Changes in executive’s duties, pay renders termination clause unenforceable

Significant changes to role beyond what was contemplated at contract signing

Changes in executive’s duties, pay renders termination clause unenforceable

“Employers should ensure that their employment agreements expressly state that their terms will continue to apply notwithstanding any changes to the employee's position, responsibilities, compensation or benefits.”

Faraz Kourangi, an employment lawyer with Williams HR Law in the Toronto area, offers these words of caution after the Ontario Court of Appeal upheld a wrongful dismissal award of more than $400,000 for a worker whose employment contract was unenforceable due to major changes in his job.

If such express language isn’t present, then if an employee is promoted or their responsibilities, compensation or other important terms of employment are increased, employers should enter into new agreements with enforceable termination clauses, says Kourangi.

Shoplogix is a company that provides software for the manufacturing sector and is based in Oakville, Ont. The worker co-founded Shoplogix in 2002 and became the company’s CEO.

Employment contract

In 2005, a venture capital firm purchased some Shoplogix shares from the founders. The worker stepped down and assumed the position of chief technology officer (CTO). He signed a written employment contract dated May 17, 2005.

The contract stipulated that the worker would perform CTO duties at the direction of the CEO and the board of directors, as well as “any other duties that may reasonably be assigned.” The worker’s duties involved transferring product and corporate knowledge within Shoplogix.

The contract also included a termination clause that permitted Shoplogix to dismiss the worker with one month’s written notice and 12 months of salary and benefits continuance.

In 2008, the worker entered into an incentive compensation agreement (ICA), which was a bonus plan for management-level employees. This significantly increased the worker’s compensation from the bonus provisions in the existing employment contract, and the ICA didn’t refer to the 2005 contract. The ICA stipulated that, in the event of termination, the worker would receive a pro-rated bonus for that year up to the date of termination.

Around the same time, Shoplogix instituted significant changes, including a reduction in management personnel. This increased the worker’s workload and responsibilities to include managing key aspects of sales and marketing, directing managers and senior staff, travelling for international sales, handling all of the company’s infrastructure, and soliciting investment funds.

Dismissed without cause

Another company purchased all of Shoplogix’s shares on March 2, 2017, and dismissed the worker without cause the same day. Shoplogix followed the 2005 contract and continued the worker’s salary and benefits for 12 months. It also paid him an amount equal to the pro-rated 2017 bonus up to that point.

The worker sued for wrongful dismissal, alleging that the 2005 employment contract was unenforceable – applying the “changed substratum doctrine” relating to significant and fundamental changes in the employee’s duties after the employment contract was implemented.

“In the employment context, [the changed substratum doctrine] is the principle that if material terms of a written employment agreement, such as the employee's duties or compensation, have significantly changed over the course of employment, the foundation of the employment has disappeared or been eroded such that the employment agreement, including its termination provisions, could no longer be enforced,” says Kourangi.

The case was granted summary judgment and the motion judge found that the worker’s job duties “changed substantially and fundamentally over the course of his employment.” When Shoplogix reduced management personnel, the worker’s job responsibilities “far exceeded any predictable or incremental changes” that he could have reasonably expected when he became CTO in 2005, said the judge, adding that the ICA significantly changed the worker’s compensation.

The motion judge also found that Shoplogix failed to obtain acknowledgment from the worker that the 2005 contract still applied while the significant job changes were occurring. In addition, the contract did not expressly state that it would continue to apply notwithstanding changes in the worker’s responsibilities, said the judge.

Contract unenforceable

The motion judge ruled that the 2005 contract was unenforceable and the worker was entitled to common law damages for a reasonable notice period of 18 months. Shoplogix was ordered to pay six additional months of salary and benefits to the worker plus an ICA bonus equal to what the worker would have earned in the 18-month notice period, minus the pro-rated bonus for 2017 that Shoplogix had already paid – totalling more than $400,000.

Shoplogix appealed, arguing that the changes in the worker’s duties were incremental. It also said that the ICA limited the worker’s bonus entitlement to the pro-rated amount up to the date of termination.

The worker cross-appealed, arguing that the pro-rated bonus paid to him should not have been deducted, as it was for the period of 2017 that he had already worked, while the damage award was for the bonus he would have earned during the notice period.

Shoplogix could have avoided the risk of the employment contract becoming unenforceable by either: including a term stating that the agreement would still apply notwithstanding any changes to the worker’s responsibilities or compensation; entering into a new employment agreement; or obtaining an acknowledgment that the original termination provisions would apply, says Kourangi.

However, Kourangi notes that entering into a new agreement or implementing significant changes would require consideration for the worker.

“Anytime you're introducing a change to the terms of an employee's employment, you should be obtaining consideration for that change,” he says. “They did provide additional compensation in 2008 [with the ICA], so that would have been an opportunity for them to have obtained either a new agreement or an acknowledgement.”

Limit on time to restrict entitlements

The Court of Appeal noted that the changed substratum doctrine serves as a limit on how long an older employment contract can restrict an employee’s common law entitlements, as it would be unfair to apply termination provisions if circumstances changed to the point where they weren’t contemplated at the time of the contract signing.

The appeal court noted that, although the worker’s job title didn’t change, the reality of the circumstances were what mattered. In this case, it was reasonable for the motion judge to find that the worker’s duties changed substantially given the evidence, and these changes exceeded any predictable or incremental changes that could have been expected when the worker became CTO, said the appeal court.

“The court focused more on the substance of the arrangement between the parties instead of just focusing on the job title,” says Kourangi. “The court dug deeper and said this employee's job responsibilities have changed significantly in a manner that was not originally contemplated when they entered into the employment relationship - that's why the doctrine was engaged.”

The Court of Appeal also agreed with the motion judge that the 2005 contract did not include a term expressly stating that it continued to apply notwithstanding any changes. The contract’s statement that the worker’s duties would include any other duties that may reasonably assigned did not cover such fundamental changes, said the court.

As for the ICA, the appeal court also agreed it did not limit the bonus entitlement to a pro-rated amount for the year. The ICA stated that the amount was pro-rated to the date of termination, but it didn’t clarify what was considered the date of termination. In the common law, termination of employment is considered to be the end of the reasonable notice period – meaning that, without express limiting language, the worker was entitled to a bonus entitlement for the 18-month notice period, the court said.

Bonus payment up to termination

The court allowed the worker’s cross-appeal that the deduction of the pro-rated bonus payment was an error. Although the 2005 contract was unenforceable, the ICA was still in effect and provided for a bonus payment up to the date of termination, said the court.

The Court of Appeal upheld the damage award for reasonable notice and bonus payments for the 18-month notice period, with a small deduction for the miscalculation of the bonus entitlement rather than deducting the whole pro-rated bonus payment – adding $37,000 to the total award.

This is yet another example from the past decade of case law where the courts have found a reason not to enforce a termination clause, says Kourangi.

“Even though there was no change to the employee's job title, the fact that there was a significant change to the employee's job duties was enough to engage the doctrine,” he says. “I anticipate that employee counsel will be capitalizing on this decision as yet one more argument that a termination provision cannot be relied upon.”

See Celestini v. Shoplogix Inc., 2023 ONCA 131.

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