Employment Contracts: How A Small Investment Now Can Protect, Save and Make Your Business Money

As a lawyer, whenever I speak to business owners who have found themselves on the receiving end of a wrongful termination claim by a former employee, I tend to ask “why”. Why didn’t they have an employment contract in place? Why didn’t they have their existing contract reviewed by a lawyer? Here are just some of the reasons I’ve heard over the years for why business owners tend to put employee contracts on the backburner or ignore them altogether:

“I’ve never had to fire any of my employees, and I didn’t think I would ever need to.”

“A handshake has always been worth more to me than any contract.”

“I found a template online and that seemed sufficient.”

“Getting contracts drafted or reviewed by a lawyer was too expensive.”

“I just didn’t have time for contracts”

What employers often don’t know – until it is too late – is that good employment contracts are worth their weight in gold! The value of good employment contracts is often underestimated because once they are completed and signed, they usually end up sitting in a drawer in the employer’s desk, collecting dust. This doesn’t seem like a good investment, right?

Wrong! Good employment contracts are a form of insurance – not for the good times when employees are behaving well, performing at their best, and business is thriving BUT for when the business is struggling, the employees are underperforming, taking advantage of the employer, or behaving inappropriately on the job. It is during these bad times that employers have to take the employment contract out of the drawer, dust it off, and determine what the employee agreed to do as part of their job, how they agreed to conduct themselves, and ultimately, what they are entitled to if they are fired.

Good Employment Contracts Translate to Significant Reduction in Termination Costs

In Canada, when an employee is fired without valid reason, they are entitled to reasonable notice of termination, or pay instead of notice, which often amounts to approximately 1 month for every year worked, up to 30 months (often called “common law notice”). The amount of common law notice goes up or down depending on certain factors such as service time for the employer, age of the employee, availability of other comparable work, etc.

The only legally protected way to pay a terminated employee less than common law notice is to have a valid contract with the employee which explicitly states that the employee will NOT get common law notice, but will only get minimum notice (or pay instead of notice) in accordance with the Employment Standards legislation in the province in which they work. The minimum entitlements in each province differ, but they are always capped at a fraction of the common law entitlements. For example, the minimum legislative entitlements for notice in Ontario is 1 week for each year worked to a maximum of 8 weeks.

Also note that during the employee’s reasonable notice period they are not just entitled to their salary but also to other payments they would have received if they were working, including:

continuation of group benefits or the monetary equivalent
non-discretionary bonuses or commissions
additional benefits (i.e. car allowance, free services, etc.)

A good contract will also limit these additional payments to the minimum statutory notice period, resulting in additional savings to the employer!

Written Contracts May Lead To A False Sense of Security

You might be saying to yourself, “I already have a contract with my employees! I am protected.” True, you are one step ahead of the rest, but beware! Often, seemingly good contracts are, or can become, invalid for various reasons. Here are two of the most common ways that signed employment contracts are often invalid or unenforceable:

Generic or Poorly Worded Contracts

It is not enough to have a basic contract that says “you may be terminated and you will get your minimum statutory entitlements”. The specific words used in the termination section(s) are extremely important and any wording that is unclear/ambiguous or that is not in line with employment standards minimums always results in the termination provisions of the contract being void – meaning that the employee will be entitled to common law notice upon termination!

Moreover, even contracts that were once valid can become unenforceable as legislation and the judge made law change and evolve over time. Case in point is a 2020 decision that invalidated many employment contracts in Ontario (and has had reverberating effects in other provinces) by finding that an attempt to contract into something slightly different than the employment standards legislation means that the entirety of the termination provision(s) will be void and unenforceable, resulting in the employee ultimately being entitled to the large common law payments discussed above instead of the minimum statutory entitlements.

Forgetting to Consider “Consideration”

“Consideration” is not a concept that many employers are familiar with, unless they have had the unfortunate experience of having an entire employment contract (not just the termination provisions) invalidated due to a lack of it.

Consideration is a legal concept which means something of value (may be money or additional benefits) to which a party is not already entitled. In Canada, for a contract to be valid, each party to the contract must provide consideration (something of value) to the other.

In the context of employment, courts have found time and again that employees working without a written contract have a verbal contract with the employer (the worker provides the services, the employer pays) – therefore, asking an existing employee to sign a written contract without offering something additional of value to the employee will always result in an invalid and unenforceable contract.

This concept of consideration does not affect employees who receive and sign a contract prior to starting their position – in this case, the job is the consideration. However, if an employee has worked and received pay for that work for 1 day, or even 1 hour, prior to signing an employment contract, then they are entitled to additional consideration in exchange for signing the contract.

An employment contract without proper consideration is, in fact, worthless. An employer with such a contract will always have to pay common law termination entitlements!

A Real Life Example (Read: Cautionary Tale)

To illustrate the point that properly drafted employment contracts can be a powerful money saving tool, lets look at the case of Fong v. Big Picture Home Entertainment Limited, 2020 ONSC 7503 CanLII.

Dwight Lue-Fong, a 47 year old man working as an installer of home entertainment systems for 20 years (making $55,000 per year) was fired, effective immediately, as a result of his employer, Big Picture Home Entertainment Limited, going out of business. At the start of his employment, Mr. Lue-Fong was provided with a generic contract, but that contract did not include any termination provisions.

What The Employer Paid: At trial, the judge found that Mr. Fong was entitled to common law termination pay of 24 months totaling $92,000!

What the Employer Could Have Paid: If Big Picture had an employment agreement that contained valid and enforceable termination provisions limiting his entitlements to the minimums, Mr. Fong would have been owed only 8 weeks of pay, equalling $8,500 – a mere fraction of what he was awarded.

Unfortunately, Mr. Fong’s case is not the exception, it is the rule. Because most wrongful termination lawsuits end up settling out of court, it is hard to estimate how many employees claim wrongful termination from their employers. However, based on my years of experience, I would say that every employer without valid contracts should expect on average one out of two terminations (or even resignations due to “constructive dismissal”) to result in a demand for common law termination pay. A strong employment contract can prevent your business from becoming the cautionary tale.

Buying or Selling Your Business?

If you are thinking of buying or selling a business, then employment contracts should be on the top of your mind!

Businesses with employees who do not have valid employment contracts (especially long-term employees) come with a lot of extra “baggage” in the form of employee liability upon termination. This added liability is often reflected in a significantly reduced purchase price.

Imagine buying a business and going through a rough patch or an event such as Covid-19 that leaves the business struggling and having to terminate employees. What if you had to terminate not one, but several employees of 20+ years service, like Mr. Fong? Terminations such as this would cost hundreds of thousands of dollars in payments to employees – a massive sum that would cause many small businesses to have no choice but to shut their doors.

As far as investments go, the relatively small sum it will take to put proper employment contracts in place is worth much more than the potential to (a) as a seller, have to lower your business’ purchase price, or (b) as a buyer, inherit and have to make good on employee baggage and exorbitant termination costs.

Bottom Line

Not only are employment contracts a good investment for now (lower termination costs of existing employees) but also for the future (increased purchase price upon sale). The difference between having valid employment contracts and not having them can be worth hundreds of thousands of dollars. So, my advice is simple:

If you do not have employment contracts – get them.

If you do have employment contracts – have them reviewed by a qualified professional at least once every year.

At HRC Law Professional Corporation, our mission is to provide small and medium-sized Canadian businesses with affordable, accessible and top-tier legal services. For one low monthly fee, you can have your existing employment contracts reviewed, new employment contracts drafted and ongoing legal advice on any employment-related legal issues that may arise. We will never bill you for our time or surprise you with additional fees. For more information on how we can help, visit www.hrcemploymentlaw.com or contact us directly by sending an email to inquiries@hrcemploymetnlaw.com and one of our experienced employment lawyers will respond within one business day.