Termination of the employment relationship is a predictable event. Every employee will leave their employment either through retirement, voluntary leaving, or a termination of some sort. The employment relationship is a contract so it ought not to be impossible to provide contractual answers to the financial issues that arise at termination of an employee. But a review of the cases going to court over executive compensation at termination show that the exact calculation of termination pay is often an area of disagreement. This is just a little puzzling. At an executive level, one would think that both the employer and the employee are well aware of the necessity of providing for certainty in contracts. So how does this happen?

Executive compensation in the last few years has often moved away from a simple yearly salary to a complex web of “total compensation” including base salary, bonus, incentive pay depending on corporate performance, incentive based on individual rating, stock options, and various forms of stock options and stock option simulations such as phantom share units. The agreements and policies governing compensation outside of basic salary are already in place and can’t be changed by an incoming employee.

From an employer’s point of view, very often, the different documents that make up an executive’s total compensation package are written by different individuals or departments. Glowing declarations of expected compensation may be written by recruiters, stock option plans are written by corporate finance and tax departments, corporate incentive pay plans are often written (and re-written) by committees of the Board of Directors, and termination letters written by HR departments. When these documents are being prepared most employers do not consider that, in the case of a terminated employee, these documents will be read together, often by a Court that may be less than sympathetic if the employer’s documents have internal ambiguities on these issues.

This can be made to look worse for an employer, even when they try to give an employee a break. For example, employers often do not allege cause for termination, even when it exists, thinking that they are doing the employee a favor. However, termination without cause or with insufficient notice is a breach of the employment contract. An employer may come to court, overtly as the wrongdoer in breach of a contract, with the Court expecting the employer to pay a full compensation package. An employer may think that its documents end compensation at “termination” but sympathetic Courts have implied “termination” to mean “lawful termination” and held the employer to payment of the full suite of total compensation items throughout a notice period. Here are some practical considerations:

  • How many months or years of notice of termination or payment in lieu of notice will be given or will it be left for the Courts to decide what is “reasonable?
  • Will a departing employee be eligible for the corporate incentive pay and bonus for the departing year even if it hasn’t been declared yet? Will it be the full incentive pay or pro-rata for the months that the employee was an active employee?
  • Will a departing employee be entitled to the corporate incentive pay that they would have received during their contracted notice period?
  • How will stock options or phantom share units be treated on termination? Perhaps options have already been granted but have not yet fully vested. Will the departing employee only receive those options vested at the date of notice of termination, or a larger number that would vest during the notice period? Perhaps all options vest immediately. What about exercise of the options? Will the options be exercisable right away (or within some period from the notice of termination) or will they be exercisable with the other option holders as before termination?
  • What about future grants of options? Is a departing employee who is asked to leave right away, but who may be entitled to one or two years’ notice, entitled to the grants of options that likely would have been given during an appropriate notice period? When will they vest, and when can they be exercised?

These are just the big ticket items. Many other forms of compensation may be available to an employee including car allowances, pension contributions, insurance and medical coverage. A departing employee may consider themselves entitled to their total compensation package during an extended notice period.

All of these items will be mentioned somewhere in the employment contract documents but the usual employment letter or contract does not always bring the various total compensation elements together. Sometimes employers take the position that the employment contract really ought to be interpreted as saying: “If your employment is terminated for any reason whatsoever, you will be obligated to leave the premises immediately upon notice, your payment in lieu of notice will be six months of basic salary only and that all entitlement to other compensation, including bonus, incentive pay, granting, vesting or exercising of options ceases as at the date of notice of your termination”.

A Court may consider that specific enough to define a departing employee’s termination entitlement but on the other hand, who would accept that job offer?

Employers who offer executive employees a complicated total compensation package need to keep in mind that in a disputed termination situation, their recruitment material, employment letter and contracts and all of their incentive pay and stock option documents will be read together to form the employee’s compensation entitlement. These documents ought to be capable of being read together even if they were drafted by different groups and ought to provide specifically for the financial consequences for the (almost inevitable) termination of the contract. Any ambiguities will almost certainly be resolved against the company and in favor of the dismissed employee.