When the employment relationship comes to an end, severance pay is front and centre. It’s designed to bridge an employee to her next job and “keep the employee whole” during the job search.
But many factors should be considered to determine the amount of severance pay an employee will receive. Each province and territory has legislation that addresses minimum standards for workers within their jurisdiction. The federal government also has similar legislation that applies to federally regulated workers. The legislation outlines the minimum obligation for severance and termination pay.
Under the employment standards legislation in Ontario, British Columbia and Alberta, employees must receive a minimum of one to eight weeks’ notice of termination or termination pay, depending on length of service.
The length of service required to trigger each additional week of termination pay varies. In some provinces, employees must have worked for at least three months in order to receive any notice or termination pay.
Employers should also be mindful that legislation may provide additional entitlements to employees upon termination.
Under Ontario’s minimum standards, employees with more than five years’ total service will be entitled to an additional severance of up to 26 weeks’ regular wages (one week per year) if the employer has an Ontario payroll exceeding $2.5 million.
The minimum severance obligations for federally regulated workplaces are set out in the Canada Labour Code. Federal employees must be provided two weeks’ notice of termination or equivalent termination pay.
These employees must also be paid additional severance, calculated as the greater of five days’ regular wages and two days’ regular wages per completed year of continuous service.
In all jurisdictions, statutory termination pay is calculated using the employee’s regular wages, which can include salary and regular bonuses. But it is important to remember the statutory requirements are rarely the end of the employer’s obligation.
Employees often have a common law entitlement to reasonable notice.
If not otherwise agreed, the courts require employers to provide a dismissed employee with reasonable notice of dismissal, which includes the minimum obligations under provincial or federal legislation. Calculating the notice period should be the starting point for assessing the extent of the severance pay obligation.
The notice period is intended to cover the period of a reasonable job search, enabling the employee to transition to new employment post-termination. Notice periods can range from a few weeks to more than two years — there is no rule of thumb.
The assessment of what is reasonable is determined on a case-by-case basis with reference to a non-exhaustive list of factors that includes:
Age: An aging employee may experience challenges that affect his ease of re-employment.
Length of service: A long-term employee will be rewarded for her service with an extended notice period.
Nature and seniority of position: An employee may have a rare skill set or occupy a senior position, resulting in fewer
opportunities to pursue.
Other relevant factors: These will likely affect the person’s ability to find other work, such as compensation, the extent of his education or the transferability of his skill set.
What must be included in severance pay?
The period of reasonable notice forms the basis of the severance package. Once it is determined, with the assistance of a lawyer, an employer must determine what to include in the severance package.
Employers should start with the question: “What would the employee have received as compensation under the employment contract had she continued to work during the notice period?”
Employees must consider whether the following items will be included.
Salary: All salary payments that would otherwise have been paid to the former employee must be paid.
Group benefits: Employees must be compensated for the loss of medical and dental benefits, which can take the form of benefits continuance (if the insurance contract permits), payment of the employer’s share of the cost of benefits or the cost to the employee of replacement benefits.
Bonus payments: Any bonus payments that are integral to the employee’s compensation or form a part of the employment agreement must be included in the severance package if it would otherwise have been earned during the notice period.
Commissions: All commissions that would probably have been earned by the employee during the notice period must be included as part of the employee’s compensation.
Stock options/equity compensation: Depending on the language contained in the governing plan documents, employees may also be entitled to compensation for the granting and vesting of stock units and options that would have occurred throughout the notice period.
Pension plan contributions: Employees are entitled to the value of continued registered retirement savings plan (RRSP) contributions for the duration of their notice period, as well as the value of pension benefits that would have accrued during that time, unless clear and unequivocal language exists in the insurance contract that expressly removes that obligation.
Other fringe benefits: Other forms of compensation, such as car allowances and club memberships, may also be necessary to include in the severance package, provided these types of benefits were not strictly tied to business-related activity.
Employers and employees can agree on the amount of severance pay owed at dismissal in a written employment contract. If properly drafted, the contract can even limit an employee’s severance entitlement to the minimum requirements provided in the applicable employment standards legislation.
The contract must, however, be properly binding and enforceable. An employment agreement that is signed after employment begins, for instance, will not be reliable to set the entitlement unless some other new benefit was provided to the employee in exchange for signing the contract.
If the severance clause is clear, unambiguous and satisfies at least the employee’s minimum entitlement under employment standards legislation, the employment contract will prevail.
If the clause is unclear or provides for less than the minimum entitlement owed under legislation (presently or at some future point), the courts will not enforce it. In such cases, severance pay would default back to the employee’s common law entitlement.
Setting the severance obligations in a contract gives each side an opportunity to agree on a reasonable severance amount ahead of time while setting up the employment relationship. Putting the severance terms in a contract also provides certainty of entitlement and facilitates a smooth departure for the dismissed worker.
A well-written contract will also minimize the potential for dispute following the dismissal.
Tips for employers
What HR needs to know
• Calculating severance obligations is a case-by-case exercise based on a number of factors — one size does not fit all.
• Unless the employment contract says otherwise, employees are often entitled to receive more than the minimum legislated standards as severance pay.
• Severance pay must include compensation for all earnings and benefits an employee would have received during her notice period, unless relevant plan documents say otherwise.
• A properly drafted and executed employment agreement can provide certainty around what precisely must be paid to the departing worker as severance.