Sunday, 29 October 2017

Scissors Beat Paper; Statutes Beat Scissors: Severability Clauses Can't Fix Illegal Termination Provisions

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Everyone knows that in the classic children's game, Rock, Paper, Scissors, scissors beat paper. But can scissors beat statutes?

To the point, can a trial judge use a severability clause to excise the offending portion of a termination provision, keeping the remainder of such provision enforceable? While that question might seem highly academic, it is one of critical importance to anyone employed pursuant to the terms of a written employment contract.

In North v. Metaswitch Networks Corporation, 2017 ONCA 790 (CanLII), the Court of Appeal for Ontario finally laid to rest both this issue and its earlier decision in the much-maligned case of Oudin v. Centre Francophone de Toronto, Inc., 2016 ONCA 514.

Facts

Doug North, the appellant in this case, was employed from November 2012 to March 2016 with the respondent, Metaswitch Networks Corporation, pursuant to written employment contract (“the Agreement”). His earnings consisted of salary plus commission.

Mr. North’s employment with Metaswitch was governed by the Agreement. When North’s employment was terminated without cause, a dispute arose as to whether he was entitled to be paid in accordance with the Agreement, or based on common law reasonable notice.

The Agreement contained a termination clause that amounted to contracting out of an employment standard mandated by the Employment Standards Act, 2000, S.O. 2000, c. 41 (the “ESA”). However, the Agreement also contained a severability clause. The issue before the application judge and on this appeal was the interpretation and application of the two clauses in light of s. 5 of the ESA, which prohibits employers and employees from waiving or contracting out of any employment standard prescribed by the ESA, except to provide a greater benefit to the employee.

The termination clause read as follows:

9. Termination of Employment

(c) Without Cause – The Company may terminate your employment at any time in its sole discretion for any reason, without cause, upon by [sic] providing you with notice and severance, if applicable, in accordance with the provisions of the Ontario Employment Standards Act (the “Act”). In addition, the Company will continue to pay its share all [sic] of your employee benefits, if any, and only for that period required by the Act.

The reference to notice in paragraphs 9(b) and (c) can, at the Company’s option, be satisfied by our provision to you of pay in lieu of such notice. The decision to provide actual notice or pay in lieu, or any combination thereof, shall be in the sole discretion of the Company. All pay in lieu of notice will be subject to all required tax withholdings and statutory deductions.

In the event of the termination of your employment, any payments owing to you shall be based on your Base Salary, as defined in the Agreement.

Mr. North took the position that this part of the Agreement was void under s. 5(1) of the ESA, because the sentence that provides that payments are to be based “on your Base Salary” contravened the ESA by excluding his commission. Therefore, he was entitled to receive termination compensation based on common law pay in lieu of reasonable notice.

Metaswitch’s position was that if the termination clause was illegal because of the one offending sentence, then that sentence should be excised from the Agreement, using the severability clause contained in para. 17(a) which provided:

17. General Provisions

(a) If any part of the Agreement is found to be illegal or otherwise unenforceable by any court of competent jurisdiction, that part shall be severed from this Agreement and the rest of the Agreement’s provisions shall remain in full force and effect.

Mr. North sought to have the issue of the applicability and effect of the severability clause determined by the court on an “Application” under Rule 14 of the Rules of Civil Procedure, R.R.O. 1990, Reg. 194, where the determination of rights depends on the interpretation of a contract and there are unlikely to be any material facts in dispute. [For more of the use of applications in wrongful dismissal cases, see my post Wrongful Dismissal Cases are Appropriate for Resolution by way of Application: ONSC.]

Decision of the Ontario Superior Court of Justice

The application judge, Justice Meredith Donohue of the Superior Court of Justice, accepted that the sentence in the termination clause, para. 9 of the Agreement, that reads: “[i]n the event of the termination of your employment, any payments owing to you shall be based on your Base Salary, as defined in the Agreement”, had the effect of excluding payment of commission to which the appellant was entitled, and therefore contravened the ESA.

The exclusion of payment of commission to which Mr. North was entitled contravened the ESA because on termination employees are entitled to the receipt of “wages”, and “wages” has been held to include commissions. By excluding commissions, the employer therefore contravened the employment standard of ss. 60 and 61.

Justice Donohue addressed the severability clause and found that para. 17(a) expressed the intention of the parties that “any illegal or unenforceable parts were to be severed to allow the rest of the agreement to stand.” She then recited the portion of the termination clause, para. 9(c), which states that notice and severance, if applicable, were to be provided “in accordance with the provisions of the Ontario Employment Standards Act”. She concluded that the parties’ intention was to comply with the ESA.

In interpreting and giving effect to the severability clause, Justice Donohue referred to the reasoning of Justice Dunphy in Oudin v. Centre Francophone de Toronto, Inc., 2015 ONSC 6494, aff’d 2016 ONCA 514, leave to appeal to SCC refused, [2016] S.C.C.A. No. 391, where, using a severability provision, he excised from a termination provision one reason among a list of reasons for dismissal without pay, stating, at para. 41, that “[t]he excision of the offending reason from the list does no violence to the integrity of the remainder of s. 4 which contains a list of other unrelated grounds for termination.”

Justice Donohue found that the same reasoning would apply to the Agreement: the illegal clause limiting the pay upon termination to be based on base salary only “could be removed in its entirety pursuant to the para. 17(a) severability clause. The parties would be left with [para.] 9(c) as to what payments would be owing.” She was satisfied that the term “any part” in para. 17(a) was not ambiguous and could apply to the offending sentence. She rejected the argument that the severability clause was void as a result of s. 5(1) of the ESA.

Decision of the Court of Appeal for Ontario

In a decision authored by the Honourable Justice Kathryn N. Feldman, the Court of Appeal for Ontario set aside Justice Donohue’s decision and found that Mr. North was entitled to receive termination pay based on common law pay in lieu of reasonable notice.

In answering “yes” to the question, “did the application judge err in law by using the severability clause of the Agreement to save the termination clause that contravened the ESA?”, Justice Feldman reasoned as follows:

[17] When deciding this case, the application judge did not have the benefit of this court’s recent decision in Wood v. Fred Deeley Imports Ltd., 2017 ONCA 158 (CanLII), 134 O.R. (3d) 481, on the issue of the interpretation and treatment of termination clauses in an employment contract. While deference is owed to the application judge on issues of contractual interpretation, no deference is owed where there is an extricable error of law…

[18] In Wood, Laskin J.A. set out the principles that govern the payment owed to an Ontario employee whose employment is terminated without cause. He summarized the law as follows, beginning at paras. 15-16:

At common law, an employee hired for an indefinite period can be dismissed without cause, but only if the employer gives the employee reasonable notice. In Machtinger v. HOJ Industries Ltd., [1992] 1 S.C.R. 986, at p. 998, the Supreme Court characterized the common law principle of termination of employment on reasonable notice “as a presumption, rebuttable if the contract of employment clearly specifies some other period of notice”.

Ontario employers and employees can rebut the presumption of reasonable notice by agreeing to a different notice period. But their agreement will be enforceable only if it complies with the minimum employment standards in the ESA. If it does not do so, then the presumption is not rebutted, and the employee is entitled to reasonable notice of termination.

[19] And continuing at paras. 25-28:

The question of the enforceability of the termination clause turns on the wording of the clause, the purpose and language of the ESA, and the jurisprudence on interpreting employment agreements. That jurisprudence is now well-established. I will summarize it briefly.

In general, courts interpret employment agreements differently from other commercial agreements. They do so mainly because of the importance of employment in a person’s life. As Dickson C.J.C. said in an oft-quoted passage:

Work is one of the most fundamental aspects in a person’s life, providing the individual with a means of financial support and, as importantly, a contributory role in society. A person’s employment is an essential component of his or her sense of identity, self-worth and emotional well-being.

As important as employment itself is the way a person’s employment is terminated. It is on termination of employment that a person is most vulnerable and thus is most in need of protection.

The importance of employment and the vulnerability of employees when their employment is terminated give rise to a number of considerations relevant to the interpretation and enforceability of a termination clause:

  • When employment agreements are made, usually employees have less bargaining power than employers. Employees rarely have enough information or leverage to bargain with employers on an equal footing.
  • Many employees are likely unfamiliar with the employment standards in the ESA and the obligations the statute imposes on employers. These employees may not seek to challenge unlawful termination clauses.
  • The ESA is remedial legislation, intended to protect the interests of employees. Courts should thus favour an interpretation of the ESA that “encourages employers to comply with the minimum requirements of the Act” and “extends its protections to as many employees as possible”, over an interpretation that does not do so.
  • Termination clauses should be interpreted in a way that encourages employers to draft agreements that comply with the ESA. If the only consequence employers suffer for drafting a termination clause that fails to comply with the ESA is an order that they comply, then they will have little or no incentive to draft a lawful termination clause at the beginning of the employment relationship.
  • A termination clause will rebut the presumption of reasonable notice only if its wording is clear. Employees should know at the beginning of their employment what their entitlement will be at the end of their employment.
  • Faced with a termination clause that could reasonably be interpreted in more than one way, courts should prefer the interpretation that gives the greater benefit to the employee. [Citations omitted.]

[20] Section 5 of the ESA prohibits employers and employees from waiving or contracting out of any of the employment standards prescribed in the ESA, except to provide a greater benefit to the employee. Any such contracting out is void. …

[21] Most importantly, in Wood, at para. 21, the court explained the effect of the principles established by the Supreme Court in Machtinger regarding the consequences of s. 5(1) of the ESA:

Contracting out of even one of the employment standards and not substituting a greater benefit would render the termination clause void and thus unenforceable, in which case [the employee] would be entitled to reasonable notice of termination of her employment at common law.

[22] This interpretation of the operation and effect of s. 5(1) of the ESA explains how a court is to approach the interpretation of termination clauses that waive or contract out of one employment standard, but comply with others.

[23] In my view, the application judge erred in her approach to the interpretation and application of the severability clause. …

[24] The severability clause directs that the part of the agreement that is to be severed is the part that a court would find to be illegal. The rule from Wood, following Machtinger, is that where a termination clause contracts out of one employment standard, the court is to find the entire termination clause to be void, in accordance with s. 5(1) of the ESA. It is an error in law to merely void the offending portion and leave the rest of the termination clause to be enforced.

[25] As a result, the application judge erred in law by severing only the offending sentence that referred to using only base salary to calculate termination pay in lieu of notice, rather than the entire termination clause. Para. 17(a) requires that the part to be severed is the part that a court would find to be illegal, which must be the entire termination clause.

[26] Because of the conclusion I have reached based on the meaning and application of para. 17(a), there is no need in this case to address the Supreme Court decision in Shafron v. KRG Insurance Brokers (Western) Inc., [2009] 1 S.C.R. 157, referred to by the appellant, and to what extent the rules regarding blue pencil and notional severance may apply in the context of the severability clause drafted by the parties. [For more on ‘blue pencil severance” see my post Blue Pencils Cannot be Used to Remove Date from Non-Competition Agreement.]

The next issue that the Court of Appeal had to address was what are the consequences of a voided clause, absent a severability clause? On this issue, Justice Feldman wrote the following:

[29] Section 5(1) prohibits contracting out of or waiving an employment standard, and provides that any such contracting out or waiver is void. An employment standard is defined in s. 1(1) as: “a requirement or prohibition under this Act that applies to an employer for the benefit of an employee”.

[30] The result is that an offending termination clause that is void has no application to oust the common law, which again applies, requiring pay in lieu of reasonable notice. As discussed above, in Wood, at para. 21, this court explained that where a termination clause contains “even one” instance of contracting out of an ESA employment standard, the clause is void.

[31] In Machtinger, Iacobucci J. gave a number of policy reasons for finding that where there is contracting out of an employment standard within a termination clause, the effect is to void the entire clause (resulting in entitlement to reasonable notice), and not just the removal of the impugned clause (resulting in entitlement to the statutory minimum termination pay provisions).

[32] He stated at p. 1003, that in light of the objective of the ESA to protect the interests of employees:

[A]n interpretation of the [ESA] which encourages employers to comply with the minimum requirements of the [ESA], and so extends its protections to as many employees as possible, is to be favoured over one that does not.

[33] He continued at p. 1004:

If the only sanction which employers potentially face for failure to comply with the minimum notice periods prescribed by the [ESA] is an order that they minimally comply with the [ESA], employers will have little incentive to make contracts with their employees that comply with the [ESA].

[34] And as many employees are not aware of their legal rights or will not go to the trouble or expense of trying to have the contract set aside in court, they will accept the illegality: see Machtinger, at p. 1004.

[35] Nor would it be a hardship for the employer to draft a contract that complies with or accounts for potential changes in the ESA. As Iacobucci J. stated, at pp. 1004-1005:

Absent considerations of unconscionability, an employer can readily make contracts with his or her employees which referentially incorporate the minimum notice periods set out in the [ESA] or otherwise take into account later changes to the [ESA] or to the employees' notice entitlement under the [ESA].

[36] Justice Iacobucci concluded his analysis by observing, at p. 1005:

Given that the employer has attempted, whether deliberately or not, to frustrate the intention of the legislature, it would indeed be perverse to allow the employer to avail itself of legislative provisions intended to protect employees, so as to deny the employees their common law right to reasonable notice.

[37] In my view, these same policy considerations should inform the approach to be taken when considering the operation of s. 5(1), where an employment contract contains a severability clause.

In discussing the approaches to interpreting and applying a severability clause, Justice Feldman noted that, “when a severability clause is introduced into the contract, the issue is whether: (i) the severability clause can be used to remove the illegality in the termination clause; or (ii) because the termination clause as drafted is void as a result of s. 5(1), there is nothing on which the severability clause can act.”

In discussing the “first approach”, Justice Feldman noted the following:

[39] In Oudin, the motion judge relied on the wording of the specific severability provision in the employment contract that directed modification “only to the extent necessary” to comply with the law: see Oudin, at paras. 35, 40. The motion judge found that this established the clear intention of the parties: see Oudin, at para. 42. Similarly in Miller v. Convergys CMG Canada Limited Partnership, 2014 BCCA 311, leave to appeal to SCC refused, [2014] S.C.C.A No. 424, the court stated at para. 42:

Where the parties anticipated the possibility of severance and chose contractual language to govern this eventuality, severability is not just a remedial question. Before turning to remedy, the starting point must be to give effect to what the parties reasonably intended if a provision of the contract is found unenforceable by reason of illegality.

[40] The problem with this approach is that, to the extent that it effectively rewrites or reads down the offending provisions, it has the very effect referred to by Iacobucci J. in Machtinger – employers will be incentivized to contract out of the ESA but include a severability clause to save the offending provision in the event that an employee has the time and money to challenge the contract in court. Similar concerns were recognized by this court in 2176693 Ontario Ltd. v. Cora Franchise Group Inc., 2015 ONCA 152, where the court declined to order severance of an illegal clause in a franchise agreement because, if the only consequence to a franchisor is that the illegal clause is read down to make it legal, franchisors would be encouraged to draft illegal contracts.

With respect to the “second approach”, Justice Feldman wrote this:

[41] The other approach is to first assess the termination clause to see whether there is any contracting out of an employment standard. If there is, then the termination clause is void, and there is nothing to which the severability clause can be applied. In that way, the severability clause is not void, but it is inoperative where the agreement contracts out of or waives an employment standard.

[42] In my view, this approach is the one that is consistent with the intent of the ESA and the Supreme Court decision in Machtinger. Nor does it do any injustice to the contractual interpretation principle of ascertaining the intention of the parties. Because the termination clause is void, it cannot be used as evidence of the parties’ intentions to comply with the ESA: see Machtinger, at p. 1001.

[43] This approach also causes no disadvantage to employers, who, as noted by Iacobucci J., are free to make a legal contract that limits an employee’s rights on termination to the standards set by the ESA.

[44] As noted above, this conclusion does not make the severability clause void. It continues to have application to the rest of the agreement. However, it cannot have any effect on clauses of the contract that have been made void by statute. Those terms are null and void for all purposes and cannot be rewritten, read down or interpreted through the application of a severability clause to provide for the minimum standard imposed by the ESA.

[45] I would therefore hold that s. 5(1) of the ESA makes the severability clause, para. 17(a), inoperative on the termination clause, which contracts out of an employment standard.

[46] This result may appear to be inconsistent with this court’s dismissal of the appeal in Oudin. The application judge found the motion judge’s reasons in Oudin to be analogous. However, the courts in Oudin also did not have the benefit of this court’s subsequent decision in Wood. Further, the issue of the applicability of the severability provision in light of s. 5(1) of the ESA was not discussed in the endorsement as the basis of the appeal. Rather, the basis of the appeal was primarily focused on the correctness of the motion judge’s determination that the termination provisions respecting notice did not offend the ESA. Therefore, this court’s endorsement in Oudin should not be viewed as supporting a broad, overarching principle regarding the motion judge’s application of the severability provision in that case …

In the result, the Court of Appeal allowed the appeal, setting aside the decision of the application judge. The court ordered that Mr. North was entitled to receive termination pay based on common law reasonable notice. No quantum was mentioned.

Commentary

When the Supreme Court of Canada denied leave to appeal in the Oudin case, I wrote a blog post confirming my criticism of the Oudin decisions, see: Supreme Court of Canada Denies Leave to Appeal in Oudin: But Does That Really Mean Anything?”.

In that post, I wrote the following:

I wish to underline that it is my opinion that the Court of Appeal for Ontario did not answer the ongoing debate raised by cases such as Oudin, which is why I wrote my post about the anticipated decision in the appeal of the Ontario Superior Court of Justice’s decision in Wood v Fred Deeley Imports Ltd., 2016 ONSC 1412 (CanLII): Will Wood Finally Answer the Question of Benefits? There’s Hope.

Respectfully stated, until the Court of Appeal for Ontario authors a decision in which it addresses the split between those who are following the Wunderman decision and those who are not, there is no certainty in this province about what it takes to draft a legally binding termination provision.

When Wood came out, I wrote my post Court of Appeal Finally Brings Much Needed Clarity to Issue of Benefits in Contractual Termination Provisions.

What I think the North case now makes clear is that Wood is the clear winner. I would be very reluctant to rely on the Oudin decision. To put it bluntly, I think the Oudin decisions are dead.

As a point of interest, one should note that the case that really started this discussion, that of Wunderman was authored by Justice Lois Roberts when she sat on the Superior Court. Justice Roberts, now a justice of the Court of Appeal, was on the North panel.

Takeaways for Employees with Labour Pains

As with every post that I have written about contractual termination provisions, the takeaway is the same: Have your employment agreement reviewed before you sign it to know what you’re signing, and if you’re let go, have your agreement reviewed before you accept any severance offer.

If you are an individual looking for assistance with respect to the interpretation or enforceability of the terms of your employment contract, the professional, experienced and cost-effective employment lawyers for employees at Ottawa's Kelly Santini LLP would be happy to be of service to you.

Takeaways for Employers with Labour Pains

For employers the takeaway is still the same: Have an experienced professional draft your employment contracts. It will save you a lot of money.

If you are an employer and you need to make changes to the terms of your employee’s employment, or if you want to introduce written employment agreements with your staff, the professional, experienced and cost-effective employment lawyers for employers at Ottawa's Kelly Santini LLP would be happy to be of service to your business or organization.

Contact Me

To reach the author of this blog, Sean Bawden, email sbawden@kellysantini.com or call 613.238.6321 x260.

Sean P. Bawden is a partner with Kelly Santini LLP, located in Ottawa, Ontario, Canada. He practices in the areas of employment law and civil litigation. He has also taught Trial Advocacy for Paralegals and Small Claims Court Practice at Algonquin College in Ottawa.

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As always, everyone’s situation is different. The above is not intended to be legal advice for any particular situation. It is always prudent to seek professional legal advice before making any decisions with respect to your own case.

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