Canada: Ontario Court of Appeal Decision Raises the Stakes for RSU and Equity Compensation Plans

A recent Ontario Court of Appeal decision has significant implications for employers that use restricted stock units (RSUs) and other forms of equity-based compensation as part of their compensation strategy. While the case arose in the context of a wrongful dismissal claim, the court's analysis extends beyond the particular facts and has the potential to affect the enforceability of termination provisions contained in many equity compensation plans.

What Happened?

The employee was dismissed without cause and successfully challenged the enforceability of his employment agreement's termination provisions. As a result, he was entitled to 10 months' common law reasonable notice. The principal issue on appeal concerned whether he was also entitled to recover the value of RSUs that would have vested during that notice period.

The Court of Appeal concluded that he was.

In doing so, the Court held that provisions in the employer's RSU agreements that terminated vesting and forfeited unvested awards immediately upon termination contravened the Employment Standards Act, 2000 (ESA). Specifically, the Court found that the provisions altered a "term or condition of employment" during the statutory notice period and were therefore void. Because the forfeiture provisions did not lawfully displace the employee's common law rights, the employee was entitled to damages reflecting the value of the RSUs that would have vested during the reasonable notice period. The resulting award exceeded US$4.7 million.

A Different Lens on Incentive Compensation Plans

The decision is noteworthy because it shifts part of the analysis away from the traditional question of whether plan language is sufficiently clear to remove an employee's entitlement to incentive compensation during the notice period. Under existing jurisprudence, courts have frequently examined whether bonus, stock option or RSU plans contain clear language limiting entitlements after termination. This decision adds another layer to that analysis by emphasizing that plan provisions must also comply with the ESA's minimum standards.

A central aspect of the Court's reasoning was its interpretation of sections 60 and 61 of the ESA. The Court held that those provisions must be read together, with the result that employees receiving pay in lieu of notice are to be placed in the same financial position they would have occupied had working notice been provided. According to the Court, this includes the statutory prohibition against altering terms and conditions of employment during the notice period. As a consequence, plan language that stops RSU vesting immediately upon termination may be vulnerable to challenge where it has the effect of removing a component of compensation during the statutory notice period.

Broader Implications for Equity Compensation

The Court characterized the RSUs in question as a term or condition of employment. In reaching that conclusion, it relied on several factors, including that the awards formed part of the employee's compensation package, vested through continued employment, were described by the employer as employee compensation, and were treated as employment income for tax purposes.

While the decision dealt specifically with RSUs, its reasoning may have implications for a broader range of incentive arrangements. Many modern compensation programs, including performance share units, deferred share units, stock options and other long-term incentive plans, share similar characteristics and are designed to reward continued service. The Court's emphasis on whether an entitlement constitutes a term or condition of employment may invite further scrutiny of termination and forfeiture provisions across a range of equity-based compensation structures.

The Court also took a restrictive approach to "saving" language commonly found in incentive plans. The RSU agreements contained language preserving rights “where explicitly required by applicable legislation.” The Court concluded that this wording was insufficient because the ESA does not expressly address continued RSU vesting. While the decision reinforces the continued judicial scrutiny of broadly worded savings provisions, it does not necessarily foreclose the possibility that more specific and direct language expressly addressing ESA minimum standards would be enforceable. 

Implications Beyond Traditional Employment Relationships

Another notable feature of the decision is its treatment of equity awards arising in the context of a business acquisition. Part of the employer's argument was that certain RSUs were connected to the acquisition of the employee's company and therefore fell outside the ESA. The Court rejected that position, emphasizing that the awards had been structured as employment compensation and were tied to the employee's ongoing service. The commercial origins of the arrangement did not displace the application of employment standards legislation.

This aspect of the decision may be of particular interest to organizations that use equity incentives as part of retention arrangements following mergers, acquisitions and other corporate transactions. Where those awards are structured as part of an employee's compensation package, they may attract the protections afforded by the ESA notwithstanding their connection to a broader commercial deal.

Key Takeaways

In light of this decision, employers may wish to:

• Review RSU plans and other equity compensation arrangements to assess whether termination and forfeiture provisions could be viewed as altering a term or condition of employment during the ESA notice period. 
• Revisit the effectiveness of broadly worded "savings" clauses. The Court's analysis suggests that generic references to compliance with applicable law may not necessarily insulate equity plan provisions from challenge.
• Organizations with compensation structures that rely heavily on RSUs, stock options, PSUs, DSUs or other long-term incentive awards may wish to evaluate the extent to which those arrangements are tied to ongoing employment and form part of an employee's compensation package.