What it is, what it's not, and how it’s 'calculated'
There is no shortage of confusion and misconceptions when it comes to “severance pay”, which I put in quotes as the term is used to mean a few different things. The information online can be complex, and does little to take into account the nuances of each individual scenario.
Here are short answers to some of the most commonly asked questions that we encounter:
What is severance pay and how is it different from termination pay?
In everyday conversation, the terms “severance” and “termination pay’” are used interchangeably, similar to “fired” and “laid off,” but in the legal sense, they all mean different things.
Broadly speaking, termination pay is the amount owed by an employer when someone is dismissed without cause. This is also commonly called severance, sometimes even by lawyers, but is not entirely accurate. Severance pay is actually a specific payment under employment standards that is only required in specific circumstances and only in certain parts of the country.
For example, under Ontario’s Employment Standards Act, 2000, severance pay must be paid to employees who have been employed with a company for five years or more (including in multiple periods of employment) if the employer has a payroll of over $2.5 million or the employee is part of a mass termination of 50 or more employees.
For the purposes of this article, I’ll use severance in the broad sense, but when it comes to arguing a legal case, it is important to know the difference.
How much notice or severance pay is a person entitled to?
The question may be simple, but the answer is not so cut-and-dry. The first guide is always going to be the employment contract, if there is one. Most employment agreements spell out what happens if someone is let go, and what compensation they are entitled to.
If, however, a contract does not outline a person’s entitlements, or there is no written contract, the employee is then eligible for what’s called “reasonable notice”, based on the “common law.” This is not an exact formula, but is based on a court’s estimation of how long it would reasonably take someone to find a similar job.
Courts will look at many factors, including a person’s age at the time that they were let go, how long they were in their previous role, the nature of their work, and the current job market in order to assess how long it might take them to find something new.
Does an employer have to pay severance pay?
The short answer is yes, so long as the employer is the one who lets the person go. If the person resigns or abandons their job, then they will likely not be entitled to any termination or severance pay.
The other exception may occur if someone is fired “with cause.” If an employer alleges that they had cause, which can occur in the most extreme scenarios, there are some instances where a person may not be entitled to any payout. However, the law says that even in most of those cases, an employee would be owed the minimum payouts under employment standards law.
What is pay in lieu of notice?
When someone loses their job, they are by law entitled to what we call notice of termination, which can take different forms. One form is working notice, where the employer notifies the person that their job will be ending in several weeks or months, and they can then use that time while still employed to find something new.
The more common method though is pay in lieu of notice, where the person’s job ends that day and instead of working notice, they are paid out for the amount of time that their notice period would have been.
Does an employer pay salary during the notice period?
The short answer is yes. During a notice period, the employer is supposed to keep a person whole, just as though they were still actively working with the company.
While the law can get complicated, this generally includes salary as well as any benefits coverage that they had, bonuses that they would have earned, or any other allowances that they would have been entitled to if they were still working. Some of these amounts are guaranteed under employment standards laws, but if an employment lawyer is going to help a person fight for an increased notice period, they will be arguing for them to be “made whole” during the notice period.
How is the severance pay given out? What are the tax implications?
There are different ways of paying out severance. One is as a lump sum payment, which covers the entire amount owing, and the other is salary continuance as though the person was still employed through the notice period. There are tax advantages to a lump sum, such as being able to transfer the amount into an RRSP if they have the allowance.
Some employers though, and even some employees, may prefer a salary continuance, and they will build in a clawback wherein they’ll owe the employee less if they find new employment within the notice period.
Both methods are perfectly legal, so it comes down to negotiating a payout at the time of termination.
If the person finds another job while still collecting severance pay, do they have to tell the employer?
If a person is paid out a lump sum, then the money is theirs, unless there are conditions on the payout that they are not yet working at the time that they receive the money.
For salary continuance, though, employers will often place an obligation that the employee notify them within X number of days about any new employment and they will likely pay out half of any amounts remaining.
The key point to remember is that termination or severance is not meant to be a windfall - it’s just supposed to keep a person on their feet until they can find something new.
Remember that these are all simple answers to complex problems, and none of them contain any legal advice. Consult an employment lawyer for legal advice on a specific scenario.
How can an employer reduce severance costs?
I have said this many, many times: through the use of strategic termination clauses in employment contracts. Such clauses can dramatically reduce the severance entitlement of an employee; for example, it could be the difference between 24 months of severance and a mere eight weeks.