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Deferred compensation: You can take it with you (sometimes)

Deferred compensation in the form of future bonuses, retention payments, and stock options has become a standard element of executive compensation. While there are countless variations of such plans, they are all designed to incent employees to remain with their employer, and to perform to the employee’s highest capability while he is there. In order to meet these goals, such plans will often include a deferral of the benefit once it is earned, in order to create an incentive to remain with the employer.

In the case of grants of stock in the capital of the corporation, a simple grant of shares would obviously not meet the goals described above. Therefore, most employers design the plan which grants the shares, but defers the employee’s ability to sell those shares for a period of time. These are generally referred to respectively as the vesting date and the exercise date. The shares granted under such plans are referred to as restricted share units, or RSU’s. The company granting such RSU’s will create a plan which will include conditions under which the RSU’s will be granted, and restrictions and requirements for the units to subsequently be sold. A typical plan will usually contain a provision that the right to sell the units will be forfeited if the employee resigns before the date on which the right to sell crystallizes.

In a decision of the Ontario Superior Court released on September 12, 2013, the court dismissed an employee’s claim for the value of such RSU’s after he had resigned his position with the employer. The employee was the Managing Director of the TD’s Institutional Equity Sales Group. At the time of his resignation, he had been with the Bank for 11 years. He had an extremely successful career with the Bank and generally earned in excess of $2 million a year in salary, bonuses, and stock compensation.

The provisions of the Stock Compensation Plan included a provision that an employee’s “entitlement to a particular award will be forfeited without notice by the bank if the participant resigns from service prior to the maturity date of such award”. The plaintiff in fact resigned from his position with the Bank. At the time of his resignation, the RSU’s which had been allocated to him had a market value of $1.6 million, based on the difference between the exercise price and the market price. The employee demanded payment of the value of the RSU’s which the Bank refused. The Bank took the position that although the RSU’s were earned, the provision in the plan referred to above disentitled the employee to any payment.

In the face of what appears to be a clear provision which disentitled the employee to payment, the employee argued that, at the time of his dismissal, he had already earned the allocated RSU’s, and that the provision of the plan that imposed forfeiture of those units was unenforceable as an unreasonable restraint of trade. He also argued that the provision in the plan documents was not enforceable as he had not received any additional compensation in exchange for signing onto the plan, legally referred to as “consideration”. It is a central tenet of contract law that there must be consideration flowing between the parties in order for a contract to be enforceable.

The court rejected this argument. Relying on a leading case of the Supreme Court of Canada, the court stated that the plaintiff had three choices when the employer sought to impose the new bonus plan:

(i) He could have accepted the change.
(ii) He could have refused to accept it and sued for his losses; or,
(iii) He could have rejected the change in which case the employer could have terminated his employment, re-hired him on the new terms, and paid any notice entitlement.

If the employer fails to take the latter step, the employee can insist that the original terms of his employment be adhered to.

In this case, the court rejected the employee’s claim of constructive dismissal. The court found that the changes imposed on the employee were generally to the employee’s benefit. By accepting them without protest, and by signing the Option Agreement, the employee demonstrated his acceptance of these changes. He therefore could make the argument that he was constructively dismissed.

The court then considered the plaintiff’s argument that the forfeiture provision was unenforceable as being a restraint of trade. The court pointed out that while there is a presumption that such clauses are in fact a restraint of trade, that presumption can be rebutted where the clause can be demonstrated to be reasonable in the circumstances. In determining such reasonableness, the court referred to an earlier British decision for the “…accepted proposition that an employer is not entitled to protection from mere competition by a former employee…the employee is entitled to use to the full any personal skill or experience even if this has been acquired in the service of his employer: It is this freedom to use to the full a man’s improving ability and talents which lies at the root of the policy of the law regarding this type of restraint. The judge therefore concluded that he must look not only at the form of the clause, but at the effect of the clause in practice. The employee could have avoided the variation of this clause by refraining from accepting prohibited employment.

The court goes on to consider whether the forfeiture provision can be said to be an unenforceable restraint of trade. In determining it was not, the court referred to previous Court of Appeal decisions in Ontario which found that employees who agreed to be bound by such provisions could not then seek to resile from them if they resigned their position. In one decision, the Court of Appeal stated “…their cessation [of the options] is not in the nature of a penalty but is in pursuance of the agreement by which [employee] voluntarily bound himself in the beginning.” In an earlier Ontario decision, the court found that a clause in a settlement agreement that the negotiated retirement allowance would be “continued at the discretion of the company subject to your attitude not being, in the opinion of the executives of the company, detrimental to the company or its personnel…” was an unreasonable restraint of trade. The court in this case reasoned that the clause placed post termination restrictions on the employee’s commercial activities, which was unenforceable. However, subsequent cases in Ontario have rejected this reasoning in upholding what is called a “claw back” clause which results in repayment to the company of benefits received. In one decision involving Nortel Networks and a claw back of previously issued options, the court upheld the clause on the basis that it was clearly understood by the employee and therefore the employee cannot complain when his conduct gave rise to the obligation to repay profits earned on the exercise of the options. The court concluded that the obligation to repay could not be considered a penalty, as the employee was only required to repay the profit he had made on the options. Generally, courts in Canada and other common law jurisdictions have held that employees who accept benefits under such plans must adhere to the restrictions in the plan.

What then can we take away from this line of cases?

Clauses making bonus payments or stock grants conditional on the employee refraining from competition will generally be enforced as long as the departing employee is free to work elsewhere and risk loss of the benefit. If such employment results in the forfeiture of benefits, it will be seen as a legitimate trade off for the employee. Similarly, a provision that requires reimbursement of funds or benefits received on the exercise of options will generally be enforced. Finally, where the options or bonus entitlement has vested as of the date of termination, a provision requires the employee to forfeit these benefits if she engages in prohibited activity will be regarded as an improper restraint of trade.

Clearly, the cases dictate that care must be exercised in the drafting and administration of bonus and stock option plans. Case law must be reviewed to ensure that the plans do not run afoul of the various restrictions in the cases. Detailed legal advice should always be obtained in the drafting of such plans.

Earl Altman
Partner
Garfinkle, Biderman LLP

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Earl Altman

Legal consultant at EA Consulting
Earl Altman was a partner at Garfinkle, Biderman and now heads his own consulting firm. Earl has practiced commercial and employment litigation. Earl’s practice focuses on employment disputes, including acting for employees and employers in wrongful dismissal claims, and in breach of contract and breach of fiduciary duty claims. Read more
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