Bonus plans in employment contracts are a great way to motivate, reward and retain employees. Many of these bonus plans have built-in conditions that must be met before these bonuses are paid out. For example, an employee must be actively employed at the time the bonus is paid. Increasingly, the courts are being asked to determine whether these conditions have to be met and whether a bonus is owing.

A recent decision by the Ontario Court of Appeal (“OCA”) will come as a surprise to many of you.

Paquette v TeraGo Networks Inc.

In this case, the employee was terminated without cause and the employer and the employee could not agree on the terms of a severance package. The employee sued for wrongful dismissal. At trial, the judge concluded that the employer should have provided the employee 17 months’ notice of termination. When calculating damages during this time, the judge found that the employee was not entitled to any bonus payments because the contract stipulated that he had to be an active employee to receive his bonus payment. In this regard, employees were eligible for a bonus only if they were “actively employed by TeraGo on the date of the bonus payout.”

The employee appealed to the OCA who ruled that the employer should pay the employee an additional $60,000 for the bonus he would have received during the 17-month reasonable notice period.

The OCA focused on the basics of contract law; an employee should be compensated for the income he would have received if not for the employer breaching his contract by failing to give the employee reasonable notice of termination. Part of the employee’s income was the bonus payments.

In this case, the main issue under consideration was whether the employee had met the condition of being “actively employed”. The employer argued that because the employee was terminated and no longer “active,” he was not entitled to the bonus. The employer’s argument fell flat. The Court stated that the wording of the plan was crucial in determining whether the bonus could be properly withheld from the employee. The rather simple wording in the contract, “actively employed by TeraGo on the date of the bonus payout” was not enough to protect the employer from its obligation to pay the bonus plan following termination. The Court stated that a term like this needed “more” to limit the employee’s claim to the bonus.

Employers can look to a past case, Kieran v Ingram Micro Inc., for an indication of what “more” is needed to limit payment of bonus plans to terminated employees. The Court determined that the following provision was able to effectively limit the employee’s right to exercise stock options on termination:

“If Participant’s employment with [the employer] is terminated for any reason other than death, disability … or retirement.. Shares… shall be repurchased by [the employer]… [A]ny termination of a participant’s employment for any reason shall occur on the date Participant ceases to perform services for [the employer] without regard to whether Participant continues thereafter to receive any compensatory payments therefrom or is paid salary thereby in lieu of notice of termination.”

Although the Court in Paquette stated that stock options and bonus plans are different, the judicial approach to limiting incentives to terminated employees is arguably similar in Paquette and Kieran. The provision that denied stock options to terminated employees in the Kieran case was upheld by the OCA because it specifically provided that employees would not be able to exercise their stock options during the time they were receiving pay in lieu of notice of termination.

Lessons to be Learned

1. All new employees should be required to sign an employment contract with a termination clause. In the Paquette case, if the employer’s payroll was under $ 2.5 million, then the employer could have reduced its obligation to provide notice of termination from over 73 weeks (or 17 months) weeks to 8 weeks.
2. Some employment contracts provide that an employee is entitled to a bonus and these provisions include conditions that need to be satisfied such as being actively employed at the time the bonus is paid out. This language must be carefully drafted otherwise a court will not enforce the condition. In this regard, the court did leave open the possibility that bonus plan conditions, if appropriately worded, could still be effective.
3. Given the decision in Paquette, employers should consider having an employment lawyer review existing bonus plans to see if their current eligibility requirements will withstand judicial scrutiny.

For over 25 years, Doug MacLeod of the MacLeod Law Firm has been advising employers on all aspects of the employment relationship. If you have any questions, you can contact him at 416 317-9894 or at [email protected]