Updating your Bonus Plans

Bonuses are a great tool to motivate and reward staff. Bonuses can contribute to employee loyalty and can provide employers with a way of tailoring compensation to revenue, allowing payment in times when revenue allows it but not requiring it when revenue does not. Payment of bonuses can also; however, create unanticipated financial liability at the time of termination if not properly drafted. An annual review of your bonus plan should include consideration of whether the plan is created in a way that provides motivation and reward and has intended consequences at time of termination.

For a bonus to provide motivation, employees must have a clear understanding of when it will be paid. What benchmarks need to be achieved? Have you incorporated performance achievements that are within the employee’s control? Do the benchmarks truly reflect the values and goals of the organization and are they designed to encourage the type of behaviour that you are hoping to nurture? Is the bonus administered in such a way that employees do view the payment as a reward? All of these questions should be considered to ensure that you are maximizing the potential performance benefits of a bonus plan.

The goal of motivating and engendering loyalty in employees is eliminated with a termination and for that reason, many employers do not want to pay bonus compensation as a part of a termination package. In 2020 the Supreme Court of Canada released a decision[1] which provided a two-step approach to determining whether bonus compensation will be included in termination compensation. That decision provides the road map for employers in circumstances where they want to ensure that bonus compensation is not part of termination compensation. As a general principle, employees who are dismissed without cause are entitled to reasonable notice of the termination, or payment of all salary, benefits, bonus and other compensation that they would have received during the period of notice. With respect to bonuses specifically, the Supreme Court of Canada has prescribed a two-step analysis to determine whether it must be paid during the period of notice. That analysis is as follows:

1. Would the employee be entitled to the bonus or benefit as part of their compensation during the reasonable notice period?
2. If so, do the terms of the employment contract or bonus plan unambiguously take away or limit that common law right?

To answer the first question a court will consider what compensation an employee would have received if they had remained employed throughout the period of notice. To answer the second question, the court will look closely at the wording of the employment contract or bonus plan. The Supreme Court said that plans that simply limit payment of a bonus to employees who are “full time” or “actively employed” are not sufficient to take away the common law right to payment of the bonus because if the employee had been provided with notice as required by law, they would have been actively employed.

The Court also found that the wording that purports to eliminate payment of the bonus when employment has been terminated with or without cause may not be sufficient in circumstances where the termination is unlawful. In the specific case that was before the Court the termination was a result of a constructive dismissal and therefore the clause was found to not unambiguously eliminate entitlement. That could apply equally in circumstances where the termination is illegal as a result of a failure to provide adequate notice.

Also found to be insufficient to eliminate the right to the bonus was language requiring achievement of a specific event prior to entitlement to the bonus. If that specific event would have occurred during the period of reasonable notice, then the clause will be found to have not unambiguously eliminated the entitlement to the bonus.

If the intent is to have bonuses eligible only for active employees your bonus plan as well as your employment contracts should be closely examined to determine whether they unambiguously eliminate the common law entitlement to the bonus. For employees where variable or bonus compensation constitutes a significant portion of their compensation, drafting of the employment agreement and bonus plan in a way that unambiguously eliminates the common law right can represent a substantial financial savings for the employer.

This update was authored by Rose Keith. Have questions regarding the topic discussed? Contact Rose at [email protected] or anyone else listed on the authors page.

[1] Matthews v. Ocean Nutrition Canada Ltd. 2020 SCC 26