The ABCs of severance pay: Is your company prepared?
We can choose to use whatever language we like: downsizing, rightsizing or firing, in the end, the result of losing one’s job can be devastating. Companies provide severance packages for a range of reasons, and most firms are good corporate Canadian citizens, wanting to help their former employees. Their reasons for providing severance pay vary from wishing to be known as fair so they can, perhaps in the future, recruit top talent when the economy improves or they may want laid-off workers to have some reason to sign legal agreements designed to protect the company.
The last thing a company would want to do would be to put in place a downsizing program and then be sued for it. Right off the bat, they’d pay more money for legal fees – and their HR staff would be trapped in legal proceedings. Unfortunately, many employers and employees negotiate severance packages at the time the employee is fired.
Many companies have found that the best way to avoid any confusion or misunderstanding between their employee and themselves at the time of termination is to have a written company policy in force on termination and severance pay which is agreed to when every employee signs their employment contract.
Each province has a piece of legislation like the Ontario Employment Standards Act (ESA). The ESA establishes minimum standards for termination and severance pay. Further, the common law requires employers to provide employees who are terminated without cause with reasonable notice. In reality, what a severance package is doing is providing employees with money in lieu of reasonable notice.
According to employment and labour lawyer Michael Sherrard, of the Toronto-based firm Sherrard Kuzz LLP, “One of the most significant requirements under employment standards legislation is the minimum standard for notice of termination and severance pay.” In Ontario, employers are required to provide notice of termination to employees who are terminated without cause who have been employed for three months or more at the time of the termination.
This notice of termination requirement increases with each year of employment to a maximum of eight weeks’ notice owing to an employee who has been employed for eight years or more.
An employer is also required to provide an employee with severance pay if, at the time of termination, the employee has been employed for five or more years and the employer has a payroll of $2.5 million or more. Severance pay is also tied to the employee’s length of employment and increases for every year of employment to a maximum entitlement of 26 weeks of severance pay. For example, an employee who had 10 years of employment at the time of termination, with an employer who had a payroll of $3 million, would be entitled to 18 weeks (10 weeks of severance pay and eight weeks’ notice of termination).
Common law employee entitlements are almost always greater than entitlements under ESA legislation which are just minimums. Generally, Sherrard has found that, as an example, “under the common law, a middle- aged manager with 10 years service who is terminated without cause would likely be awarded between nine to 12 months, subject to the duty to mitigate. Senior executives with longer service may be entitled to as much as 24 months notice with some recent cases seeing greater periods awarded by the courts where there are unique circumstances.”
When the economy was very hot, not so long ago, many highly qualified individuals were lured away from secure positions to join new companies to only find that within a year they were unemployed. Sherrard refers to this type of situation as “inducement or luring.”
In these cases, the new employer under the common law could find itself responsible for paying damages to these employees with consideration being given by the courts for not only the length of employment with the employer, but also the period of employment with the previous employer.
During the past decade, an emerging trend in Canada has been the move northward of American employment principles. For example, class action lawsuits are seeing more success in the last three years than they have in the previous decade. Sherrard points out that “it appears that our Canadian courts are now prepared to certify class action suits for breach of employment related obligations.”
This exposes an employer to a group of employees who may be more apt to withstand the financial pressures of litigation than the individual employee might have otherwise been equipped to.
When considering the employment issues which arise when an organization has to make the difficult decision to restructure and reduce headcount, prudence warrants engaging a qualified employment and labour lawyer.
The financial side of layoffs and severance packages
Typically severance packages include some or all of the following:
- some form of lump-sum severance payment and/or a severance payment paid out over a set period of time;
- an extension of group benefits, such as medical and dental plans, for a predetermined period;
- an option for the employee to convert group life insurance to a private policy;
- a provision for the employee to obtain financial planning and outplacement services for a specified period of time; and
- if the company has a pension plan there are usually three options given to terminated employees: (1) an option to keep their money in the company pension plan, (2) an option to transfer their pension to a new employer’s plan or (3) an option to transfer their entire vested portion of their pension into a locked-in RRSP. (The law requires that the plan administrator of a pension plan give former employees a Termination Statement within 30 days of being let go, if these employees are entitled to a deferred pension.)
An organization may need to make the following arrangement for laid off employees:
1) Employees may need to look at their Notice of Assessment from the Canada Customs and Revenue Agency to see what RRSP contribution limits are, to know how much severance they can invest in their RRSP to reduce taxable income for the year. A company many arrange to direct a portion of the severance payment directly into the employee’s RRSP before the payroll department calculates taxes that will be withheld.
2) If a company has a defined benefit pension (DB) and the employee decides to transfer the vested amount into a locked-in RRSP, by leaving the DB plan the individual is eligible for the Pension Adjustment Reversal (PAR). PAR was created by the federal government to address lost RRSP room for employees who participated in a company’s DB plan as a result of termination from their pension plans. As a rule of thumb, a person’s PAR will be equal to the amount by which both their company’s and their contributions to their pension plan exceed the lump sum amount they will receive when they are terminated from the pension plan. ( Pension plan administrators are required to report an employee’s PAR by the Dec. 31 of the year of termination from the DB plan.)
3) If the former employee was involved in the company’s Registered Pension Plan and started working for the firm in 1995 or earlier, they should be able to transfer at least $2,000 of their severance payment to their RRSP for each year of service before 1996. And if their employment goes back to 1988, they may be able to top this up by another $1,500 for each year before 1989 in which the company’s pension plan contributions did not vest in their name.
Beyond the financials
Several years ago I was very fortunate to meet a certified financial planner named Gilles R. Marceau, who had a profound influence on the way I viewed layoffs and severance packages. Marceau developed a system called “Beyond The Financials.” It arose out of his experience in the early 1980s; he had a specialty called early retirement, severance and pension plan wind-ups. Remember those days? During that period he had more than 1,000 one-on-one discovery interviews with ordinary people who were going through transitions. Transitions they could not understand, and when he would sit down and present the financial severance package, he quickly realized there was never enough money in the world because these people were emotionally hurt.
As employees learn their legal rights, a company’s fiduciary obligations could perhaps be the most worrying of all for creating potential employer liabilities. In Canada, employers have been found liable for failure to bring the terms of benefit policies to the attention of employees. From Marceau’s experience with severance packages, the pattern he noticed emerging as a solution to help people deal with being let go was to have them visualize the life that they wanted to create, to see a new life beyond the one they had just left.
Employees in today’s employment environment need to take responsibility for their careers and finances. It is important that employees don’t perceive your pension plan, benefit plan or the company group RRSP as their “retirement plan.” Many employers are confused about company’s fiduciary obligations to employees in regards to company benefit plans.
This confusion arises over the distinct differences between the meanings of “information,” “education” and “employee financial knowledge.” When a company just provides information about its pension, RRSP and other benefit plans, 99.9 per cent of these employers are not meeting their fiduciary responsibilities because the information just adds to the confusion of their employees. And having an education program for employees about benefit packages only goes so far to explain what they need to know.
Education is not enough without employees having the knowledge and wherewithal to take responsibility and be empowered to integrate the company’s benefit plan with what they are doing outside the company with their entire financials.
In addition to help with financial planning, employers should offer tangible assistance with job search, retirement and life transition. These so-called “career transition services” might be offered in-house or handled by a company specializing in providing such assistance. It is also important to understand that the employees left behind after a downsizing are also hurt. You don’t want your employees to believe that they will vastly receive different severance payouts from one round of layoffs to the next and for remaining staffers to believe they have no assurance that they would get anything.
Individually, employers have no say over the direction of the Canadian economy but what employers do have control over is how they choose to navigate with their employees through their careers and life transitions. It is how corporations act during these transitions that will result in creating or losing goodwill in the labour force and marketplace.