The severance balancing act

Crafting the best deal for the company while avoiding legal actions

For employers and human resources professionals, making a decision to terminate a non-unionized employee without cause is often very difficult. Equally difficult can be deciding on the terms of the separation package offered to the departing employee.

Where no employment contract exists, or one does exist but it does not have a termination provision, two key factors must be considered when terminating an employee without cause: the timing of the termination, and the terms and conditions of the proposed separation package.

When timing the termination, an employer has two options. First, the employee may be terminated effective immediately. Here, the employee is told about the termination and leaves the workplace shortly thereafter. The second option is to provide working notice of termination. Here, the employee is told employment will end on a specified date, and in the interim, the employee is expected to perform regular duties and will continue to receive salary and benefits at current levels.

Which timing option is appropriate will depend on the individual circumstances of the case. The main advantage of providing an employee with working notice of termination is that the employer can receive the benefit of the employee’s work in return for the employee’s salary. However, often working notice is not practical or appropriate.

Often after an employee is told of a pending termination, individual productivity declines. Further, the employee’s presence in the workplace may have a negative impact on staff morale. Such employees may also engage in disruptive behaviour, and potentially do harm to the employer’s operations if there is resentment about the termination. As a result, particularly where the employee occupies a position of trust or one in which they’ve had exposure to confidential company information, it is often advisable to make the termination effective immediately.

With certain exceptions, employees terminated without cause are entitled to notice of termination, or pay in lieu thereof, under employment standards acts (ESA). They may also be entitled to statutory severance pay. However, generally speaking employees are entitled to a greater amount of notice based on common-law decisions made in the courts. As a result, the employer must ensure that the separation package offered to the employee not only meets the minimum statutory requirements, but also that it provides adequate and reasonable notice at common law.

The amount of notice an employee is entitled to will depend on that individual’s particular circumstances.

Pros and cons of lump-sum payments

Employers have a number of options in determining the form and substance of a separation package which will be offered to a departing employee. One option is to provide a lump-sum payment which is inclusive of minimum ESA payments and entitlement to notice at common law.

However, many employers reject this option for a number of reasons. In particular, providing a lump-sum payment does not take into account a departing employee’s obligation to mitigate losses by seeking and obtaining alternate employment or self-employment during the notice period. If a terminated employee receives a lump-sum payment and then obtains new employment during what would be the notice period, that employee will have received a windfall payment from the previous employer since they have mitigated losses by securing the new employment.

In these circumstances had the employee been provided with salary continuation or working notice, the overall liability of the employer to pay the employee amounts in lieu of notice would be reduced. Another reason not to pay a departing employee a lump sum relates to cash flow. Many employers simply cannot afford to pay out a large lump-sum payment on termination.

There are, however, some advantages to parties agreeing to a lump-sum severance package. First, by agreeing to a lump-sum payment at or shortly after the time of termination, the employer will avoid the potential of costly and protracted wrongful dismissal litigation. Second, the employee may be willing to accept a lesser overall payment from the employer if it is provided by way of a lump sum with no obligation to mitigate, as opposed to through salary continuation payments.

A salary-continuation arrangement

Another option for structuring a separation package is salary-continuation payments in lieu of actual working notice or a lump-sum payment. The employee receives a regular salary for a specified period following termination. That period coincides with what the parties have agreed constitutes the period of reasonable notice to which the employee is entitled at common law. Further, typically the parties agree in writing that the salary-continuation payments are inclusive of the employee’s entitlements to termination pay and, if applicable, severance pay under the ESA.

Salary continuation may be structured to take into account the possibility that the employee will mitigate damages by obtaining new employment or self-employment after termination. Specific language can be included in the severance agreement stating that if the employee secures new employment during the salary-continuation period, the ongoing payments will cease.

The employee would then get a lump-sum payment equal to, for example, 50 per cent of what would have been received under the salary-continuation arrangement between the date that new employment was secured and the end of the salary-continuation period. Such an arrangement provides an incentive to the employee to seek out and obtain new employment since the lump-sum payment would constitute a windfall for the employee, assuming the new employment was similar in terms of salary and benefits.

Many employers prefer this type of arrangement since if the employee mitigates losses, thereby earning the lump sum, the employer has paid less in salary-continuation payments than it otherwise would have had the employee remained unemployed for the balance of the salary-continuation period.

A mixed approach

Another option for a separation package involves a combination of a lump-sum payment and salary continuation. Although they can be structured in a number of ways, one common approach is to provide the employee with a lump-sum payment equal to the number of weeks of the employee’s ESA entitlements at or about the time of termination. Then, if the employee has not secured new employment by the end of the number of weeks’ pay provided, the employer places the employee back on payroll for a further period of salary continuation. The employee may also be offered a lump-sum bonus should the person mitigate during the period of salary continuation.

The advantage to the employer of structuring the separation package in this manner is that if the employee secures new employment before the end of the period representing the lump-sum payment, no further payments are required. This type of separation package is often recommended where the employee will likely be able to secure new employment shortly after termination, and where the person is motivated to do so.

Benefit coverage

Benefit coverage must also be considered when structuring a separation package. Under employment standards legislation, the employer must continue to provide all employment benefits for at least the number of weeks’ notice of termination to which the employee is entitled under the legislation. At common law, however, the employee is entitled to continue to receive regular employment benefits, or compensation in lieu of such benefit coverage, for the duration of the period of notice at common law. That being said, parties are free to negotiate an agreement relating to the provision of benefits following the termination date.

However, particularly with respect to short-term and long-term disability benefit coverage, employers should consult their benefit provider to ensure coverage can be maintained after the employee ceases to be actively employed. Employees should be made aware of any rights to convert life insurance coverage to private coverage, and any time limitations.

Regardless of the structure of the separation package offered, the employer should ensure that acceptance of any offer is conditional upon the employee executing a full and final release acceptable to the employer. Remember, however, that even where the employee rejects the separation package offer, all wages, outstanding vacation pay, ESA termination pay and statutory severance pay (if applicable) must be provided to the employee. In the case of Ontario, the ESA states this must be done within seven days of the effective date of termination.

What else can come up?

In addition to the general structure of a proposed separation package, there are a number of other issues which may have to be considered. Those issues include, but are not limited to, the following:

•Is the employee entitled to bonuses, profit sharing, stock options or pension entitlements both as of the date of termination and during the period of common law notice?

•Will the employee continue to receive payments for a car allowance, cellular phone or Internet access during the period of common-law notice?

•Is the employee entitled to roll over all or some of any lump-sum payment as a “retiring allowance” into a registered retirement savings plan?

•Will outplacement counselling be offered?

•Will the employee be provided with a letter of reference, or names of contact persons within the company who would act as references? The answer to this question will depend upon the employer’s policies. However, it is recommended that reference letters of some type should always be provided upon request.

•Does the employee have an outstanding company loan which will be either written off or repaid as a condition of acceptance of the separation package offer?

•Is the employee entitled to more notice on the basis that the person was induced away from previous secure employment based on representations made by the employer?

•Should the offer be made conditional upon the employee agreeing to certain restrictive covenants, such as non-solicitation and confidentiality terms, in the separation agreement documents?

•Is there certain company property, such as office keys, pass cards, laptop computers, which must be returned to the employer as a condition of receiving the severance money?

•If the employee has been receiving employment insurance benefits, there will be an obligation on the employer to contact Human Resources Development Canada for a direction regarding the withholding of money from the separation payments to repay employment insurance benefit overpayments .

There are a number of options available to employers when considering the appropriate structure and terms of a separation package. Each employee’s circumstances are unique. As a result, it is recommended that employers obtain the advice of experienced employment counsel when making the decision to terminate an employee. By carefully structuring the separation proposal, employers can increase the likelihood that a mutually acceptable separation package can be agreed upon without the resort to expensive and protracted wrongful dismissal litigation.

Christopher M. Little is a partner with Filion Wakely Thorup Angeletti LLP, a law firm which practises in the areas of labour relations and employment law on behalf of management. For more information contact (416) 408-3221, [email protected] or [email protected]

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