] 1 S.C.R. 986 (“Machtinger“) that if an employment contract contains a termination clause that provides an employee with an entitlement upon termination other than reasonable notice, that entitlement must be at least equal to the employee’s entitlement pursuant to the ESA. If the termination clause provides the employee with less than his or her entitlements pursuant to the ESA, the termination clause will be unenforceable and the court will strike the termination clause from the employment contract and award the employee reasonable notice of dismissal. The court will not rewrite the termination clause to bring it into compliance with the ESA.

In Machtinger, as an example, the termination clause that was found to be void provided the employee with 2 weeks’ notice of dismissal. However, the employee was entitled to a minimum of 4 weeks’ notice pursuant to the legislation in force at that time. The Court held that there is a common law presumption that employees dismissed without cause are entitled to reasonable notice of termination. The presumption will be rebutted if the employment contract clearly specifies some other period of notice.⁵Machtinger v. HOJ Industries Ltd., [1992] 1 S.C.R. 986 at para 20 While specifying another termination notice period, a termination clause cannot contract out of any employment standard under the ESA for the benefit of employees, including minimum notice of termination.⁶Machtinger v. HOJ Industries Ltd., [1992] 1 S.C.R. 986 at para 26 A termination clause that attempts to contract out of the minimum standards of the ESA is void and will not rebut the presumption of reasonable notice of dismissal.

It is well established that courts interpret employment contracts differently from commercial contracts. When interpreting a contract the main focus is to determine the intention of the parties. However, when interpreting a termination clause in an employment contract the first step is to determine if the termination provisions in the contract have the potential to breach the ESA.  The intention of the parties is irrelevant. If the termination provisions have the potential to breach the ESA at some point in the future – the clause is void.

This modification to the traditional approach to interpreting contracts is driven by the policy considerations set out by the Supreme Court of Canada in Machtinger.  The ESA is remedial legislation designed to protect vulnerable employees by establishing minimum employment standards.  The courts recognize that there is a power imbalance between employees and employers and that many employees do not understand their legal rights.  The underlying policy objective is therefore to ensure that employers draft employment contracts that comply with the minimum provisions of the ESA.  When a court reviews a termination clause the focus of the judge is to interpret the clause in a manner that encourages employers to draft employment contracts that comply with the ESA.⁷Wood v. Fred Deeley Imports Ltd., 2017 ONCA 158 at para. 47;

This principle was recently reiterated by the Ontario Court of Appeal in Waksdale v. Swegon North America Inc.⁸Waksdale v. Swegon North America Inc., 2020 ONCA 391 where the court ruled at para. 10:

An employment agreement must be interpreted as a whole and not on a piecemeal basis. The correct analytical approach is to determine whether the termination provisions in an employment agreement read as a whole violate the ESA. Recognizing the power imbalance between employees and employers, as well as the remedial protections offered by the ESA, courts should focus on whether the employer has, in restricting an employee’s common law rights on termination, violated the employee’s ESA rights. While courts will permit an employer to enforce a rights-restricting contract, they will not enforce termination provisions that are in whole or in part illegal.

Further, the employer will not be able to rely on a severability clause in the employment contract to strike a void termination clause or a void part of that clause. If a termination clause is void there is nothing to which a severability clause can be applied.  The severability clause is not void, but it is inoperative where the agreement contracts out of or waives an employment standard;⁹North v. Metaswitch Networks Corporation, 2017 ONCA 790 at paras 41-46 As noted by the Court of Appeal in Waksdale at para. 44,

A severability clause cannot have any effect on clauses of a contract that have been made void by statute.

The above notions are not novel and the Ontario Court of Appeal as well as the Supreme Court of Canada have repeatedly reiterated this approach in prior years. The rationale for this approach was laid out by Iacobucci J. in Machtinger as follows:

• the terms of the employment contract rarely result from an exercise of free bargaining power. Individual employees on the whole lack both the bargaining power and the information necessary to achieve more favourable contract provisions than those offered by the employer, particularly with regard to tenure;¹⁰Machtinger v. HOJ Industries Ltd., [1992] 1 S.C.R. 986 at para 31
• the ESA is remedial legislation, intended to protect the interests of employees. The objective of the ESA is to protect the interests of employees by requiring employers to comply with certain minimum standards, including minimum periods of notice of termination;¹¹Machtinger v. HOJ Industries Ltd., [1992] 1 S.C.R. 986 at para 31 
• many employees are likely unfamiliar with the employment standards in the ESA and the obligations the statute imposes on employers. These employees may not seek to challenge unlawful termination clauses;¹²Machtinger v. HOJ Industries Ltd., [1992] 1 S.C.R. 986 at para 33
• if a contractual term is null and void, then it is null and void for all purposes, and cannot be used as evidence of the parties’ intention. If the intention of the parties is to make an unlawful contract, no lawful contractual term can be derived from their intention;¹³Machtinger v. HOJ Industries Ltd., [1992] 1 S.C.R. 986 at para 28
• an interpretation of the ESA which encourages employers to comply with the minimum requirements of the ESA, and so extends its protections to as many employees as possible, is to be favoured over one that does not;¹⁴Machtinger v. HOJ Industries Ltd., [1992] 1 S.C.R. 986 at para 32
• termination clauses should be interpreted in a way that encourages employers to draft agreements that comply with the ESA. If the only consequence employers suffer for drafting a termination clause that fails to comply with the ESA is an order that they comply, then they will have little or no incentive to draft a lawful termination clause at the beginning of the employment relationship;¹⁵Machtinger v. HOJ Industries Ltd., [1992] 1 S.C.R. 986 at para 32-33 and
• one of the purposes of the ESA is to ensure that employees who are discharged are discharged fairly. If an employer has attempted, whether deliberately or not, to frustrate the intention of the legislature, it would indeed be perverse to allow the employer to avail itself of legislative provisions intended to protect employees, so as to deny the employees their common law right to reasonable notice.¹⁶Machtinger v. HOJ Industries Ltd., [1992] 1 S.C.R. 986 at para 36

The Ontario Court of Appeal continued building on the legal principles set out in Machtinger, including the following:

• the question of the enforceability of a termination clause turns on the wording of the clause, the purpose and language of the ESA, and the jurisprudence on interpreting employment agreements;¹⁷Wood v. Fred Deeley Imports Ltd., 2017 ONCA 158 at para 25
• faced with a termination clause that could reasonably be interpreted in more than one way, courts should prefer the interpretation that gives the greater benefit to the employee;¹⁸Wood v. Fred Deeley Imports Ltd., 2017 ONCA 158 at para 28
• if a termination provision’s application potentially violates the ESA at any date after hiring, it is void;¹⁹Coveanoho v. Pendylum Ltd., 2017 ONCA 284 at para 72 and
• it is not possible to simply void the part of a termination clause that offends the ESA. If a termination clause purports to contract out of an employment standard without clearly substituting a greater benefit in its place, the entire termination clause is void.²⁰Andros v. Colliers Macaulay Nicolls Inc., 2019 ONCA 679 at para 20

Limiting Bonus and Stock Option Entitlements During the Notice Period

It is common for employers to attempt limit an employee’s right to continue to collect specific benefits or incentive compensation once the employee has been terminated from his or her employment.  In other words, the employer may take the position that the employee is entitled to his or her base salary during the reasonable notice period but is not entitled to continue to collect his or her bonus, stock options or employer pension contributions.

A court will only limit an employee’s entitlement to the continuation of these benefits if the employee’s employment contract (which can include an employee’s policies) contains clear and unambiguous language to the contrary.

Wrongful dismissal litigation involving disputes over entitlements to bonuses, stock options and other forms of variable compensation generally focuses on the specific language used in the employment contract or the stock option or bonus plan.

Language in a plan referring to the termination of the employee’s employment will be presumed to be referring to a termination in accordance with the law (in other words, that the employee is entitled to be given working notice of dismissal). The agreement should not be presumed to provide for an unlawful trigger event (such as dismissal without working notice) absent clear language to the contrary.²¹Veer v. Dover Corporation (Canada), 1999 CanLII 3008 (ONCA) at para. 14;

This was reiterated by the Ontario Court of Appeal in 2016 in Paquette v. TeraGo Networks Inc.²²Paquette v. TeraGo Networks Inc., 2016 ONCA 618 at paras 45 and 46; that found that a term in a bonus policy that requires that the employee be actively employed when the bonus is paid, without more, is not sufficient to deprive an employee terminated without reasonable notice of a claim for compensation for the bonus he or she would have received during the notice period, as part of his or her wrongful dismissal damages.

If the employer relies upon a corporate policy, it must prove that the policy actually forms part of the employee’s employment contract. The language of the policy must unambiguously alter or remove the employee’s common law rights.

Any attempt to limit an employee’s entitlement to specific benefits or variable compensation must also be compliant with the minimum notice and severance provisions of the ESA.

If the variable compensation plan is ambiguous about whether the employee is entitled to the variable compensation during the reasonable notice period, then the employee will be entitled to the variable compensation if the variable compensation would have been paid during the reasonable notice period.²⁵

If a plan states that payment of variable compensation is discretionary the employer must use its discretion in a fair and reasonable manner²³Chann v. RBC Dominion Securities Inc., 2004 CanLII 66310 (ON SC)

Leading Ontario decisions that have considered the issue of stock options, restricted stock units and bonus entitlements upon dismissal include: Veer v. Dover Corporation (Canada);²⁴Veer v. Dover Corporation (Canada), 1999 CanLII 3008 (ONCA) at para. 14Kieran v. Ingram Micro Inc²⁵Kieran v. Ingram Micro Inc., 2004 CanLII 4852 (ON CA) at paras. 56 -61;Love v. Acuity Investment Management Inc.²⁶Love v. Acuity Investment Management Inc., 2011 ONCA 130;;Paquette v. TeraGo Networks Inc²⁷Paquette v. TeraGo Networks Inc., 2016 ONCA 618;Lin v. Ontario Teachers’ Pension Plan²⁸Lin v. Ontario Teachers’ Pension Plan, 2016 ONCA 619; and Rossman v. Canadian Solar Inc.²⁹Rossman v. Canadian Solar Inc., 2019 ONCA 992;

Notice Periods Set Out in Termination Clauses Are Not Subject to the Duty to Mitigate

The Ontario Court of Appeal confirmed in its 2012 decision Bowes v. Goss Power Products Ltd.³⁰Bowes v Goss Power Products Ltd., 2012 ONCA 425; that an employment contract that contains a termination provision that provides the dismissed with a specified amount, whether fixed or readily calculable, is not subject to the duty to mitigate if the employment contract is silent with respect to mitigation. This statement of law applies to contracts that specify payment of a lump sum or payment by way of salary continuance.

Employers who desire to require former employees to mitigate their damages and thereby potentially reduce the amount to which employees are entitled upon dismissal must ensure that the employment agreement expressly states that the termination entitlement is subject to the duty to mitigate. A major problem faced by employers whose current employment contracts contain termination clauses silent on the subject of mitigation is that they cannot simply have their current employees sign new employment contracts containing a revised termination clause. A court is unlikely to enforce the new termination provision because the revised employment contract will lack the necessary consideration to form a legally binding contract.

Inserting a Termination Clause into an Existing Employee’s Employment Contract

The courts will not enforce a termination clause inserted into an existing employment contract unless certain conditions are met.

The Ontario Court of Appeal set out what an employer must prove before a court will enforce a termination provision placed into an existing employment contract in Braiden v. La-Z-Boy Canada Limited³¹Braiden v. La-Z-Boy Canada Limited, 2008 ONCA 464 at para. 61. At a minimum an employer must establish that:

1. it clearly communicated the change in the employment contract to the employee;
2. the employee was aware that they were giving up their legal right to reasonable notice of dismissal; and
3. consideration flowed to the employee in exchange for forfeiting that right.

If the employer does not prove these required elements it is likely that a court will not enforce the termination clause and the employee will be awarded reasonable notice of dismissal.

It is well-settled that a promise to perform an existing contract is not consideration. Fresh consideration, such as pay increase, is required to support the change to the terms of employment.

Employers in Ontario rarely comply with the requirements of the La-Z-Boy test when inserting termination clauses into existing employees’ contract of employment. This oversight the potential of being a very costly mistake.

The La-Z-Boy test has yet to be considered by a lower court. Some have argued that the La-Z-Boy test will not be binding on a lower court because it is only “obiter“. However, the better view is that the La-Z-Boy test is the type of obiter dicta that, as discussed by the Court of Appeal in R. v. Hajivasilis³²R. v. Hajivasilis, 2013 ONCA 27 at para. 20, will be binding on a lower court.

The Need for Fresh Consideration

A contract is an exchange of promises and/or acts, as a result of which each party to the contract receives something from the other. Consideration refers to the exchange of something of value between the parties. For a contract to be binding, consideration must flow between the parties. Absent consideration, there is no contract.

The courts have repeatedly held that a new notice provision in an employment contract is a significant change to the terms of employment. As a result, new consideration is required to support that change.

As noted by the Court in La-Z-Boy at para. 49:

The requirement of consideration to support a change to the terms of an agreement is especially important in the employment context where, generally, there is inequality of bargaining power be-tween employees and employers. Some employees may enjoy a measure of bargaining power when negotiating the terms of prospective employment but once they have been hired and are dependent on the remuneration of the job, they become more vulnerable.

Continued employment will not be viewed by the courts as consideration except in exceptional circumstances. This is because a promise to do something that a party to a contract is already bound to do is not consideration.  In Hobbs v. TDI Canada Ltd.³³Hobbs v. TDI Canada Ltd. (2004), 246 D.L.R. (4th) 43 (C.A.);  Juriansz J.A, writing for the Ontario Court of Appeal, explained at para. 32 the reason why a court will normally not consider continued employment to be consideration:

…the law does not permit employers to present employees with changed terms of employment, threaten to fire them if they do not agree to them, and then rely on the continued employment relations as the consideration for the new terms.

Therefore, if an employer is intent on inserting a termination clause into an employee’s employment contract it must do so at a time when it will be supported by consideration such as a promotion, bonus or significant pay raise.

However, as stated above, fresh consideration is not sufficient to support the insertion of a binding termination clause into an employment contract. It is common for employers and lawyers to overlooked the requirement that the employer must also be able to demonstrate that the employee knew that he or she was giving up the right to reasonable notice at the time the new employment contract was signed. This could be done by presenting the employee with a letter that clearly set out the employee’s entitlement to reasonable notice and the impact of the resulting change or by ensuring that the employee received independent legal advice prior to executing the new employment contract.

If you want legal advice that is specific for your case, book a consultation today.

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