Written by Lewis Waring, Paralegal, Editor, First Reference Inc.
In a recent Ontario ruling, an employer was found to have wrongfully dismissed an employee whose role had evolved beyond its characterization in his original employment contract. By attempting to rely upon a contract that no longer applied, the employer deprived the employee of his presumed right to reasonable notice of termination.
The employer provided data solutions to manufacturers. The employee co-founded the employer and served as its Chief Technology Officer (“CTO”), after being replaced as its CEO after a venture capital firm purchased shares.
When the employee became CTO, he signed an employment contract with the employer. The contract stated that the employee would be employed as CTO and would carry out the duties of that office set out in any Shoplogix by-laws and as specified by the CEO, subject to the overall direction of the board and “consistent with such office. He was also to perform “any other duties that may reasonably be assigned to him by the CEO or the board. The employee was to report to the CEO.
The 2005 contract provided that the employer could dismiss the employee without cause by giving one month’s written notice and continuing to pay his base salary and group health coverage for 12 months from the date of termination. The employee would also be entitled to be paid an amount equal to the bonus he received in the prior year, pro-rated for the period of the current year up to termination. The 2005 contract provided that its provisions concerning notice and termination were fair and equitable and the payments it contemplated would be in full satisfaction of any claims regarding termination of employment.
The employee’s role as CTO at the time of the 2005 contract involved certain duties as assigned by the CEO. These focused on transferring product and corporate knowledge within the employer. The CTO role at that time did not involve sales, travel, infrastructure responsibilities or financing.
In 2008, the employer and employee entered into an Incentive Compensation Agreement (“ICA”), a bonus plan for management-level employees. The employer did not mention or ratify the 2005 contract when the ICA was agreed to. The 2008 ICA significantly changed the employee’s compensation from the bonus arrangements in the 2005 Contract. The increased compensation provided by the ICA was consistent with substantial and fundamental changes to the employee’s role that began in 2008, when a third CEO replaced the employee’s successor. This third CEO instituted dramatic changes to revitalize the employer. One change was the drastic reduction in the number of senior management personnel, which caused the employee’s workload and responsibilities to increase substantially. These new responsibilities included: managing important aspects of sales and marketing; directing managers and senior staff who were reassigned to report to him; travelling to pursue international sales; handling all of the company’s infrastructure responsibilities; and soliciting investment funds.
In 2017, a new investor purchased all of the employer’s shares and dismissed the employee without cause. The employer offered the employee notice in line with the terms of the 2005 contract, ignoring the 2008 ICA. The employee filed an action for wrongful dismissal, claiming that fundamental changes to his role had taken place, rendering the 2005 contract unenforceable. The court agreed and awarded the employee almost $40,000 in damages.
The common law “changed substratum” doctrine was central to this ruling. Under it, provisions in a written employment contract that restrict or limit the amounts payable to a dismissed employee may be unenforceable. The doctrine applies where there have been fundamental expansions in the employee’s duties after the employment contract was made, such that the substratum of the employment contract has disappeared or substantially eroded, or it can be implied that the contract could not have been intended to apply to the role ultimately occupied by the employee.
In other words, the legal system prevents employers from relying on a contract when the contract is no longer applicable to their real relationship with their employee. When an employee’s job no longer matches the job description as described in his or her employment contract, the employer’s ability to rely on the contract is limited. Specifically, when the employment contract’s description of the employee’s role no longer applies, the employer cannot rely on the contract to determine the employee’s entitlement to compensation upon dismissal. As the contract no longer accurately describes the relationship between the parties, the legal system considers the contract irrelevant.
Since the employment contract did not apply, the court applied the default option for determining an employee’s right to notice upon dismissal, “reasonable notice. Determining what amount of notice is reasonable requires understanding how much difficulty the employee will encounter in finding a similar position. The difficulty an employee will encounter in finding a new position depends upon factors such as:
- The character of the employee’s job;
- The length of service;
- The age of the employee;
- The availability of similar employment; and
- The experience, training and qualifications of the employee.
The changed substratum doctrine operates as a limit on when an employee’s common law entitlements will be restricted by the express terms of a historical written contract. Given that an employer-employee relationship may evolve in a fundamental way after the written contract was made, the doctrine recognizes the potential inappropriateness and unfairness of applying the contract’s termination provisions to circumstances that were not contemplated at the time of contracting.
In other words, the legal system recognizes that strictly applying the terms of a contract, in certain cases, is unfair. When an employment relationship outgrows the relationship originally imagined in its contract, the employer cannot expect to rely on that contract to limit the employee’s right to notice. An employee whose overall value and experience within a role has increased has an increased right to notice, regardless of the rules of their contract.
This ruling demonstrates the importance of understanding when an employment contract applies and when it has become inapplicable. Employers make a dangerous mistake when they presume that a contract signed by both parties governs their relationship absolutely. Contracts themselves are governed by a complex web of rules established by legislators and judges. While contracts may state that the rights of an employee are limited, this attempt to limit an employee will fail if not in line with the larger rules that govern employment relationships in Canada.
In this case, the employer’s new leadership thought it could rely upon the contract signed in 2005 as the one sole authority of the employee’s rights to compensation upon dismissal. It failed to understand that a contract signed in 2008 had replaced the 2005 contract. As such, the employer relied upon a document that had no relevance to the employee’s right to notice. In doing so, the employee breached the employee’s presumed right to reasonable notice, resulting in a wrongful dismissal.
Employers considering a dismissal without cause must always proceed with caution. Before assuming that an employment contract provides an ability to limit an employee’s right to notice, an employer must make sure that the contract is still applicable. By avoiding reliance upon faulty provisions that are no longer relevant, employers can avoid massive risks of liability that may result in costly damage awards and legal fees.