Brian Grosman has been invited to speak at the Canadian Bar Association Continuing Legal Education Program on Employment Law: The Essential Course on Thursday, November 9, 2000 at 2:00 p.m. He is addressing approximately 100 lawyers who practice law in the Province of Ontario.

The following is the talk which he is delivering titled "Executive Compensation and Termination: Negotiating Executive Compensation and Employment Security Agreements":

EMPLOYMENT LAW: THE ESSENTIAL COURSE

Thursday, November 9, 2000

EXECUTIVE COMPENSATION AND TERMINATION

NEGOTIATING EXECUTIVE COMPENSATION AND EMPLOYMENT SECURITY AGREEMENTS

by

Brian A. Grosman, Q.C.

The Balance of Power

The former Chief Justice of the Supreme Court of Canada, in a leading employment law case, took judicial notice of "the unequal balance of power that normally exists between an employer and an employee". Chief Justice Dickson was talking about the unjust dismissal provisions of the Canada Labour Code which, in his words, were aimed at the "protection of a particularly vulnerable group, or members thereof". He then went on to quote with approval from a legal text book the following statement: "The relation between an employer and an isolated employee or worker is typically a relation between a bearer of power and one who is not a bearer of power. In its inception it is an act of submission, in its operation it is a condition of subordination."

From the same quote approved by Chief Justice Dickson that appears in Kahn-Freund: Labour and the Law it is said by the learned author that "The main object of labour law has always been, and we venture to say will always be, a countervailing force to counteract the inequality of bargaining power which is inherent and must be inherent in the employment relationship." The author goes on to say "It is an attempt to infuse law into a relation of command and subordination."
(Slaight Communications Inc. v. Davidson (1989), 26 C.C.E.L. 85)

Traditionally, employment and labour legislation has assumed a relationship between employer and employee as one of command and subordination. The executive employment relationship in the 21st century, particularly in an era of full employment, is hardly one of master-servant in the traditional sense. Executive employees, particularly in the high tech and financial industries exercise considerable leverage when negotiating with potential employers. In an era when Silicon Valley employers are providing young high tech employees with BMW convertibles, along with significant signing bonuses and stock options, the times have indeed changed.

When negotiating executive compensation, the balance of power as between potential employee and needy employer is a critical component to the process. Simply put, most negotiations are based on a concept of leverage. Potential executive-level employees entering into negotiations with a potential employer in an era of full employment do not, for the most part, start in a subordinate negotiating position. Quite the contrary, in a high-tech, financial and other key industries the demand for talent clearly outruns supply. Accordingly, historical legal assumptions may no longer have currency in the real world of business. The law is a crude tool that is not easily fine-tuned to take into account rapid change in the world of work.

It was not so long ago that employees felt that they had no choice but to accept the conditions of hire set out by an employer without negotiation. The thought of engaging in tough negotiations on issues like responsibilities, compensation and severance was considered borderline fantasy. All that has now changed. Employment arrangements are scrutinized at an early stage by sophisticated executive employees who will not just question the terms of an employment agreement but often actually dictate them.

The Hiring Process

In the past, employment lawyers have spent most of their time negotiating severance packages on behalf of terminated employees. There is now a real need for sophisticated legal advice to be available to executive employees entering into employment relationships. This is particularly true since a growing number of these relationships are now based on extensive written contracts. Consultancy agreements, letters of hire and employment contracts detail not only levels of responsibility and authority, compensation and equity participation, but also deal with the growing phenomenon of restrictive covenants and stock options, pension top-ups and a variety of other issues which require careful legal advice.

Regrettably, most clients still come to see a lawyer when they perceive that they have a problem rather than retain our services to prevent one. There are a number of contentious issues surrounding the hiring process which require legal advice from an experienced employment lawyer. My brother, Norman, has written an important book on this subject titled "A Practical Guide to the Law of Hiring in Ontario". In chapter 12 of that book he deals with contracts of employment. But whether it is a written contract of employment, letter of hire, consulting agreement or handshake it is important for the individual as well as the employer to understand the nature of the contractual relationship and the enforceable terms of that relationship. For example, when does the employment relationship commence and is it accurately characterized as an employment relationship. What if a potential employee works out a deal verbally with a potential employer and yet does not actually sign anything until after the commencement of his work. Under those circumstances can that employee legitimately argue that the deal changed once employment commenced and that an ex post facto signature on a "changed" deal lacks consideration and is, accordingly, unenforceable.

In Francis v. CIBC (1994), 7 C.C.E.L. (2d) 1. The court had to determine the enforceability of an employment agreement that was signed on the first day that Mr. Francis began his employment with the bank. Mr. Francis had been hired following two interviews with the bank and the completion of an application form. On June 9, 1978 he received an offer of employment, which he unconditionally accepted on June 15, 1978. When he attended for his first day of work on July 4, 1978 he was presented with numerous forms and documents, one of which was a document titled "Employment Agreement". In that document Mr. Francis' notice on termination was limited to three months salary after he had completed three years of service.

The trial Judge, Mr. Justice Hoilett, held that the "Employment Agreement" could not operate so as to limit the implied term of reasonable notice to which Mr. Francis was entitled at common law under the contract of employment of indefinite duration which was concluded by the exchange of correspondence. On appeal this finding was upheld. Madam Justice Weiler, speaking on behalf of a unanimous Court of Appeal for Ontario, stated, in part:

"This principle of contract law, namely, that new or additional consideration is required to support a variation of an existing agreement, was implicitly recognized by this court in the context of an employment relationship in Stott v. Merit Investment Corp. (1988), 19 C.C.E.L. 68. .Here, the consideration for the "Employment Agreement" signed by the plaintiff is stated in the document to be the employment of the plaintiff by the Bank. The Bank was already bound to employ the plaintiff as a result of the exchange of correspondence and the fulfillment of the condition of a suitable reference." (p. 10)

The above-noted principle could also apply to unilaterally imposed changes to the employment contract at any time during the employment relationship.

In some cases the letter of hire does not deal with the issue of termination or compensation if the relationship is terminated by the employer without cause. The employee may believe that, under those circumstances, he is unprotected. It may very well be, however, that he is better protected by the common law than he is under the minimum statutory protections provided by the Employment Standards Act, particularly if his employment has been long term.

Pre-Employment Representations

Employers may overstate and even misrepresent during the hiring process because of an over-enthusiastic attempt to snag a top-level employee. Nowadays much of the marketing is done by an executive recruiter who may paint a much rosier picture than the one that is found to exist when the recruited employee begins work. Promises and representations made in an attempt to induce the uncertain candidate into an executive position may lead to legal consequences if the promises and representations fail to materialize. That is particularly so if the employee relied upon such promises or representations to his or her detriment and suffered damage as a result. An action of negligent or reckless misrepresentation may lie against the employer and perhaps even against the individuals who made such a representation, particularly if that individual or individuals were acting outside the scope of their proper duty and authority when the representations were made.

Executive employees are often in a position of significant leverage during the honeymoon period leading up to an employment contract or letter of hire. Of course, they cannot overplay their hand but, nonetheless, with sophisticated legal advice they may be able to make a much better deal than might otherwise be the case, particularly as it relates to compensation going in and coming out. Every negotiated employment contract should have as part of its fundamental provisions a built-in successful exist strategy. Relationships in the business world are not forever. Dealing with the consequences of break-up at the beginning of the relationship is much less painful than not dealing with those consequences and having to pick up the pieces when it ends.

The leading decision in Canada involving damages based on employer misrepresentations during the hiring process is the Supreme Court of Canada's decision in Queen v. Cognos Inc. (1993), 45 C.C.E.L. 153. Mr. Queen had applied for an advertising position as an accountant to assist with the company's development of a line of computer software. During the interview Mr. Queen was told by the Manager of Product Development that this was a major project which would be developed over a period of two years with enhancement and maintenance thereafter, and that the position would be needed throughout that period. Mr. Queen was not told that there was no guaranteed funding for the project or that the position was subject to budgetary approval. He was offered, and accepted, the position. In order to accept employment with Cognos Mr. Queen was required to give up a relatively well-paying and secure job in Calgary and to move himself and his family more than halfway across the country. Barely five months after his arrival in Ottawa Mr. Queen was advised that he would most likely be laid off owing to a lack of research and development funding. His employment was terminated shortly thereafter.

At trial Mr. Queen was awarded approximately $62,000.00 for damages for negligent misrepresentation as well as $5,000.00 in general damages for emotional stress. The Ontario Court of Appeal set aside the trial Judge's award of damages for negligent misrepresentation for two reasons. First, it held that there was a disclaimer within the written contract which effectively negated any such claim. Secondly, it ruled that there had been any negligent misrepresentations in any event.

On further appeal to the Supreme Court of Canada the judgment of the Ontario Court of Appeal was reversed and the trial judge's award of damages for negligent misrepresentation was reinstated. In his reasons for judgment Mr. Justice Iacobucci, speaking on behalf of a majority of the Supreme Court of Canada, held that there were five elements that must be satisfied in order to succeed on a claim for damages for negligent misrepresentation:

1. there must be a duty of care based on a "special relationship" between the representor and the representee; or
2. the representation in question must be untrue, inaccurate or misleading;
3. the representor must have acted negligently in making said misrepresentations;
4. the representee must have relied, in a reasonable manner, on said negligent misrepresentations; and
5. the reliance must have been detrimental to the representee in the sense the damages resulted.

One of the central issues in the Queen case was whether an employer has a duty of care to a prospective employee based on a "special relationship" in the pre-employment discussions. That question was answered in the affirmative in the Queen case.

Contract Considerations

In the past many people were hired after graduating from school and stayed with that company virtually until retirement. Today most employment is short-term and much of it is project-related. An employee is likely to change jobs six or seven times during his or her career. If the employment will be relatively short-term and the potential employer has a pressing need for particular services at a particular time then there is an opportunity for the candidate to negotiate a compensation package, which takes into account the potential short-term nature of the employer's commitment. Under these circumstances, the consequences of early termination looms large.

In a positive job environment where the terminated employee may have a number of employment opportunities, post-separation compensation is no longer a financial bridge to new employment paid on a month to month basis until re-employed. It is rather a recognition that the employer benefited from the employee's expertise without making a long-term commitment and the employee should be compensated for the employer's freedom of action when terminating the arrangement before its term has ended. Thus, lump sum severance arrangements are built into high-tech and financial employment contracts that are not subject to mitigation. Negotiations may not only deal with the level of compensation but how that compensation is to be calculated and packaged. This is particularly so if stock options are under water or have not vested because they have been backend loaded. There will be a desire on the part of the terminated employee to package the compensation in a manner which permits the employee to pursue other work options with maximum financial protection and minimum restrictions on his or her future employment opportunities.

Negotiating compensation packages also depends on a number of other factors such as whether the company is in play, likely to be sold or purchased or merged with one or another company and how that activity will impact on the future of the potential employee. "Bridging agreements" or "self-triggering agreements" are often attached to the contract because of the unstable nature of this corporate world. By entering into such agreements the company is able to ensure continuity of employment during a transition period by agreeing in advance to protect the executive employee during transition by way of guaranteed severance. The amount of that severance depends to a large extent on the level of responsibility of the executive employee and whether the employer wishes to include a restrictive covenant. It is not unusual for the executive employee to be fully compensated for the duration of the restrictive covenant as part of the severance package.

Negotiating Executive Compensation on Termination

It is much more usual for an employment lawyer to be called in when the employee feels he or she has suffered a black eye by the premature termination of the employment relationship. It is then that the employee wishes the employment lawyer to deal with his or her entitlement. That entitlement will depend, of course, to a large extent on the provisions of the letter of hire or contract of employment and any other documents signed by the parties in the interim. It is important for the lawyer to go through a check list with the client that deals not only with all of the potential documentation dealing with the terms of hire and fire but also to detail the nature of the compensation and how it was structured over time. Were there any company loans, special benefits, stock options, equity positions, bonuses, pension, pension top-up, insurance, travel expenses, other expenses and a variety of specific compensation-related issues all of which must be carefully canvassed in advance of advice. Of course, severance is based on legal entitlement, that is, whether the employer had cause to terminate the employment relationship. In all cases an assessment must be made about your client's ability to vary the proposed termination package. Part of the client's leverage will be based on how much the corporate defendants wish to avoid conflict with this particular employee.

From a plaintiff's point of view, before entering into negotiations, you, as counsel, must assess the role you play and how best to enhance the compensation which is available on termination. In some cases, it is best for the lawyer to remain in the closet. That is, not write any letters or make any telephone calls but rather to advise or coach the executive employee client who negotiates the severance package on his own without a lawyer's "obvious" intervention. This approach may be appropriate in high level executive situations where the termination process has been relatively friendly and the executive employee has significant leverage. The company does not want any potential negative publicity associated with the departure of its Chief Executive Officer and is prepared to work with that individual to provide a generous settlement to avoid any hassle whatsoever. Under these circumstances, a third party intervener may disrupt what may otherwise be a congenial somewhat clubby atmosphere. An intelligent client will take instruction from a respected and experienced career coach. Some of the best negotiated settlements and highest levels of compensation have been negotiated without the formal intervention of a lawyer.

It may be important for the corporate employer and the corporate employee not to create a paper trail at an early stage which requires formal positions and formal responses to each other's position. Under certain circumstances a respected employment lawyer may be in the position of picking up the telephone and calling in?house counsel or the Vice-President of Human resources and indicate that the client wishes to resolve this matter on an amicable and businesslike basis without resort to litigation if it is at all possible. Under these circumstances a confidential meeting may take place, with or without the client. If the client is highly emotionally involved in the situation it is probably inadvisable to have the client present at such a sensitive juncture in the negotiating process. If, on the other hand, the client takes a very businesslike approach to his or her own termination then, if the client is properly advised, he or she may attend the meeting as a resource person in order to provide detail that may not be within the knowledge of his counsel. Whether the client participates in the meeting or not is a judgment call and for the most part I believe it is an error to bring a client to a first meeting, particularly if there is a chance that he or she may engage in a finger-pointing exercise which ultimately will inhibit a businesslike resolution of the problem.

When your client is part of middle-management or is impacted by a general downsizing or reorganization in the company or where your client has little or no leverage, then a careful letter must be sent which, in my opinion, ought not to threaten litigation. The letter should be written in order to open up discussions rather than to threaten action and close them down.

In some situations the only way to get the attention of a corporate employer is to actually serve a Statement of Claim. Some corporate employers will stonewall on the basis that they have deeper pockets than a potential plaintiff and that in any case mitigation will take its course shortly and their liability will be thereby reduced. Under these circumstances delay is always in the interest of the employer and contrary to the interests of the employee who is out of work, may be out of money and despondent. But in some situations where a claim is drafted, in order the get the attention of a corporate employer, that claim should not be formally served and issued until the corporate employer or its counsel has at least 48 hours to review it in advance of its issuance. If indeed you proceed to issue a claim the company may feel it has no alternative but to circle the wagons and defend the claim in order to discourage other like- minded potential plaintiffs.

Once a claim has been issued there is still a good likelihood of a negotiated severance as long as lawyers remain in friendly contact up until the discovery. It may also be that even at the discovery the lawyers for the corporate defendant discover facts that were not made available to them which assist in a reasonable resolution at this stage. It is not unusual in major cases of this kind to settle the case on the courtroom steps, because it is only then that significant resources and time need to be spent. A trial focuses everyone's attention. Settlement is more difficult if the corporate employer has terminated on the basis of justifiable cause and is prepared to argue cause at trial even though it is your opinion that the grounds for that cause will not stand up to judicial scrutiny.

The downside for every plaintiff is mitigation. This is particularly true in a booming economy. Either the plaintiff will find a position within a reasonable time or the defence may establish that the plaintiff did not make reasonable efforts to do so. In most cases a plaintiff's counsel has a window of opportunity. That is within the first six to ten weeks after termination to work out a settlement on a negotiated basis, thereafter the plaintiff becomes vulnerable to making insufficient effort to mitigate or to being forced to take a job because funds are running low.

When negotiating a compensation package either at the time of the initial hire or subsequent to termination, it is most important that the client remain fully informed so that you do not find a situation where the client is dreaming about getting rich quick when the reality of the compensation package will not reach his stellar standards. One of the problems that counsel must deal with is that it is not unusual for the client to provide anecdotal evidence about friends at the company who have received substantial severance packages over the last few years and consider that he or she is entitled to at least those mythical standards or more. Accordingly, each proposal must be reviewed carefully with the client before it is made. The client must understand the law and the nature of the awards made by the courts in similar situations. You do not wish to create poor client relations because the client is ill-informed and is engaging in significant wishful thinking. One of the ways to move forward with a recalcitrant plaintiff is to carefully explain the costs of litigation and the chances of success so that he or she can factor that into the settlement proposal. Before entering into such a settlement proposal it is good practice to obtain a written direction from your client with regard to the negotiated settlement so that there can never be an allegation that she entered into such an arrangement reluctantly or that you subjected her to some duress in order to make the deal.

The Corporate Employer

If you are acting for a corporation (assuming there is no termination for cause) you too must assess the leverage of the potential plaintiff. Too often in-house counsel are not made aware of special circumstances relating to certain executive employees until discovery. For corporate counsel time is on your side because of the potential mitigation of damages and that a month-to-month proposal with a 50% payment of the balance on re-employment makes sense. On the one hand you limit the company's liability and on the other hand you encourage the ex-employee to make reasonable efforts to find re-employment because 50% of the balance will be payable on re?employment. In some cases corporate employers need to deal with the termination quickly and quietly by way of a mutual announcement and a lump sum payment.

Corporate employers wish under most circumstances, to enter into a confidentiality agreement so that the negotiated settlement does not create an uncomfortable precedent. This is the case if the corporate employer is dealing with an executive employee on an individual basis.

If there is a downsizing or merger or restructuring the corporate counsel will have to advise and even negotiate with the corporate client in order to put together a comprehensive plan of fair compensation packages from which there will be little or no deviation. The problem, from corporate counsel's point of view, of negotiating a major deviation from the plan that is in place is that unless the circumstances are dramatically different then the alteration of the plan may cause considerable disruption to other like-minded individuals. It is best to customize the plans in advance in order that individual employee's differences in length of service, level of responsibility and age are carefully taken into account rather than attempt a cookie cutter approach to this delicate process. Most corporate employers wish to maintain a reputation of dealing fairly with employees. This is important in order to maintain the commitment and loyalty of those employees who continue with the company and who are not made redundant by the process. They want to believe that their colleagues are going to be treated fairly because that will have a direct impact on how they anticipate being treated in similar circumstances. An enlightened corporate employer will be open to advice from counsel to manage the downsizing, reorganization or merger in a manner which is not only cost-efficient but humane when it comes to the compensation outplacement and benefits provided to departing employees.

Employment Security Agreements

The power shift from employer to employee leverage is evidenced in the changing nature of employment contracts. It is now in the employer's interest to build into the contract provisions which secure the commitment of the employee to the term of the arrangement. Self-triggering and transition agreements that form part of the employment contract protect the executive employee on a takeover, merger or sale. These provisions combat the insecurity that might otherwise be felt by an executive employee who may feel that events beyond his control may impact negatively on his future with his employer. Self-triggering and transitional provisions in the contract not only provide security to the potentially vulnerable executive employee but they provide continuity to the corporate employer as the employee is much less likely to jump ship during a disruptive period (merger or takeover) if he knows that his personal financial situation remains secure.

Executive level employment contracts not only contain a variety of golden handcuffs such as stock options, share participation and backend loaded vesting but may also contain provisions for retention bonuses and pension top-ups. The pension top-up may be tied to a tough restrictive covenant. Some companies, in order to insert a restrictive covenant during the term of post-employment provide pension top-ups as the consideration for the restrictive covenant. The argument has been made that a pension top-up does not provide adequate new consideration for tough restrictive covenants because a pension is earned throughout the currency of employment and the top-up ought not to be made conditional on the employee's agreement to new restrictions. The courts, however, have treated the pension top-up as adequate fresh consideration as the employee has the option of either accepting or not accepting the financial incentive of a top-up.

One of the leading decisions in Canada on the enforceability of a non-competition restriction in a pension top-up agreement is the decision of Mr. Justice Stayshyn of the Superior Court of Justice of Ontario in Woodward v. Stelco Inc. (1996), 20 C.C.E.L. (2d) 70. In Woodward the plaintiff signed a retirement benefits contract after he had been employed for a period of 27 years and in his capacity as Vice-President, Sales and Marketing. Mr. Woodward had signed this contract along with other key executives of Stelco who were entitled to participate in the pension top-up plan. In Clause 4 of that contract the executive covenanted that he would not, after his retirement, engage in any activity that was directly or indirectly competing with any business carried on by Stelco or any of its subsidiaries without the consent of Stelco. Mr. Woodward ultimately retired from Stelco in 1991. In May of 1994 Stelco discontinued Mr. Woodward's supplemental pension benefits under the retired benefits contract on the basis that he was in breach of his undertaking under Clause 4 of the retirement benefits contract to refrain from competing with Stelco.

Mr. Woodward commenced a law suit against Stelco in which he requested specific performance of the retirement benefits contract. In addition he argued that the non-competition clause was unenforceable on the basis that it was unreasonable and contrary to the public interest. In the alternative, he argued that the non-competition restriction should be interpreted narrowly so that his consulting activities did not amount to a breach of the covenant. In dismissing Mr. Woodward's claim Mr. Justice Stayshyn stated, in part:

"This Court should not interfere with the Retirement Benefits Contract. Stelco and Mr. Woodward are both sophisticated and experienced parties who, without any undue influence entered into a bona fide agreement. Stelco agreed to pay a monthly retirement benefit to Mr. Woodward by supplementing his base pension handsomely. Woodward in exchange would not compete with Stelco upon his retirement without Stelco's written consent.

Even if the restraint of trade cases are applied to this case, the restraint prescribed by Clause 4 of the Contract was reasonable as between Stelco and Woodward."

Another way of holding onto key executive employees is by the imposition of tough restrictive covenants that are enforceable. In a knowledge-based economy the loss of a key employee and the knowledge that she has may instantly damage her former corporate employer beyond repair. Accordingly, employment contracts today are laced with restrictive covenants in an attempt to ensure that the employee does not take key corporate information and enhance her own value by trading it to a new employer engaged in a competitive enterprise. Accordingly, restrictive covenants are being fine-tuned. Also there is a new willingness on the part of corporate employers to enforce restrictive covenants by way of injunctive proceedings if they are forced to do so. Such proceedings send an important political message to like-minded individuals and other corporate employers who may wish to entice away key employees, that their present employer is prepared to take all the steps required to enforce its rights to limit employee departures to competitors. This, of course, is an attempt to use a big stick approach when often a carrot is more palatable and effective.

Corporate employers who treat executive employees as investors in the company and provide them with a real return on that investment are more likely to reap the benefits of continuity of employment and even loyalty than are those employers who rely solely on negative restrictions and injunctive relief.

Executive compensation has over the last few years climbed into the stratosphere. These numbers reflect the limited supply of special talent and a growing need for that talent in a highly competitive marketplace. Executive employees believe that they must build into their employment arrangement fail-safe provisions that reflect their real value in the marketplace and compensate them for the risk to their career, reputation and profile of an unanticipated short-term engagement.

<< back