Employee Bonuses and Legal Pitfalls

By Carman J. Overholt, Q.C. and Victoria Petrenko

Introduction

Incentive compensation is increasingly an important term of employment for employers and employees. Employers are using incentive compensation to achieve a variety of business goals.

Incentive compensation for many employees now represents a much larger element of an employee’s compensation than ever before. To limit and define the contractual obligation to pay incentive compensation, employers are introducing a range of written policies and terms of employment.

A number of recent noteworthy cases have identified problems related to the enforceability of some of the more common contractual terms utilized. Two back-to-back decisions of the Ontario Court of Appeal recently helped to clarify the circumstances in which a dismissed employee will be entitled to damages for the loss of the opportunity to earn incentive compensation.

Paquette v TeraGo Networks Inc., 2016 ONCA 618

Mr. Paquette was dismissed without cause from TeraGo after 14 years of employment and initiated a wrongful dismissal proceeding seeking compensation for the loss of salary, benefits, and bonus.

Under TeraGo’s bonus program, employees are eligible for a bonus only if they are "actively employed by TeraGo on the date of the bonus payout". Employees would be eligible to receive a bonus on two conditions; if the employee met his or her personal objectives (which were determined by management), and if the company’s performance met their overall corporate objectives.

At trial it was determined that Mr. Paquette was entitled to a notice period of 17 months. However, the Court declined to award any damages for the loss of the opportunity to earn a bonus on the basis of the Bonus Plan which required the employee to be actively employed at the time that the bonus was payable. The trial judge found, at paragraph 64 of the judgment, that "Paquette may be notionally an employee during the reasonable notice period; however, he will not be an ‘active employee’ and, therefore, he does not qualify for a bonus."

On appeal, the Court determined that the motion judge was incorrect. When awarding damages for wrongful dismissal, the starting principle is that the dismissed employee is entitled to compensation for all losses arising from the employer’s breach of contract, which occurs when the employer fails to give adequate notice. When determining the quantum of damages, the Court typically includes all of the compensation that the employee would have earned during the notice period. This may include an amount for a bonus that the employee would have received had he or she continued to be employed during the notice period, particularly where the bonus is an "integral part" of the employee’s compensation package.

A bonus provision in a contract may include eligibility criteria or a formula that determines whether or not the employee is entitled to the bonus, and thus the Court determined that the terms of a written bonus plan will "often be important in determining [that] component of a wrongful dismissal damages award". The motion judge incorrectly focused on the wording of the Bonus Plan to the exclusion of other considerations. On appeal, the Court found two errors in the judge’s approach.

The first error was that the employee’s entitlement to a bonus did not actually depend on whether or not he was actively employed after his dismissal. The Court should have only focused on the determination of his damages, which included his total compensation and benefits, "to which he would have been entitled but for the wrongful termination of his employment". Put another way, the employee would have been actively employed but for the wrongful termination of his employment, and presumably would have been eligible for that bonus payment during the notice period.

The second error was the focus of the judge on whether the term, "active employment" was "ambiguous". At paragraph 24:

  • The motion judge ought to have commenced his analysis from the premise that the appellant’s common law right to damages was based on his complete compensation package, including any bonus he would have received had his employment continued during the reasonable notice period, and then examined whether the bonus plan specifically limited or restricted that right.

The question before the trial judge was not whether the bonus plan was ambiguous, but "whether the wording of the plan…was effective to limit his right to receive compensation for lost salary and bonus during the period of reasonable notice".

The Court found that the term, "active employment" was not sufficiently clear to deprive the employee of his claim to a bonus that he would have received had he not been wrongfully dismissed. The employee was granted compensation for the loss of bonus for the length of his notice period, which added $58,386.64 to the judgment he obtained against his former employer.

Lin v Ontario Teachers’ Plan, 2016 ONCA 619

On the same day that the Paquette decision was handed down, the Court of Appeal delivered their decision in Lin, a case which also dealt with the subject of incentive compensation and the loss of the opportunity to earn that compensation in a wrongful dismissal action.

Mr. Lin, an employee with eight years of service, was terminated, allegedly for cause and claimed damages for wrongful dismissal. The trial judge found that the employee had been terminated without just cause and awarded him 15 months damages in lieu of notice. Included in the employee’s damages were specific amounts that the employee would have earned pursuant to the employer’s short-term and long-term incentive plans. The employer, the Ontario Teachers’ Pension Plan Board, appealed the decision on numerous grounds, including that the employee was entitled to be paid in accordance with the company’s bonus plans.

At issue was the fact that the two bonus compensation plans had similar language which the employer argued disentitled the employee to any bonus after his employment was terminated. These "forfeiture provisions" were introduced in 2010, a year before the employee was dismissed. The employer’s alternative argument was that the plans contained language, prior to being amended in 2010, that provided for no bonus payment after termination of employment. The Court of Appeal summarized the employer’s central argument as being that the "trial judge erred in determining that dismissed employees are always entitled to compensation for bonuses" 1.

Citing Paquette, the Court of Appeal in Lin noted that "’[d]amages for wrongful dismissal may include an amount for a bonus the employee would have received had he continued in his employment during the notice period, or damages for the lost opportunity to earn a bonus. This is generally the case where the bonus is an integral part of the employee’s compensation package’" 2

The Court looked at the language of the two plans and rejected the argument that the employee was barred from recovery of compensation for the loss of the bonus or opportunity to earn a bonus. The Court likened the wording of these terms to the "active employment" provision in Paquette, and found that it was "insufficient to deprive a terminated employee of the bonus he or she would have earned during the period of reasonable notice".

Best Practices

An employee who has been wrongfully dismissed may be entitled to damages for the loss of bonus and the opportunity to earn a bonus and other loss of incentive compensation. Damages are not restricted to salary, wages and benefits. Employees are also entitled to compensation for the loss of bonus and other forms of incentive compensation unless the wording of the employment agreement is clear in limiting recovery of incentive compensation upon termination of employment.

Written employment contracts and policies that reflect the goals of the organization and include reasonable limitations on incentive compensation upon termination of employment are necessary. Where a bonus is, as the Court in Paquette noted, an "integral part of the employee’s compensation package", it is more likely that the employer will be responsible for payment of the bonus to the employee upon termination of employment, or an amount that reflects the loss of the opportunity to earn a bonus. In determining that amount, the Court will look at the amount of prior bonuses or incentive compensation paid to the employee.

These cases demonstrate the importance of written employment contracts and policies that clearly define any limitations on the payment of bonuses and other incentive compensation upon termination of employment.


[1] Lin, supra, at para 8.

[2] Lin, supra, at para 84, citing Paquette, supra, at para 17.