Entitlements to stock options, other incentives upon termination

Properly drafted bonus plan can save employers significant liability in future

Entitlements to stock options, other incentives upon termination

It is common for a high-level employee’s compensation to consist of not only base salary, but also bonuses, stock options and other incentives. Sometimes, these incentives form a significant portion of the employee’s compensation.

If their employment is terminated, what is the employee entitled to with respect to their unpaid bonus, unvested stock options and any other incentives? The answer will depend in large part upon the terms of their employment contract or company plan (for instance a bonus plan or stock option plan).

As readers of Canadian HR Reporter are likely aware, an employee who is dismissed without cause is entitled to reasonable notice or termination, or payments in lieu of notice, in accordance with the common law, unless there is an employment contract containing a legally enforceable termination clause that defines or limits the employee’s entitlements.

My recent commentary on the latest developments in the law of termination clauses can be found here and here.

As a general rule, the employee is entitled to damages for the loss of wages, salary, benefits and all other compensation they would have received during the reasonable notice period. This applies to bonuses, stock options and other incentives that would have accrued, vested or be earned during the reasonable notice period.

The legal principle is that the employer is effectively breaching the employment contract by not providing the employee with working notice for the full duration of the reasonable notice period, and the employee is entitled to damages representing the full compensation that they would have received if their employment had continued during that period.

However, just as a legally enforceable termination clause can limit an employee’s entitlements to common law notice, so can a properly drafted bonus plan or stock option plan limit what an employee is entitled to receive during the reasonable notice period. Such a plan must be brought to the employee’s attention in order to be enforceable.

Supreme Court test

In the case of Matthews v. Ocean Nutrition Canada, the Supreme Court of Canada formulated the following test, which applies to claims arising out of the loss of stock options and other bonuses during a reasonable notice period:

“Courts should accordingly ask two questions when determining whether the appropriate quantum of damages for breach of the implied term to provide reasonable notice includes bonus payments and certain other benefits: Would the employee have been entitled to the bonus or benefit as part of their compensation during the reasonable notice period? If so, do the terms of the employment contract or bonus plan unambiguously take away or limit that common law right?”

For such a plan to be enforceable, it must unambiguously limit the employee’s entitlement to bonuses, stock options and other incentives, based on the presumption that the parties intended for the plan to be in accordance with the law. That means, for instance, that if a plan states that an employee is not entitled to bonuses or stock options “once their employment is terminated”, the court will imply that this means “once their employment is terminated with proper notice”.

In such a scenario, the employee would remain entitled to their bonuses and stock options until the end of the reasonable notice period, despite the language in the plan.

Limited entitlements

A properly drafted plan that is brought to the employee’s attention can successfully limit the employee’s entitlements to bonuses, stock options and other incentives during the reasonable notice period. A recent example is the case of Battison v. Microsoft Canada Inc., in which the Court of Appeal found that the dismissed employee was not entitled to unvested stock awards after his termination, as a result of the clear language of the company’s stock option plan.

Such a plan, if drafted properly at the appropriate time, can save a company significant liability in the future. It is always better to ensure that you have a legally enforceable plan at an early stage, rather than waiting until you face a wrongful dismissal claim, at which point it will likely be too late.

Furthermore, we anticipate that the law on the enforceability of these plans will continue to evolve, similar to the evolution of the law on termination clauses. Therefore, we recommend that you retain a lawyer to ensure that your applicable plans are legally enforceable, and if they are not, to fix these plans at an early stage before you are faced with legal issues.

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