Minimizing Exposure To Termination Pay

The COVID-19 pandemic has forced many employers to downsize their workforce through dismissals without cause (i.e., as opposed to a dismissal with cause, arising from an employee’s misconduct). Such employers are required to provide their dismissed employees with advance notice of the pending dismissal (called “working notice”) or, more commonly, pay the employee in lieu of advance notice. 

What are the termination pay requirements?

The required amount of pay in lieu of notice (called “termination pay”) will be determined by three sources:

1. The Employment Standards Act, 2000 
2. The common law; and/or,
3. The employee’s written employment agreement. 

The Employment Standards Act, 2000 (the “ESA”) is known as “minimum standards legislation” and, as the name implies, it establishes the minimum amount of working notice (or pay in lieu of notice) that an employer must provide when dismissing an employee without cause. Employee entitlements under the ESA are roughly equal to one (1) week of notice (or pay in lieu) per full year of service up to a maximum of eight (8) weeks. The Ontario Government offers a detailed explanation of ESA termination pay.

What is pay in lieu of reasonable notice?

There is a common and costly misconception among employers that they will satisfy their legal obligations by paying ESA termination pay upon dismissing an employee without cause. The error arises from the assumption that the ESA establishes an employee’s default entitlement upon termination. In reality, employees have greater entitlements upon termination unless the employer expressly limits termination pay to the ESA entitlement via a written employment agreement. 

In the absence of express written language, an employee is entitled to “reasonable notice of termination” (or pay in lieu of reasonable notice) at common law. Reasonable notice is not based on a specific mathematical formula like ESA notice and is instead an estimate of the time that it will take the terminated employee to find comparable alternative employment with reasonable effort. Reasonable notice is specific to each employee and will consider things like:

• Length of service
• Age
• Seniority of the role
• Skillset 
• Disabilities
• The current job market 

What is approximate length of reasonable notice?

Some employment lawyers will refer to a “rule of thumb” that reasonable notice is approximately equal to one month per year of service up to a maximum of 24 months. This rule is roughly supported by evidence, although there is significant individual deviation. For example, a 24-year-old worker with basic transferable skills in a strong job market is likely to receive less than one month per year of service, while a 68-year-old executive in a poor job market might receive more than one month per year of service, due to poor prospect of finding comparable work without a lengthy and difficult job search. 

Consider this Case study 

The most important takeaway is this: Common law reasonable notice tends to be significantly more than ESA notice and it is the default entitlement for employees upon dismissal. 

Consider the following example to see how this misconception can cost employers:

ABC Inc. employs John Doe for 10 years in a mid-level position. John is 50 years-old, earns $50,000 per year, and has no written employment contract. Due to declining business during a recession, ABC Inc. feels compelled to cut costs by eliminating John’s position. Management conducts due diligence by reviewing the Ontario Government’s website regarding termination pay and determines that he is entitled to eight weeks’ notice under the ESA. Like most employers, ABC Inc. does not want John to continue working after informing him of his dismissal and opts to pay him in lieu of working notice. Management calculates the cost of the dismissal as $7,692.31 (8 weeks’ gross wages), which is a significant payment in the current business environment, but it is deemed necessary for the long-term survival of the company. John is informed of his dismissal without cause and paid eight weeks’ wages in lieu of notice. A week later, ABC Inc.’s management is surprised to receive a letter from John’s lawyer demanding an additional $33,000.00 for eight months’ pay in lieu of common law reasonable notice. ABC Inc. consults their own lawyer who confirms that their exposure is indeed much higher than originally understood. ABC Inc. ends up paying $25,000.00 to settle the matter, which was not budgeted and is disruptive to the already struggling company. 

The lawyers at SV Law have witnessed variations of the example above on hundreds of occasions over the years. Employers will often express anger with the confusing state of employment law in Ontario and, after getting over their initial frustration, they frequently ask “how do I prevent this from happening again?” The answer is relatively simple: Hire employees with a written employment agreement that specifically limits their entitlement upon dismissal to the minimum notice period prescribed by the ESA. Such contracts need to be carefully drafted to be enforceable, but it is not an overly-complicated task for an employment lawyer.

Professionally Draft Employment Contracts

Although there is some expense associated with retaining a lawyer to draft contracts, the cost will be recouped several times over if a dismissal is ever required. In the example above, the employer would have saved $25,000.00 if the employee had been hired with a properly drafted contract. These hypothetical savings are significant, and they are associated with just one dismissal of a mid-level employee. 

Failure to limit exposure upon termination can even instigate a chain reaction that leads to the collapse of a company; for example, where reduced revenue necessitates dismissals which can result in termination pay obligations that are so significant that other financial obligations cannot be met.

Conclusion

Terminating employees can be costly to employers, but it does not have to be. Long-term thinking supports short-term investment in properly drafted employment contracts. 

If you require assistance with your employment contracts, please reach out to a member of the Employment Law team at SV Law.