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Terminating employment based on frustration of contract – what employers need to know

Employers face challenges when an employee suffers from a long-term illness or disability and cannot return to work for significant periods of time.  Often in such circumstances the critical question for the employer is whether the employment relationship can be terminated due to the employee’s long-term absence.  In other words, has the employment contract been frustrated by the employee’s sustained inability to return to work?  If the employment contract has been frustrated, the employer is entitled to terminate the employment without liability (other than what is required under the applicable employment standards legislation).  On the other hand, if the contract is not frustrated, an employer who terminates the employment may face a civil claim for wrongful dismissal and a discrimination claim under human rights legislation.  Therefore determining whether an employment contract has been frustrated is laden with legal risk.  Two recent Ontario decisions may assist employers to determine whether an employment contract has been frustrated to the extent that the employment relationship can be terminated.

THE NACCARATO v. COSTCO DECISION

In Naccarato v. Costco (May 2010) Mr. Naccarato, a Costco employee of 17 years, was dismissed after a prolonged absence of five years due to illness.  Mr. Naccarato sued Costco claiming wrongful dismissal. 

Costco attempted to defend the dismissal on the basis that the employment contract was frustrated by Mr. Naccarato’s sustained absence.  The employer relied on the Supreme Court of Canada’s decision in Hydro-Quebec v. Syndicat des employé(es) de techniques professionnelles et de bureau d’Hydro-Quebec, section locale 2000 (SCFP-FTQ) (2008).   In the Hydro-Quebec case, the Supreme Court upheld an arbitrator’s decision to dismiss the grievance of an employee who had been terminated from employment after missing 960 days of work over 7 ½  years due to illness.  The Supreme Court stated,

“…The employer’s duty to accommodate ends where the employee is no longer able to fulfill the basic obligations associated with the employment relationship for the foreseeable future.” 

The court in Naccarato started its analysis by setting out the doctrine of frustration in the employment context as explained in Skopitz v. Intercorp. Excelle Foods Inc. (1999):

“Whether a contract of employment has been frustrated by an employee illness or incapacity depends on whether or not the illness or incapacity was of such a nature, or likely to continue for such a period of time, that either the employee would never be able to perform the duties contemplated by the original employment contract or that it would be unreasonable for the employer to wait any longer for the employee to recover.”

The court also cited the decision in Dragone v. Riva Plumbing Limited (2007) which holds that the onus is on the employer to prove that the employee is permanently incapacitated from returning to work. 

Based on the evidence before it, the court in Naccarato was not satisfied that Mr. Naccarato was no longer able to fulfill the basic obligations of the employment relationship:

“In this case, although the duration of the illness is significant, a period of five years, the medical evidence does not support a finding that there is no reasonable likelihood of the employee returning to work in the reasonably foreseeable future.  Rather, the evidence is that the employee is still being treated by his doctor as a new psychiatrist is being sought.”

The court then considered whether the employer would suffer hardship if the employment relationship was maintained.  It found that, due to Mr. Naccarato’s position as a “return-to-vendor” clerk, it would not be unreasonable for Costco to wait longer for Mr. Naccarato to recover.  It cited the following from the decision in Dragone,

“…when the absent employee is a senior executive whose absence cannot be long tolerated if the business enterprise is to succeed, then a relative short period of incapacity may frustrate a contract.  However, a longer period of time before frustration occurs may be the case for employees with lesser roles in the business.”

Given the absence of both medical evidence showing that Mr. Naccarato would not return to work, and evidence showing hardship or disruption to Costco’s business as a result of maintaining Mr. Naccarato’s employment, the court rejected Costco’s frustration of contract defence.  It held that Mr. Naccarato had been wrongfully dismissed and awarded him damages in lieu of reasonable notice calculated in light of the Bardal factors.

THE DUONG v. LINAMAR DECISION

In Duong v. Linamar (May 2010) Mr. Duong was dismissed based on frustration of contract after he had been on disability leave for almost four years.  Mr. Duong suffered from back pain and qualified for long-term disability (LTD) benefits.  These benefits were ultimately withdrawn as a result of Mr. Duong’s failure to participate in a rehabilitation program.   

The court began its analysis by setting out the test for contract frustration from the Supreme Court’s decision in Naylor Group Inc. v. Ellis Don Construction Ltd (2001).:

“Frustration occurs when a situation has arisen for which the parties made no provision in the contract and performance of the contract becomes ‘a thing radically different from that which was undertaken by the contract’.”

The court noted that a somewhat refined test for frustration was applied in the employment context in the decision Marshall v. Harland & Wolff Ltd, (1972) as follows:

“…the question to be asked is: was the employee’s incapacity, looked at before the purported dismissal, of such a nature, or did it appear likely to continue for such a period, that further performance of his obligations in the future would either be impossible or would be a thing radically different from that undertaken by him and agreed to be accepted by the employer under the agreed terms of his employment?” 

With this legal framework in mind, the court then considered the circumstances and the evidence.  It found the length of the absence—just less than four years—to be significant.  The case law suggests that the longer an illness persists, the more likely that frustration has occurred.  There was no medical evidence of an improvement to the employee’s condition or that there would be improvement in the future.  The court also found that the employee’s failure to participate in the rehabilitation program, coupled with the failure to appeal the termination of the LTD benefits, supported the notion that there was no foreseeable date for Mr. Duong to return to work.

In applying the case law to the facts above, the court found that maintaining the employment relationship would require the employer to do something radically different from what it undertook in the contract of employment.  The court dismissed Mr. Duong’s claim because the employer was entitled to terminate the employment relationship due to the frustration of the contract.

LESSONS FOR EMPLOYERS FROM THE DUONG AND NACCARATO DECISIONS

Although the results in Duong and Naccarato differ, employers may still take guidance from these decisions when assessing whether an employment contract has been frustrated.  The most important aspect in such an assessment, as shown in Naccarato, is whether there is sufficient evidence to show that the employee will not be able to return to work in the future.  An independent medical assessment showing a permanent incapacity to return to work should suffice to establish frustration of contract in most situations. 

In the absence of conclusive medical evidence showing the employee’s inability to return to work, the most important consideration may be the length of the employee’s absence.  In Wightman Estate v. 2774046 Canada Inc. (2006) the court made it clear that the longer an illness persists, the more likely that frustration has occurred:

“Sickness will not frustrate an employment contract when the employee appears likely to return to work, but the longer the sickness persists, the more likely the employment relationship has been destroyed.”

Another important consideration is whether the employer provides long-term sick and disability benefits.  The effect of the presence of such benefits was stated in the Dragone decision:

“The presence of long-term sick leave and disability benefits indicates a greater tolerance for the duration of an employee’s absence before frustration occurs.  Indeed, it has been suggested that contracting for these benefits may postpone the time of frustration because it may be inferred that the contracting parties anticipated that the employee might take leave for illness.” 

Employers should also be aware of the requirements of human rights legislation.  In Ontario, the Human Rights Code prohibits discrimination against employees on the basis of disability.  Employers are required to accommodate disabled employees to the point of undue hardship.  In the context of an employee’s long-term absence due to illness or disability, the employer will be required to make whatever accommodations are necessary for the employee to return to work, short of undue hardship.  As noted above, the Supreme Court has stated that the employer’s obligation to accommodate in this regard ends when the employee is no longer able to fulfill the basic requirements of the employment contract for the foreseeable future.

The courts will also consider other factors in assessing whether an employment contract was frustrated by an employee’s long-term illness.  These factors may include the nature of the employment; how long the employment was likely to last in the absence of illness; and the period of past employment.  Although these factors may be considered by a court, they are not determinative.  As the decisions in Naccarato and Duong demonstrate, each case will be decided on the basis of its own facts.

In Our View

To a certain degree, the differing results in Naccarato and Duong can be explained by the presence or absence of medical evidence showing a permanent incapacity to return to work.  Nevertheless, the courts in each case seem to diverge somewhat in their approach to contract frustration.  In Naccarato the decision turned on the absence of evidence showing a permanent incapacity on the part of the employee.  In Duong the court seemed to focus on the length of the absence, and the lack of evidence showing the possibility of improvement in the employee’s condition.  If a court is persuaded by the Duong approach, there may be a lesser burden on employers to demonstrate a permanent incapacity.  Instead the court may be satisfied that the contract has been frustrated by the length of the employee’s absence, the lack of evidence showing improvement in the employee’s condition, and the other factors discussed above.  Since the Naccarato and Duong decisions were released at about the same time, it will be interesting to see which approach courts will adopt in future contract frustration cases. Mr. Duong has recently appealed the court’s decision. The appeal is scheduled to be heard in January 2011. We will keep readers informed of future developments.

For further information, please contact Sheri Farahani at (613) 940-2745.