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Finishing touches -- wrapping up the termination process

In our discussion of the termination process in the last issue of FOCUS (see "Terminating employees: a tough job, but someone's got to do it" on our Publications page), we concentrated on the issues employers should bear in mind to make a termination unassailable in court, whether or not dismissal is for cause. We arrived at the point at which the employee is given the news, leaves the premises, and the active employment relationship comes to an end. Now we will turn our attention to the matters that typically arise towards the end of the termination of employment, starting with the release agreement that formalizes the breaking off of the relationship.

MAKING THE RELEASE EFFECTIVE

The purpose of a release is to protect the employer from legal action by a departing employee, in return for payment to the employee of a settlement package. As a result, a release will be required predominantly where no just cause has been alleged.

The observations we made in connection with the enforceability of employment contracts in the April 1999 edition of FOCUS (see "The effective employment contract" on our Publications page) also apply to release agreements. Not only are release agreements contracts which must conform to certain legal requirements in order to be valid, they are a form of contract that is subject to increased judicial scrutiny because of the perceived inequality in the bargaining power of the two parties to the agreement. Failure to ensure the agreement's validity may pave the way for a wrongful dismissal action.

The first legal requirement for validity is consideration: each party must receive something of value from the agreement. This means, for example, that the employee's severance must exceed that to which he or she is entitled under the Employment Standards Act. If an employer pays only the minimum statutory entitlement, it has not given anything of value to the employee, because the employee was already entitled to this amount before the agreement was concluded.

Second, an employer must be able to show that the employee was not coerced into signing the agreement. This can be achieved by giving the employee adequate time to seek legal advice before signing the release, and by including a clause indicating that this was done.

Third, the agreement should contain specific language addressing all the employee's potential claims against the employer. As a rule, courts will not enforce an agreement that speaks only in vague generalities of the employee releasing the employer from all liability. The agreement should set out that the payment is made in full satisfaction of all statutory and common law entitlements to termination and severance pay, vacation pay, benefits, and any other amounts owed to the employee. It should also state that the payment satisfies all common law and statutory obligations. Note however that, under the Workplace Safety and Insurance Act, any agreement by a worker to forego benefits under the Act to which the worker or the worker's survivors may be entitled is void. Moreover, the result in Pritchard v. Ontario (Human Rights Commission), which we report in this issue of FOCUS (see "Bringing human rights complaint after signing release not necessarily bad faith" on our Publications page), would appear to indicate that the Commission is not bound to honour a release of liability under the Human Rights Code, should the employee subsequently file a complaint.

EMPLOYMENT REFERENCES

The topic of employment references was dealt with in detail in the October 1998 issue of FOCUS (see "Employment references: Care, not silence, required" on our Publications page). What should be stressed here is that care must be taken to avoid either defaming the employee or misleading a prospective employer about the employee in a way that causes that employer to incur damage. This balancing act is made even more delicate when cause has been alleged against the employee and litigation is a possibility. However, refusing to give references or providing only minimal, factual references entail other difficulties and are not satisfactory solutions. To minimize the chances of transmitting erroneous or defamatory information, therefore, employers should set up a centralized system for providing references under the supervision of a designated person. This individual should be trained in the issues that may arise when a reference is given or refused.

EMPLOYEE'S DUTY TO MITIGATE

Even if an employee is dismissed with notice, that employee is bound to mitigate his or her damages by making reasonable efforts to secure alternate employment. In practice, the duty to mitigate usually becomes a factor when the termination has ended up in court, as an employee's failure to mitigate can then be deducted from damages awarded by the court. It is important to bear in mind that the employer has the onus of proving that the employee's efforts to mitigate were not reasonable. Courts have signalled that a "reasonable" effort does not mean that the employee must aggressively pursue every possibility of new employment.

In the absence of litigation, there may be circumstances in which an employer may wish to pay the severance in instalments over the notice period and have the release agreement specify that the payments to the employee will cease when the employee finds new work.

EMPLOYEE BENEFITS DURING THE NOTICE PERIOD

Courts have held that employees must be compensated for any lost benefits to which they would have been entitled during the notice period. The Employment Standards Act also requires that benefits be maintained during the prescribed statutory period. Generally, courts will award damages for loss of medical and dental benefits and lost contributions to RRSPs and private pension plans.

However, FOCUS readers will recall from the October 1997 issue (see "Supreme Court rules disability benefits must be deducted from wrongful dismissal damages" on our Publications page) that the Supreme Court of Canada has ruled that, when the employer has fully funded a disability plan and the dismissed employee is in receipt of disability benefits, these benefits will be deducted from the damages. On the other hand, when the dismissed employee receiving benefits had contributed to a private plan, an Ontario court has declined to deduct these benefits from the award.

In general, when a benefit is provided under a private insurance plan, and the plan requires that the employee be actively employed, the prudent course is to advise the dismissed employee of any conversion rights that may be available under the policy and the time limits for exercising the rights. Failure to do so may result in the employer being held liable to the employee or to the employee's beneficiary for benefits to which they would have been entitled during the notice period.

Clothing, automobile and meal allowances are generally not compensated, on the basis that they are intended to reimburse employees for work-related expenses. The situation will be different, however, when it can be demonstrated that the allowance was intended to be a form of personal benefit or remuneration.

Accumulated vacation pay is generally awarded as damages, unless this accumulation is barred under company policies or the employment contract. Conversely, unused sickness benefits are usually not compensated, unless such compensation is provided for under the employer's policies or the contract.

TAX CONSIDERATIONS

Wrongful dismissal damages, whether awarded or agreed to by the parties, are fully taxed. The issue is whether Revenue Canada considers such damages to be "income from employment" or "retiring allowances". The significance of the distinction between income and a retiring allowance is that the latter is not subject to deductions for Canada Pension Plan or unemployment insurance premiums. Also, income, unlike a retiring allowance, cannot be transferred directly into an employee's RRSP without withholding tax.

Generally speaking, lump sum payments in lieu of notice are considered to be retiring allowances, despite some indications by Revenue Canada that payment in lieu of notice may be considered to be income. Where the payment can be characterized as severance, including severance under the Employment Standards Act, or as damages for wrongful dismissal, it will be viewed as a retiring allowance. While there have been contradictory signals from the courts, it would appear that mental distress damages, which normally are not taxable, are considered to be part of a retiring allowance when they arise in connection with a loss of employment.

A portion of a retiring allowance must be deducted from the payment and remitted to Revenue Canada. This is the employer's responsibility, and failure to comply may result in penalties or prosecution. Accordingly, an employer that is in doubt about its obligations should err on the side of caution -- withhold and remit.

In Our View

The termination process can be made easier if the employer has a clear understanding of the extent of its obligations. This knowledge will help prevent litigation, or increase the chances of prevailing where litigation cannot be avoided. When an employer is contemplating dismissal for cause, there will be considerable savings, but it is vital to know what constitutes cause, and to document both the evidence for cause and the attempts to remedy the employee's conduct or performance.

Where no cause is alleged, and no explicit contractual provisions apply, the employer must determine what constitutes a reasonable notice period for the employee, having regard to the employee's age, years of service, position in the organization, and his or her likelihood of securing similar employment. Above all, the employer must ensure that the matter is handled with sensitivity, and must avoid embarrassing or humiliating the employee.

For further information, please contact André Champagne at (613) 563-7660, Extension 229.