When Do Benefit Cuts Constitute ‘Constructive Dismissal’?

June 29, 2018 11:56 am

‘Can’t afford to keep matching employee DC contributions or pay out those big discretionary bonuses the way you have in the past? You’re not alone. Lots of companies are under pressure to pare back or rework their benefits arrangements. Just be careful. It’s not just the howls of protest from employees and their unions; cutting benefits can expose you to liability for wrongful dismissal, even if your intent is to preserve, not terminate your employment relationships. The danger stems from the so called constructive dismissal law. Here’s a look at the risk and how to avoid it when cutting employee benefits.

The Law of Constructive Dismissal 

The penalties for wrongful dismissal run the gamut from lost wages to Wallace and punitive damages if termination or the way it’s carried out is egregious. What you might not realize, though, is that wrongful dismissal comes into play not just when you deliberately terminate an employee you want to get rid of but when you make changes affecting the employees you want to keep in the fold if the changes are so unfavourable that they force employees to leave.

This situation is called constructive dismissal. And what makes it so dangerous is that you can be liable even if you have no intention to force an employee out.

Benefits Cuts May Result in Constructive Dismissal

Constructive dismissal is essentially the result of unilateral, substantial and unfavourable changes to the key terms of an employee’s employment. Although this can encompass many different aspects of the employment relationship, it typically involves changes to the employee’s:

  • Work hours;
  • Job responsibilities;
  • Title or status within the company; and
  • Of course, compensation and benefits.

The bottom line: When you unilaterally cut or change an employee’s benefits and compensation you run the risk that the employee will leave the company and sue you for constructive dismissal.

When Do Benefits Cuts Cross the Constructive Dismissal Line?

Exactly how far must you cut benefits and compensation to give an employee grounds for constructive dismissal? Unfortunately, there’s no bright line rule. Courts and arbitrators (“courts” for simplicity) consider the facts of each case. And no 2 cases are ever exactly the same.

The good news is that by looking at the cases you can see how courts approach the question and recognize patterns that you can apply to judge the soundness of your own benefits decisions. Here are some of the leading cases from across Canada in which courts had to decide whether changes in compensation and benefits made the employer liable for constructive dismissal.

Caveat: Be aware that otherwise minor changes in compensation and benefits could constitute constructive dismissal when combined with unilateral changes in other terms of employment such as job responsibilities or titles.

7 RULES OF THUMB

1. Wage Cuts of 10% or Less Generally Not Enough

The deeper the wage cut, the greater the risk of liability. But constructive dismissal isn’t just about math. In the words of one case, courts can’t rely “exclusively on a mathematical calculation of the loss of income” [McSeveny v. Phone Directories Company, Inc.]. However, the courts do consider the percentage reduction in employee’s income when deciding whether constructive dismissal resulted.

Based on our case research, courts are generally unwilling to find constructive dismissal when compensation cuts resulted in a less than 10% change in an employee’s income. However, 10% or less could be enough when coupled with unfavourable changes in the other terms of employment. Thus, for example, an Ontario court ruled that a pharmacy that reduced an employee’s salary from $40 to $36 per hour, a 10% cut, and also changed her position was liable for constructive dismissal [Ontario Chemists Rx Inc. v. Ibrahim].

2. Wage Cuts of 20% or More Generally Are Enough

Conversely, we found that changes resulting in at least a 20% reduction in income generally did result in a finding of constructive dismissal. For example, a BC court ruled that reducing an employee’s monthly salary from $3,600 to $2,400—a 30% cut—breached a fundamental term of the employment relationship and was constructive dismissal [Farquhar v. Butler Brothers Supplies Ltd.].

3. Cuts in Commissions & Bonuses May Cross the Line

Unilaterally cutting employees’ bonuses and commissions can be just as bad as, if not worse than cutting their salary, depending on the amount of the cut and how much of the employee’s income comes from bonuses and commissions.

Example: As part of a change in the employee’s job responsibilities and title, an employer removed a bonus of five percent of company revenues. The court said the employee had been constructively dismissed because the revenue bonus was a critical part of his compensation package. Eliminating the bonus would likely cut his compensation 25%–a substantial change [MacLean v. CrossOff, Inc.].

That’s not to say that you can never reduce bonuses and commissions. If the reduction doesn’t have a significant dollar impact, it won’t by itself amount to constructive dismissal.

Example: As a result of corporate restructuring, a company cut an employee’s bonus from 15% to 10% of salary—a net income loss of $4,500. The court ruled that the cut was too insignificant to amount to constructive dismissal [Poole v. Tomenson Saunders Whitehead Ltd.].

4. Paying Late Can Be Just as Bad as Paying Less

In addition to potentially violating employment standards laws, failing to pay bonuses or commissions on time may also give an employee grounds for claiming constructive dismissal. For example, the failure of a car dealer to pay a substantial portion of the employee’s $2,000 monthly bonus on time was constructive dismissal. The bonus constituted nearly half of the employee’s monthly compensation, the court explained [Ilkay v. Acadia Motors Ltd.].

5. Making Guaranteed Compensation Conditional May Be Constructive Dismissal

Although it’s more subtle than a wage or bonus cut, unilaterally changing the structure of an employee’s compensation package can achieve the same effect. If the restructured package is substantially less favourable than what the employee agreed to at the start of employment, it could be constructive dismissal. One way to restructure your way into constructive dismissal is to convert guaranteed salary to contingent payments such as commissions and bonuses.

Example: An employee had a guaranteed base salary with commissions and benefits and managed 21 branches of a real estate company that produced more than $16 million in gross income. The company demoted him to manager of a poorly performing branch. At the new position, the employee received commissions rather than a guaranteed base salary. Adding insult to injury, his commissions were based on the sales of the poorly performing branch. True, the commission was 3% higher than what other branch managers got. The company also threw in a “reorientation allowance.” But the Supreme Court of Canada ruled that the company had constructively dismissed the employee because the new package didn’t compare to the previous one due to its failure to include a guaranteed base salary [Farber v. Royal Trust Co.].

6. Making Contingent Compensation Guaranteed May Also Cross the Line

Shifting from guaranteed to contingent isn’t the only way to adversely re-engineer a compensation package. The reverse change can also rise to the level of constructive dismissal. In other words, there are no pre-determined formulas. Courts will look at the overall impact of the changes, including the amount and nature of the cuts.

Example: A store manager earns $92,000, including $33,000 in base salary plus a personal bonus and a bonus tied to the store’s profitability. The employer decides to merge salaries with personal bonuses. To make up for the lost bonus opportunity, the store adjusts the manager’s base salary to $64,000. The manager claims that this is really a pay cut and resigns. The BC court rules that the manager was constructively dismissed because the store bonus was a fundamental term of the employment contract and eliminating it resulted in a significant salary reduction [Wood v. Owen De Bathe Ltd.].

7. Cutting & Restructuring Benefits May Be Just As Bad as Cutting Direct Pay

Significant changes in benefits can also result in constructive dismissal, especially when combined with cuts in direct compensation. As with direct compensation, the most obvious form of an adverse change is a direct cut in benefits. This could include eliminating or reducing contributions to pension, health and other employer-sponsored benefits plans.

Of course, the size of the cut is a key factor in determining if benefit reductions amount to constructive dismissal. Although there’s no pre-determined cutoff point, courts do look at the value of the benefits cut and the percentage by which it decreases the employee’s earnings in determining if constructive dismissal occurred.

Example: In addition to cutting her salary and removing a wellness bonus, a BC employer stopped paying Medical Services Plan premiums on an employee’s behalf. The total impact of those changes was an approximately 20% reduction in compensation. The court found this to be “material” and found the employer liable for constructive dismissal [Streight v. Dean].

Example: A SK employer failed to make $1,218 in pension contributions for an employee. This represented 3% of her salary. The court dismissed the employee’s constructive dismissal claim, ruling that this wasn’t significant enough to amount to a fundamental breach of the employment contract [Hlewka v. Moosomin Education].

Example: As a result of hard economic times, an Alberta employer suspended matching contributions to an RRSP plan and cut vacation benefits from six to four weeks. Two employees claimed constructive dismissal. The cuts represented between six and eight percent of the employees’ total compensation, not enough to make the employer liable for constructive dismissal, according to the court [Otto v. Hamilton & Olsen Surveys Ltd.].

2 WAYS TO AVOID LIABILITY

In addition to understanding what is and is not constructive dismissal, you can take the following 2 steps to minimize the risk of liability.        

1. Reserve Right to Make Changes to Pay

At heart, constructive dismissal is a violation of the employment contract. The sin the employer commits is unilaterally changing the agreement with the employee. The operative word is “unilaterally.” To the extent that employees knew and agreed that such changes would or could happen when they took the job, they’ll have a harder time winning a constructive dismissal lawsuit. So one of the things you can do to protect yourself is let an employee know up front that certain aspects of the compensation package aren’t guaranteed and are subject to change.

Example: A 9% cut in compensation wasn’t constructive dismissal because, among other things, the employer had reserved the right to make such cuts in the employment contract [McSeveny v. Phone Directories Company, Inc.].

2. Give Advance Notice of Changes

Notifying employees in advance of the change can also help minimize the risk of liability. The more notice employees get, the less they can claim they were waylaid by the change. “A fundamental change that is accompanied by reasonable notice is not constructive dismissal,” according to one court [Fellowes-Strike v. Co-operators Group Ltd.].

CONCLUSION

Nobody is suggesting that it’s illegal to cut compensation and benefits. However, the risks of such actions extend beyond the obvious potential for employee backlash. They could also make you susceptible to constructive dismissal claims. If you understand the risk, you can take steps to manage it. Better yet, you can make constructive dismissal a moot point by getting employees to agree to the changes. But if unilateral action is your only realistic recourse, make sure you account for constructive dismissal risks when making decisions.