Limiting exposure for breach of contract

Terminating a contract before the date specified

Background

If an employer terminates a contract worker before the early-termination date specified, the maximum amount of exposure for breach of contract is usually limited to the early-termination date.

This is what the Ontario Court of Appeal ruled in a recent case concerning an agency contract, but it seems reasonable to conclude the same principles govern employment contracts..

In Hamilton v. Open Window Bakery Ltd., the defendant sued for damages for breach of contract after she was terminated before the early-termination date specified in the contract for what the bakery considered to be just cause.

The trial judge determined there was no just cause, and that the bakery would not necessarily have exercised an early-termination clause in the contract if it hadn’t dismissed her for just cause.

This resulted in the defendant receiving damages based on a 75 per cent chance that, but for wrongful dismissal, the contract would have continued for the completion of the fixed term. In disagreeing with the trial judge, the appeal court has attempted to create certainty in establishing the rights and obligations of the parties in respect of the early termination of fixed-term contracts.

The case: Hamilton v. Open Window Bakery Ltd. (2002), 58 O.R. (3d) 767

Ms. Hamilton was contracted to provide services to Open Window Bakery for a term of 36 months. Under the contract, the bakery was permitted to terminate her with three months’ notice after the completion of 18 months. The bakery wanted to expand its export business by using Hamilton to assist in supplying and selling bagels in Japan.

The contract, which began in February 1997, had a 36-month term with two termination provisions. The first provision entitled the bakery to terminate the contract for cause if Hamilton acted in a manner which was detrimental to the reputation and well-being of the company. The second provision allowed the bakery, at its sole discretion and for any reason, to terminate the agreement on three months’ notice after the expiry of the first 18 months.

About 15 months after Hamilton began, three months short of the date the early termination could be exercised, the bakery terminated the contract on the basis it had just cause to do so because Hamilton had allegedly acted dishonestly and with an intent to deceive by falsifying ingredient lists on certain shipments of bagels to Japan.

Then, almost three months later, at the start of the 19th month, the bakery again terminated the contract, this time by giving three months’ notice in accordance with the early-termination provision — although it continued to maintain she had acted dishonestly. No explanation is given as to the bakery’s decision to terminate the agreement a second time, although it is apparent this was intended as a fall back position for the purpose of limiting exposure on notice damages.

At trial the bakery failed to establish fraud or bad faith and failed to show there was any entitlement to terminate for cause without notice or pay in lieu thereof. The trial judge found, at worst, Hamilton had simply made a mistake. Accordingly, there was no question the bakery would be liable for breach of contract for wrongful termination. The court then turned to the task of calculating damages.

The trial judge determined that had the bakery appreciated Hamilton's conduct was due to a mistake or negligence she would have been forgiven and not only would there have been no termination for cause after 15 months, there would also likely have been no exercise of the right of early termination on the expiry of 18 months. The trial judge determined that while he could not conclude the contract would have been allowed to run its full term there was probably a 25 per cent risk the contract would not have been completed because the bakery may have exercised its right to terminate “at some point after it got the right to do so.” The trial judge awarded damages in the amount of $38,812.50 and awarded costs to Hamilton on a partial indemnity basis up to the date on which examinations for discovery were complete, and on a substantial indemnity basis thereafter. On the appeal, the bakery argued the trial judge erred in failing to find the damages were limited to the period from the original date of termination (15 months into the contract) to the expiry of the 18th month, plus three months, in accordance with the early-termination provision. The bakery also argued the trial judge erred in his award of costs on a substantial indemnity basis.

A minority of the appeal court held that since the bakery had breached the contract by having terminated for cause when no such cause could be established, it was precluded from relying upon the early-termination provision for the purpose of limiting exposure for damages to the amount which would have been paid had the early-termination provision been exercised at the earliest permissible time. The majority of the appeal court, however, disagreed with this approach, criticizing the minority’s finding that the bakery might, in different circumstances, have exercised the right of early termination at some later date, which was neither at the start of the 19th month nor towards the end of the 36-month term. The majority found such an approach to be speculative and simply wrong in law. The majority found the early-termination clause contained in the contract defined the upper limit of the bakery’s exposure for damages for wrongful termination. Since the bakery was entitled under the contract to terminate at the start of the 19th month, upon giving three months' notice, it could not be held liable for greater damages on the speculative basis that it might not have exercised the right of early termination after 18 months under different circumstances.

Damages limited to minimum requirements

The minority’s conclusion that Open Window Bakery had no protection with the early termination provision because it had wrongly alleged just cause is troubling, and was quite rightly rejected by the majority of the court.

The minority’s view would lead to the disturbing implication that parties who breach agreements can no longer rely on the provisions of the agreement to establish their remaining rights and obligations and the limits of exposure for breach-of-contract damages. The majority correctly affirmed the provisions of the contract, including the right of early termination, as “this provision effectively stipulates how the appellant could fulfil its contractual obligations in the event of wrongful termination. As such, it reflects the parties’ reasonable expectations concerning minimum guaranteed benefits under the contract in the event of termination, as well as maximum exposure for damages.” Since the bakery was not obliged to continue the agreement beyond the start of the 19th month, subject only to giving three-months' notice, it could not now be held liable for a greater period simply because it had a right to continue that agreement for a full 36 months.

Since the decision to terminate the agreement at the start of the 19th month, or at some later date, was exclusively within the control of the bakery, it was not right to assume it would choose to incur a greater loss or more onerous obligations than it was contractually required to do.

Accordingly, the majority reduced the damages from nearly $39,000 to $14,250. It also set aside the trial judge's order for substantial indemnity costs and substituted an award on the partial indemnity scale, as it found although the bakery had not met the high standard of proof required to sustain allegations of fraud or dishonesty the charges were not without foundation.

The message here is that a contract will be enforced on its terms and in a manner that recognizes the rights of the parties. This case makes it clear that damages for breach of an employment contract will be limited to the minimum obligations required under the contract. Courts will not speculate as to how parties may choose to perform their obligations beyond the minimum requirements stipulated in the contract.

Tips for employers

•Always have a written employment contract which limits the exposure upon termination and creates certainty as to the rights and obligations of both parties.

•The content of an employment contract is limited only by the creativity of the parties and by statutory restrictions which protect employees (such as human rights, minimum employment standards, health and safety, and so on.)

•The contract must use language that clearly sets out the obligations, avoids all ambiguity and anticipates potential areas of future conflict.

•Where, in a contract for a fixed-term, an employer wishes to have the right to terminate the employment relationship at some date before the expiry of the term without being liable for the full balance, the contract should clearly stipulate that such a right exists and the employer won’t be liable for damages for breach of contract exceeding the obligations contained in the early termination provision.

Although Hamilton makes it clear the parties will revert to the not-for-cause entitlements in the contract when allegations of just cause can’t be proven, it may still be a good idea to expressly provide that the early-termination entitlement of the employer shall be the fall back position in the event that a termination for just cause is not upheld.


This in-depth look at employment contracts was provided by Peter L. Biro, a partner practising employment law with Goodman and Carr LLP in Toronto. He can be reached at pbiro@goodmancarr.com or (416) 595-2341.

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