Negotiating the severance package

Discipline and Dismissals | Severance

In many dismissals without cause, the parties engage in extended negotiations regarding the severance package that the dismissed employee will receive. If negotiations fail, litigation may ensue. Where there is no enforceable termination clause in place, there is ambiguity regarding the employee’s entitlement which allows for room to negotiate. Both parties should understand the issues, as well as their options, before engaging in such negotiation. We assist both employers and employees in assessing and negotiating severance packages. When negotiation fails, we go to court on their behalf.

Ambiguous Requirement of “Reasonable Notice” Leads to Negotiation and Litigation

The common law provides that all employees are entitled to “reasonable notice” of termination. Our courts have deliberately refused to define reasonable notice or provide an easy way to calculate an individual’s entitlement. Rather, our courts have steadfastly maintained that every situation is to be assessed based upon its own particular characteristics. Contrary to popular belief, there is no rule of thumb of one month per year of service (or any other amount), and severance is calculated based upon a number of factors, including

  1. length of service,
  2. age of the individual,
  3. nature of position / employment, and
  4. the availability of similar employment.

Other relevant factors can include inducement. Because courts have significant discretion in determining what is “reasonable”, it is difficult to predict with any certainty what a court will award in any particular case. For that reason, where there is no contractual term which clearly sets out what the individual is entitled to, there will typically be negotiations.

Know the Strengths and Weakness of Your Case

When negotiating a severance package, both parties should assess the likely outcome if they were to go to court. Any potential resolution should be compared to that outcome, while also bearing in mind the practical reality that a negotiated settlement allows a party to avoid the unnecessary expenditure of time and money, as well as the indirect costs and stress, of trial.

For the employee, there is an obvious benefit in receiving the severance payments relatively quickly, rather than having to wait until trial. There is also a benefit in avoiding the cost, risk and stress of litigation. From the employer’s perspective, while they may prefer to delay payment, avoiding the litigation process will mean that they can reduce legal fees as well as avoid having staff and management spend their time preparing for litigation when they have more productive ways to spend their time. That said, in many cases, employers will decide to take a hard line when negotiating in order to avoid being seen as an “easy target”.

Consider Whether to Continue Paying While You Negotiate

Employers should also recognize that there is often little purpose served in trying to starve the employee by refusing to pay anything more than the statutory minimum amounts. In almost every case, the employer will be ordered to pay more than that the statutory minimums. In some cases, it will be strategic to continue the individual’s salary and benefits while negotiations are ongoing. This will create diminishing returns and provide a disincentive to the employee when they are considering litigation, as their potential recovery will be reduced with every paycheque. At the same time, if the matter does proceed to litigation, they will look good in the eyes of the judge if they say that they acted in good faith by recognizing their common law obligations and continuing to pay the employee in an effort to meet those obligations.

Conversely, there may be times where it does make sense to exert financial pressure upon the employee by cutting off their pay at the end of the statutory notice period, unless the employee signs a full and final release.

Consider All Forms of Remuneration

While many people focus on the length of the notice period, it is also important to focus on what is being provided during that time. For example, is the employer only offering base pay, or are they offering bonuses, commissions, car allowance, and other benefits?

By default, a dismissed employee is entitled to receive all forms of compensation during the period of notice, as they would have received if they were still actively working. In other words, employers cannot offer base salary only unless they have a contractual right to do so. Otherwise, all forms of compensation are to continue.

Everyone Benefits if the Employee Finds New Work

When engaging in severance negotiations, employers should bear in mind that by law, they would benefit if the employee finds new work quickly. That is due to the law of mitigation, which provides that if an individual obtains new employment during the notice period, any employment or self-employment income will be conducted from the amount that the former employer must pay. For that reason, it is in the employer’s best interest to assist the employee in obtaining new employment. Letters of reference and outplacement counseling are two ways to do this. The employer can also keep an eye out for job opportunities that would be suitable, and pass these on to the employee. This may help the employee find new work quickly, and can also be used against the employee if the employee fails to make reasonable efforts to find new employment by pursuing such opportunities.

Sometimes, employers will suspect that the individual has new employment or will obtain new employment quickly. In such circumstances, it would be wise to avoid entering into an agreement too quickly, particularly if it is to be based upon payment of a lump sum. If the individual expects to find new work quickly, they will be motivated to enter into an agreement before they start their new job.

The Benefits of Lump Sum Payments

Employees attempting to negotiate their severance should recognize that there are definite advantages to being paid by way of lump sum. First, lump-sum payments will typically be treated as a Retiring Allowance pursuant to the Income Tax Act and be subject to lower tax withholdings than regular salary payments. They will also not have the regular deductions such as Employment Insurance or Canada Pension Plan premiums. Furthermore, if the individual has room in their RRSP account, they can have some or all of the money paid directly into that account and avoid taxes altogether. In addition, even if the individual obtains new employment right away, they will still have the full lump-sum payment, as opposed to salary continuance which will usually be accompanied by a “clawback” that is triggered if the individual finds a new job.

If the dismissed employee is of the view that they will be able to find new work fairly quickly, it will usually be wise to negotiate for a lump-sum payment, even if the payment is based upon a shorter notice period than they might otherwise be entitled to. From the employer’s perspective, it is often possible to negotiate a lesser severance for a lump sum, and in some cases, it is possible to have the employee agree that they will waive benefits during the notice period.

Avoiding Taxes

The only other ways, aside from RRSP contributions, to avoid having severance payments taxed is to have them paid as general damages or as reimbursement for legal fees since neither of those is considered to be income. Of course, there must be a legitimate basis to characterize any payment as general damages, such as a potential human rights claim. Any amount paid as reimbursement for legal fees is to be based upon actual fees incurred.

If it is possible to reduce the taxes applicable to settlement funds, that will help the parties reach a resolution, since the employer does not any more, but the employee gets more money. Typically, the employer will require that the employee indemnify them against any interest or penalty levied by CRA if they disagree with the characterization of funds.

Summary Judgment Means Less Time to Get to Judgment

In the past, many employers were quite content to threaten that if an agreement could not be reached, the individual would have to wait a year or more for trial. However, employees can now respond to such threats with a threat of their own: summary judgment is readily available in cases where the only, or the primary, issue to be addressed is the amount of severance to which the individual is entitled. As a result, an employee can make it clear to the employer that if a resolution is not reached, they will file a claim and immediately move for summary judgment, which will mean that the employer will have to deal with the issues sooner rather than later and may face the potential for judgment within months, as opposed to years.

Settlement is Likely

The bottom line is that the vast majority of dismissals are resolved without litigation. Furthermore, less than 2% of claims filed with the courts actually get to trial. It is extremely unlikely that a matter will end up going to trial. However, both parties will do what they can to negotiate the best possible settlement while trying to avoid the unnecessary expenditure of time and money on litigation. They should both be aware of the likely outcome of trial or summary judgment, as well as the options that are available to them as they negotiate a potential resolution.

In order to reach a resolution, both parties must be willing to negotiate, and they must have a proper understanding of the law and the likely outcome. If one or both parties have unrealistic expectations, then it will be very difficult to reach a resolution. It is always wise to resolve a claim without litigation if a reasonable resolution can be achieved. Neither party should be scared of litigation, and of course the old adage that “the best way to achieve peace is to prepare for war” applies equally to litigation; parties that are willing to engage in litigation, and make the effort to organize their case and prepare their evidence, are more likely to achieve a good settlement. If they don’t settle, they will be well-prepared for trial.

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