Upon termination of their employment, employees in Ontario are entitled to reasonable notice of termination (or pay in lieu) at common law, subject to a term in their written employment contract limiting such entitlement.
What may come to the surprise of many employers is that the quantum of the pay in lieu of notice must account for an employee’s total compensation, which could include bonuses, among other things. Effectively, the employee should be put in the same financial position they would have been in had they worked the entire notice period. However just like the length of notice period, these entitlements can be modified by way of an employment contract and in the case of a bonus, by a company-wide bonus plan as well.
Types of Bonus Entitlements at Termination
Without any written employment contract or bonus plan limiting termination entitlements, upon termination of employment, an employee could be entitled to an unpaid bonus. Unpaid bonuses could be in the form of any of the following:
- Vested bonus – unpaid bonuses relating to completed bonus periods;
- Stub bonus – pro-rated bonuses relating to partial bonus periods; and
- Notice period bonus – the pro-rata bonus that an employee would have earned during the notice period had they been provided reasonable notice of termination.
At common law, an employee would be entitled to any or all of the above bonus amounts. However, a well drafted employment agreement or bonus plan could limit (or entirely eliminate), a former employee’s entitlement to such amount.
When is an Employee Entitled to a Bonus on Termination?
In the recent decision by the Ontario Court of Appeal in Paquette v. TeraGo Networks Inc., the court provided an in-depth discussion of an employee’s entitlement to unpaid bonuses on termination. Most importantly, the court set out a two-step test to determine whether an employee is entitled to unpaid bonuses upon termination:
- Is the bonus an integral part of the terminated employee’s compensation; and
- Does a bonus plan/employment contract limit an employee’s entitlement?1
Is the Bonus Integral to the Employee’s Compensation?
In determining whether a bonus is an integral part of an employee’s compensation, courts will generally consider:
- whether the bonus was regularly paid;
- the value of the bonus as a portion of the employee’s overall compensation; and
- whether it is industry standard to pay bonuses.
Does a Bonus Plan/Employment Contract Limit the Employee’s Entitlement?
The Ontario Court of Appeal recently concluded in each of the respective decisions that the bonus provision did not successfully limit the employee’s common law entitlement to a stub or notice period bonus as described above:
- in Paquette v. TeraGo Networks Inc2., the bonus provision required an employee to be “actively employed by TeraGo on the date of the bonus payout”; and
- in Lin v. Ontario Teachers’ Pension Plan3, the bonus provision stated “In the case where [an employee] resigns or the [employee]’s employment is terminated by [the employer] prior to the payout of a bonus (normally the first pay period in April), no bonus shall be earned or payable to the [employee].”
The reasoning in both cases was that damages in lieu of reasonable notice should place an employee in the same financial position as if such notice had been given and the employee had worked to the end of the period of reasonable notice. In other words, an employee, if given sufficient working notice of termination, would have been “actively employed” and therefore would have been entitled to the bonus.
It is also important to note that where an employer seeks to rely on a term that limits an employee’s entitlement to a post-termination bonus, the employer must communicate that provision to the employee. If an employer fails to do so, the employee will be entitled to claim the bonus4. An employer could communicate this limitation by incorporating a bonus plan into an employee’s employment agreement by reference or providing a copy of the bonus plan to the employee. However, simply posting the plan on its intranet, without doing anything more, would be insufficient5.
While these cases lean in favour of entitling employee’s to unpaid bonuses, they do not shut the door on employers contracting out of such entitlements. Though neither case discusses what is necessary to successfully displace an employee’s common law entitlement to a bonus that is integral to their compensation, it is clear that something more than requiring the employee to be “actively employed” is needed.
Employers should consider reviewing their bonus plans and template employment agreements with the principles from these new cases in mind. Legal counsel should be sought to bolster the provisions to ensure they do more than just rely on requiring an employee to be actively employed. For many organizations, this modest investment in legal advice upfront could limit substantial liability at the back end when key employees with substantial bonuses are terminated.