Employment Contracts: The Top Five Mistakes Made by Small Businesses

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BY NEENA GUPTA  |  PARTNER, GOWLINGS

As lawyers, we encourage our clients to have written agreements in order to avoid misunderstandings and disagreements regarding what the parties intend.

This is especially important when small businesses are building their teams and hiring new staff. A well-written employment contract will help avoid misunderstandings and disagreements regarding what is expected of both the employer and the employee.

In this article, I’ve outlined the 5 most common (and avoidable) employment contract errors.

Error #1  — Assuming that the employment standards legislation is comprehensive

Business owners routinely look up the employment standards legislation on the internet in order to understand the basic legal requirements governing their business.  In almost every province, the employment standards only describes minimum obligations.

It is a huge mistake to assume, however, that just because the legislation permits something that it applies to a specific employment relationship.

For example, under section 54 of the Ontario Employment Standards Act, 2000, no notice or compensation in lieu of notice is required if an employee is terminated within the first three months of employment. Ontario employers often assume that because of section 54, the first three months of employment serve automatically as a “probation period.” Wrong!

Courts have decided differently.  The law states that most employment relationships can only be terminated by the employer on “reasonable notice” or for just cause.  Reasonable notice can be 1 to 12 months, even for a new employee, especially if the employee was enticed away from secure employment. There are numerous cases where employees get more after they are terminated than they ever earned before!

If the employer wants a probationary period, it must prove that the employee knew and accepted the probationary clause. The easiest proof is to incorporate a well-worded probationary clause in the offer letter or employment contract.

Error #2 – The incorrect use of fixed term or fixed-task agreements

There are numerous employment precedents that are structured as a fixed-term employment agreement. Fixed-term or fixed-task contracts are certainly appropriate where an employer has a logical basis on which to limit the term of employment. Examples include:

  • Maternity leave replacement;
  • Hires for specific task or project;
  • Grant-based project with definite completion dates;
  • Time-limited transition requirements, e.g., after a sale or acquisition.

The common law’s position on fixed-term or fixed-task arrangement starts with the logical assumption that since the employer and the employee are aware of the inherently temporary nature of the employment, the formality of notice ought not to be required.

Legislation can change that common-law proposition. For example, in Ontario, there have been significant legislative amendments to the common law position. Regulation 288/01 of the Ontario Employment Standards Act, 2000 provides that where the fixed-task or fixed-term exceeds 12 months or where the employment ends before the end of the term or task, statutory notice is due. Furthermore, where the term has been extended more than 90 days beyond the original term, notice is due.

Error #3 – When indefinite employment is disguised as a series of fixed-term contracts

Another common problem is the use of a series of fixed-term contracts, some of which are subject to an “automatic renewal” clause. In other cases, the contracts essentially run “back to back,” creating a continuous chain of employment.

The Ontario Court of Appeal in Ceccol v. Ontario Gymnastics Federation dealt squarely with this issue. Diane Ceccol had worked continuously for almost 16 years with the Ontario Gymnastics Federation (OGF), pursuant to a series of written one-year term agreements.

At the time of termination, the OGF tried to rely on the term clause as a basis for termination, thereby avoiding the provision of reasonable notice or compensation in lieu thereof. The courts looked at the underlying reality of an employee who had clearly served without interruption for almost 16 years. The courts did not accept that the situation was truly that of a fixed-term employee and found that the relationship was one of a contract of “indefinite” employment.

Since the contract is found to be indefinite, the fundamental common law principle applies: “a contract of employment for an indefinite period is terminable only if reasonable notice is given.” This presumption of reasonable notice can be rebutted only if the employment contract “clearly specifies some other period of notice.”

It should be noted that many not-for-profits use term agreements, because of the uncertain nature of grant funding. Such organizations can ill-afford payment of huge amounts of notice. In the circumstances, careful attention must be paid to termination clauses in order to limit exposure as much as possible.

Error #4 – Sloppy Drafting of Termination Clauses

Most lawyers recommend a termination clause. Be careful how these clauses are worded and make sure the standard offer is reviewed by a skilled professional every year or two.

Just saying that a person will get “x amount of notice or compensation in lieu” is not good enough.  The phrase “compensation in lieu thereof” is often not appropriately defined.  Employees often enjoy a package of compensation including:

  • Base salary;
  • Retirement benefits, either RRSP or pension contributions;
  • Car allowance;
  • Health, dental and prescription drug coverage;
  • Short- and long-term disability coverage;
  • Stock options or similar rights, such as Restricted Stock Units or Stock Appreciation Rights;
  • Bonus;
  • Commission;
  • Reimbursement of professional fees and dues; and
  • Reimbursement of professional education or tuition subsidy.

The use of the phrase “compensation in lieu” is simply not precise enough to deal with situations where an employee benefits from many types of compensation.

Compensation in lieu should be specifically defined. The types of group benefits that will be provided beyond the termination date should be specified, since most group insurance plans will not permit disability and out-of-country travel to be extended beyond the statutory notice period.

There can be dangerous surprises lurking in stock option agreements, many of which restrict vesting and exercise rights post-termination. Unless the employment agreement is unambiguous, the courts will imply an obligation to compensate an employee for the loss of stock option benefits during any contractual or common-law notice period.

Even where the pension or stock option document purports to limit accrual of benefits to active service, the over-arching employment agreement will be found to provide the employee with a right to damages. As such, it is important to ensure that termination clauses explicitly describe what rights exist or do not exist upon termination.

Finally, even with great clauses, employees might try to sue because of some human rights issue. There are ways of ensuring that an employee does not get anything more than the minimums without a full Release.

Error #5 – Not having a written offer at all.

The worst and most common error: not having a written offer at all.  To quote Samuel Goldwyn, “a verbal contract isn’t worth the paper the it’s written on.” Even worse, a verbal contract allows a judge to impose terms and conditions of employment. Without a written offer, a judge will decide on:

 

  • Whether changes to the terms and conditions of employment are fair and permissible;
  • Whether or not certain types of misconduct are bad enough to constitute just cause for immediate termination;
  • Whether an employer can change benefits or compensation to reflect a downturn in the economy;
  • How much notice or compensation in lieu of notice is fair when an employee is terminated without just cause.

In every case, the judge or court will favour the rights of the underdog or the employee.

Conclusion

Small businesses are not given any breaks and are often required to meet the same standard as large multi-national conglomerates.

The best way to help your start-up avoid an expensive court battle with an employee is to invest in a clearly-worded offer letter that is vetted by a skilled employment lawyer. Every year or so, take your employment lawyer out to lunch and ask whether any updates are required.  You will save thousands of dollars and countless headaches. Remember, an ounce of prevention is worth a pound of cure!

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If you have questions about drafting an employment contract or would like more information on anything mentioned above, please visit the Gowlings website to speak with a legal professional.