Executive Termination

"Nasty, brutish and short" was how the 17th century English philosopher Thomas Hobbes described civil life without the stabilizing presence of a monarchical system. Similar words can be used to describe the employment experiences of an increasing number of senior executives. You either perform or you're out. It's that simple. As noted by Randall Scott Echlin at the Toronto offices of Borden Ladner Gervais LLP: "There's a rule of thumb that the average shelf-life of a CEO in Canada is about 18 to 24 months, unless he or she is performing."

Unpleasant for sure. However, many terminated executives in the US, the UK, and Canada find considerable consolation in the fact-and there is really no other way to put this-that the price of failure has never been quite so high. Executives who have resigned prematurely, been dumped by their boards, or sacked under pressure from short-fused shareholders, are laughing all the way to the bank.

As always, the real nosebleed figures come from the States. A recent Washington Post article examining situations where CEOs had been forced out by their boards rattled off the following jaw-dropping severance arrangements: a $25.5 million package to Doug Ivester at The Coca-Cola Co., a $50 million package to Jill Barad at Mattel, Inc., and a $95 million package for Xerox Corp.'s G. Richard Thoman. Part of Ms. Barad's legacy was the disastrous acquisition of The Learning Co., which Mattel has just recently unloaded for a fraction of the purchase price. Fiasco notwithstanding, Mattel, as one wiseacre calculated, will have to sell something like 600,000 additional Barbie dolls annually for the next 10 years just to cover the yearly $1.2 million pension that Barad will receive as part of the broader $50 million package.

Things are not much different in the UK. For example, Bob Ayling, the former British Airways Chief Executive who was roundly criticized for replacing the Union Jack with ethnic designs on the tail-fins of the airline's planes, received a package worth £4 million ($10 million Canadian) when he was forced out last year. As Ira Gershwin put it, nice work if you can get it.

And in Canada? Last summer John Gray wrote a hard-hitting article in the June 12, 2000 issue of Canadian Business entitled The Golden Parachute Club. Mr. Gray caustically reviewed the performance of four Canadian CEOs-Bill Fields at the Hudson's Bay Co., George Kosich at Eatons, Jim Bullock at Laidlaw Inc., and George Watson at TransCanada PipeLines Limited-and the very substantial severance packages, or "retiring allowances", they received. Top marks were given to the $5.95 million payment Bill Fields received from The Bay, purportedly the highest severance settlement of last year. This payment was made notwithstanding the fact that, according to Canadian Business, in "the quarter ending January 31, 1999-three weeks before Fields resigned-the Bay's earnings before interest, unusual items and income tax (EBUIT) was a paltry $12.9 million, down 85.7 per cent from the same quarter in 1998 when EBUIT was $90.1 million." Mr. Field's counsel? Well, that was Mr. Echlin at Borden Ladner.

What is going on here? It used to be that "nothing succeeds like success". Now it appears, in many instances, that "nothing succeeds like failure". Yale Tauber, a senior compensation consultant with William M. Mercer in the US, looked at 28 CEOs who exited their corporations prematurely over the past three years. He found that they received, on average, 186 per cent of the amount they would have been paid had they served out their terms. Further, almost all of them received their full option entitlements. Can't a board screw up the courage to penalize failure? Or, legally speaking, is "failure" just too strong a word? What is happening in the world of executive employment and termination?

"Things just aren't the way they used to be," observes Richard Moore, Chairman & CEO of the Canadian division of TMP Worldwide. "In the 1960s and 1970s, the general thinking was that if you join an organization you work there for the rest of your life. You might be daring and have two or three careers, but that was really pushing the limit. And these values were espoused by the business schools and the law schools: That was part of our culture, part of our value set." Today, TMP's thriving Executive Search Division is a testament to the fact that somewhere along the way, things dramatically changed.

Stewart Saxe of Baker & McKenzie in Toronto links this transformation to economic events over the past thirty years which resulted in the "breaking of the loyalty bond that existed between companies and employees." The recession that occurred between 1979-1984, according to Saxe, "broke the back of the general concept that if you got into a middle management position you had a job for life." Downsizing and organizational restructuring meant that many executives were forced out. But even when economic stability and job security returned, it was clear that the damage had already been done.

Jack Marshall, Q.C., Chairman of Macleod Dixon LLP in Calgary and Head of the firm's litigation group, has represented many senior executives. The current market turmoil is no surprise to him. "I've seen an attitude develop, more than we saw years ago, that people are working for themselves today." Though his words imply a critical tone, Marshall is, in fact, a supporter of this new "attitude". "I don't really think it's a negative thing. I think it's a healthier attitude for an individual to think 'I'll go where there's the best opportunities'." Healthier, Marshall

notes, than the days when executives stayed rooted in 'safe' positions.

Ask any CEO today and they'll tell you that a 'safe' executive position is a thing of the past. "There is no question that turnover has increased," notes TMP's Richard Moore. "Both because it's being forced by the organizations and because people are attracted to other opportunities and to other companies that are growing more rapidly."

The corporate landscape is a blur. There is rapid and significant structural change taking place in terms of mergers, acquisitions, divestitures, new organizational and management models, new leadership models (i.e. you now need to be a strategic visionary), and so forth. One of the keys to understanding the turmoil in the market is the accelerated pace of change. The collapsing time frames. "The fact of the matter is that organizational change in terms of new management structures is happening more rapidly than ever before," explains Moore. "What used to take ten years to happen can now be done in a year and a half." Things are happening so fast, it's not real.

Name partner Barry Kuretzky of the employment and labour law boutique Kuretzky Vassos LLP in Toronto agrees. "There is no question that the pace of business has changed," he notes. But Kuretzky goes on to provide an important additional point. He couples this development with heightened expectations from shareholders and directors in explaining the increase in executive turnover. "There's an impatience. I think there's a general trend that you've got to prove success very quickly, and if success isn't moving the company in the direction that the Board wants, then change is very quick in the offing." In other words, the fast-paced corporate world has a short fuse.

But how is executive performance measured? Robert Bonhomme of Heenan Blaikie in Montreal is quick to point out that "it's the performance of the company, not performance of the individual, that is in issue." The distinction is important. It means, for example, that notwithstanding an executive making what would normally be seen as "the right decisions", a turnaround in performance that does not match expectations of immediate and significant improvement is not satisfactory. In these cases, Bonhomme adds, the executive sees the writing on the wall. "If the first fiscal year is bad, the second will be their last." Investors no longer tolerate more than a few quarters of corporate underperformance. Gavin Hume, Q.C., in the Vancouver offices of Fasken Martineau DuMoulin LLP, agrees. "The increased emphasis on strong stock performance results from pressure from institutional investors. Long-term improvement is not viewed as sufficient, and this was particularly the case until quite recently when comparisons were constantly, and probably unfairly, being drawn with the performance of high-tech stocks."

Measuring how a company is performing, and in turn, whether the executive is secure in their position, "depends on what the company is looking for," notes Echlin. "They can be looking for improvement in the value of the stock, improvement in profits, improvement in sales. There will be certain benchmarks that the executive will be given at the outset and told to meet." Echlin adds that today's shareholders are a far more sophisticated, informed group of investors than ever before. "These are serious investors-teacher pension funds, municipal employee pension funds, mutual funds, and so on-who know what they're doing." In short, these are people who are constantly monitoring the performance of their significant holdings and who increasingly show little reticence about publicly second-guessing senior management or voting with their feet. As Echlin notes, "Any company that's not moving ahead quickly is going to have pressure on it, no question, and that pressure will be on the CEO."

The precarious nature of the executive's position is often exacerbated by the turbo-charged nature of corporate life cycles. In a pre-IPO situation, notes Kuretzky, "what the executive has to do is prepare the company for the IPO, to create the market and build a team. The criteria in selecting an executive in these circumstances are particular to this stage in the life cycle." This is contrasted with a post-IPO company which may require very different deliverables. A CEO who thrives in one situation may simply not fit the bill when circumstances change.

Taken together, all of these variables-organizational restructuring, the frantic pace of business, high expectations respecting performance-account for many executives who find themselves pounding the pavement. According to George Enns, founder and partner of Toronto-based executive search firm Enns Hever Inc., there used to be a significant stigma that twenty, even fifteen years ago, attached itself to these terminated executives. But today, Enns observes, there generally is no such stigma. "The reality is that there are so many good individuals who are caught by circumstance. Consolidation, selling off businesses-they become victims of how the economy is going." Richard Moore at TMP agrees. "We used to think that if you were terminated there was obviously something terribly wrong. Sometimes it is the case. But often it has nothing to do with that."

At Enns Hever, the period of time when an executive is "between jobs" is carefully referred to as being on "waivers". And according to partner Rita Eskudt, when the market is hot, as it has been for the past few years, executives on waivers essentially retain their bargaining power in negotiations with prospective employers. "Our clients fundamentally don't care whether the person's in or out, as long as they have the skills that it takes for their organization. If they've got the right background, the right style and disposition, our clients are interested."

George Enns goes so far as to suggest that the "stigma" of past terminations can serve as an advantage for executives today. "I think to a certain degree, some companies value an individual who's had an experience that was a failure-that wasn't all success. It's a different experience and it's one that sometimes people are, in fact, looking for." Resilience, in particular, is a quality that is often sought at the most senior levels. What an executive wants to ensure, says Enns, "is that there isn't a pattern of failure." Absent a pattern, executives on "waivers" are a valuable commodity.

Finding talented executives is not the greatest challenge faced by Canadian corporations. And here is another key to understanding the current market turmoil. The real contest is the super-competitive international market for top talent-and the most powerful contender is south of the border. "In spite of what Jean Chrétien believes, there is a brain drain," George Enns wryly notes. "And were he to enter the real world, he would learn that very quickly." A distinct defeatist tone marks discussions about US competition. "There isn't any competition," says Stewart Saxe. "The Americans get everyone they want. You can't exactly call that competition."

Indeed, this was precisely the significance of Bill Fields and his associate Ira Pickell joining the Bay. It was a reverse brain drain. They were the US retailing dream team that would take on the big-box US retailers invading the Canadian market. Fields' career included 25 years at Wal-Mart before becoming its CEO, and then moving on as CEO of Blockbuster. Pickell came from The Bon Marché, a Seattle-based fashion retailer. As they say, the rest is history.

Is it really as bad as it sounds? It certainly is, according to Michael A. Thompson, Vice-President and Managing Director, North American Reward Consulting for the Hay Group. Thompson examined the compensation differential between the US and Canada in a paper entitled Border Crossing: Canadian Talent Heading South, published by the American Compensation Association in May, 2000. Thompson notes that since 1989, the number of work visas issued to Canadians to work in the US has outpaced the movement of US citizens to Canada by a ratio four to one. His examination of overall compensation differences provides a clear explanation for this disparity. According to Thompson: "at the CEO level, Canadian compensation levels fall below the US by more than 20 per cent," while "US annual incentive payouts in 1999, based on 1998 performance, were almost 30 per cent greater at the managerial level and 57 per cent greater among CEOs." Long-term incentive plans were found to follow a similar pattern.

But that's only half of the story. As Thompson further notes, "compensation differences are one issue, while tax and purchasing power are quite another." He concludes that "Canadian total tax levels, depending on income, continue to remain approximately 5 to 10 per cent higher than in the United States," though there are significant variances among different regions in both countries. But there are other taxation issues to consider. For example, stock option exercise gains are generally taxed in Canada at the equivalent of capital gains rates, whereas in the US, non-qualified option exercise gains are taxed as ordinary income. The result, Thompson observes in Border Crossing, can be preferential to the executive in Canada. So while the US tax regime is generally more favourable to executives, according to Thompson, "the gap in taxation is narrowing."

This may be so, but to many executives in Canada it offers little consolation. "There are a lot of people who've become fed up," notes Richard Moore of TMP. "They're fed up with the tax regime in this country. They're sick of for every buck they make giving 53 cents away. And then you've got the tax within the tax-you're going to pay GST every time you buy something. Now, unfortunately I think our government is being very slow to react. So the brain drain/opportunity drain continues. I think the budget has gone part of the way to help, but there's still a long way to go."

Money isn't the only factor accounting for the drain of Canadian executives. US companies are actively recruiting Canadians. George Enns knows of one search firm that has a specific mandate to poach Canadian talent for US clients. "The reality is that we're a smaller country and individuals tend to get a broader responsibility earlier in their career," Enns observes. "So Canadians have become very, very much in demand by US corporations." Enns cites the consumer products industry and technology sector as two examples where this trend is particularly evident.

When you combine all of these factors-the US demand, the accelerated pace of change, the impatience of the market, and the premium attached to executives who hold out the prospect of a "quick fix"-it should come as no surprise that in many cases it is the executive, and not the prospective employer, who calls the shots in negotiations. Nowhere is this power manifested more clearly than in today's soaring executive compensation and the growing popularity of pre-positioned termination packages, i.e. severance packages, negotiated at the time of hiring as opposed at the time of termination. Several components comprise the typical executive compensation package-base salary, a bonus, and long-term incentives are just the basics. But the hottest form of compensation today is the stock option or stock purchase plan.

"Stock option madness," as Robert Bonhomme calls it, has turned the traditional compensation model upside down, with the result that options have become an almost god-given right for new employees, while salary has achieved a 'secondary' status. The stories of overnight millionaires-particularly in the dot.com sector-are endless. But as Stewart Saxe notes, it would be inaccurate to suggest that stock options are a new method of compensation. "They existed back in the 1960s, but they were limited and were only available for the highest level executives." And of course, they weren't worth talking about until people started getting super-rich.

There's no mystery surrounding the reason for the explosion of stock options in the 1990s. It's economics, pure and simple. "From the employer's perspective," notes Saxe, "stock options are a very attractive form of compensation because the value never comes out of the corporate treasury-it comes out of the stock market." They are the ultimate recruiting strategy-a win-win model of compensation which doubles nicely as a "golden handcuff", locking executives in until the options have vested.

In some instances, however, the handcuffs aren't tight enough. In the high-tech industry-where many of the normal rules just don't apply-stock option plans are at their most lucrative. But it's also the industry where competition is most fierce. The result, according to James Hassell at the Toronto offices of Osler, Hoskin & Harcourt LLP, is that "it ups the ante, because the new employer basically has to buy them out of whatever it is they're walking away from." According to Colleen Dunlop of Ottawa's Emond Harnden, a high-profile employment and labour law boutique in the heart of Canada's high-tech sector, executives simply aren't waiting for the options to vest anymore. Particularly, notes Dunlop, if the new opportunity is pre-IPO. "It's like gambling. There's a risk in going to start ups, but the windfall can be tremendous."

And so, while the markets were on the rise, options were the hottest thing going. But since last fall, when many high-techs cratered, there's been a chill in the air. Suddenly, salary and bonuses are becoming a more important consideration. According to Stewart Saxe, we are in "the very beginning of a new period in the employer/employee relationship." And during this period, it won't be the 'loyalty bond' that is affected-it will be compensation. "Executives will start re-evaluating the whole compensation package." The popularity of long-term incentives may give way to the more traditional model, or perhaps, to new and innovative ways to compensate, and to attract, top executives.

At first blush it seems unimaginable, in a period where an executive's shelf-life may be only 18 to 24 months, that anyone would consider new employment without first entering into an air-tight contract with all the termination issues covered off. As Jason Hanson at Oslers observes, "folks on both sides of the fence tend to be more content with the result following a termination when they have a contract. There may be some squawking about details, but the broad parameters usually have been worked out ahead of time." Hanson notes that at the executive level, the contract is particularly significant. "A difficulty for both executives and their former employer if there is no contract is that the results of negotiation or litigation can vary widely-up or down-from what their first expectations were."

Yet, on the other hand, and central to the concern over payment for failure, there would appear to be a fundamental flaw in agreeing to termination terms prior to the possibility of assessing performance. To be sure, there are mechanisms which attempt to tie various payouts to performance or performance related criteria. But nevertheless, many of the important payout provisions are in place prior to the commencement of employment. Such is the bargaining power of some executives.

But according to Chris Paliare at the Toronto offices of Gowling Lafleur Henderson LLP, there are people-on both sides-for whom a negotiated contract is not always the best solution. "It doesn't leave the kind of flexibility that some people want," notes Paliare. "The sense I get is that employers don't really want to get into that kind of hard bargaining with the senior people that they really want to recruit. And sometimes the parties can't decide who really has the strongest bargaining position, so it's better to say nothing than to spend time, effort and energy-not to mention legal fees-on arm wrestling over this term or that term."

Unquestionably, negotiating termination provisions prior to the commencement of employment can dampen the ardour of both parties. Yet, this appears to be where the market is and, obviously, such agreements can lead directly to payment for failure scenarios. It is all about market power.

There is a strong sense among senior employment lawyers that executive contracts with detailed termination provisions are becoming increasingly commonplace. Echlin at Borden Ladner Gervais LLP notes that things were much different twenty years ago, when executives were more willing to secure employment without first negotiating what he calls a "safety net severance". "Today," Echlin observes, "I don't know of any senior executives who would accept a major move without it. I think companies and executives both want the certainty of knowing what's going to happen if the relationship doesn't work out. It's just as much an advantage to the company to know that if we get rid of this person, this is what we're going to have to pay."

And Echlin is right. As executive terminations become more common, "safety net severance" becomes a condition precedent for a new executive coming on board. Recent research by Rakesh Khurana of the Sloan School of Management at the Massachusetts Institute of Technology finds that boards are disproportionately likely to replace a sacked CEO with an outsider. But-and here is the rub-the outsider will come only with suitable insurance in place.

This isn't to say that a predetermined severance package will necessarily eliminate the need for post-employment negotiations. To the contrary, some employers shun the notion of negotiating a detailed employment contract for the very reason that at the executive level disputes will inevitably arise-with or without a contract in place. But, as James Hassell at Oslers notes, this is precisely where the value of the agreement shows itself. "If the relationship does sour, for one reason or another, there's a roadmap there," says Hassell. "There may still be negotiations over issues like the stock options, and they might be quite heated and difficult, but at least you're not arguing over whether this person's supposed to get 18 months or 24 months. A lot of companies are, frankly, sick and tired of negotiating notice periods with employee counsel after a termination."

This frustration is coupled with a growing unease regarding judicial inconsistency as to what constitutes reasonable notice for termination. The common law requires that if the employment agreement is terminated by the employer without cause, then the employer must provide reasonable notice of termination, or pay in lieu thereof. For the most part, a comprehensive body of case law provides relatively clear guidance as to what constitutes a reasonable period of notice. According to Allison Taylor at Toronto employment and labour law boutique Stringer, Brisbin, Humphrey, "the month per year rule is still generally used at the managerial level." But at the executive level, Taylor's assessment is less precise. "Well, it's going to be more than that, let's just put it that way."

Though there may not have been a precise formula in the past, most lawyers were at least in agreement for some time that 24 months was the cap for executives, with only a few select cases actually warranting such a generous notice period. As Gavin Hume, Q.C., at Fasken Martineau DuMoulin LLP in Vancouver notes, the general ballpark of negotiated settlements for long-term executives was in the 18 to 22 month range.

This benchmark was shaken, however, by the Supreme Court of Canada's 1997 decision in Wallace v. United Grain Growers Ltd., giving rise to what are now commonly referred to as "Wallace damages". After having been employed with United Grain Growers for only 14 years, Mr. Wallace was awarded 24 months salary in lieu of reasonable notice-approximately 6 to 9 months more than would normally be expected in such a case. In assessing reasonable notice, the court went beyond the normal factors that are usually considered, such as age, length of service and chance of reemployment, and stated that employers ought to be held to an obligation of "good faith and fair dealing in the manner of dismissal." The court was sympathetic to Mr. Wallace in this case because he had been lured away from secure employment, had performed well for his new employer and was given assurances of job security. Further, allegations of termination for cause by the employer up until the time of trial had made it difficult for Mr. Wallace to find other employment.

Despite the fact that reasonable notice was designed solely as a means to enable dismissed employees to find alternative suitable employment, the Wallace decision has added a new dimension. Now, if an employee is treated 'badly' at the time of termination, the court will simply tack more time onto the notice period. This, according to Barry Fisher, whose practice is largely devoted to mediating and arbitrating employment law disputes, "is just another manifestation of the court's mandate to compensate dismissed employees who are treated poorly, but also to punish the employer."

Chris Paliare sees Wallace, and cases that have followed it, as evidence of the new, more flexible approach that the courts have adopted towards employment law generally. "I think that courts are beginning to appreciate, in a way that they hadn't in the past, the critical importance and significance of work to people's lives." Paliare saw first hand evidence of this "flexibility" when in April, 1998, he won, on behalf of William Kilpatrick, the highest wrongful dismissal award in Canadian history. Kilpatrick was hired as the Executive Director of the Peterborough Civic Hospital after working at The Moncton Hospital for 29 years. Kilpatrick's employment was terminated, without notice, after six years in his new position. The case came to court on summary motion to determine the appropriate notice period. Characterizing the employer's actions at the time of termination as "unreasoned and cavalier", and stressing the employer's 'inducement' of Kilpatrick from a secure position elsewhere, the motions judge decided the proper notice period should have been an unprecedented 30 months. Although the Ontario Court of Appeal later set aside this judgment on procedural grounds, Kilpatrick ultimately achieved the same result at arbitration.

Such cases obviously substantiate Paliare's comment that some clients "would prefer uncertainty to the certain." This is particularly so when you consider what 30 months' compensation means for most executives. According to The Toronto Board of Trade's 2000 Executive Compensation Report, the average base salary for CEOs in the Greater Toronto Area during the past year was $217,900. Thirty months' salary, then, translates into approximately half a million dollars-before you consider any other forms of compensation like stock options or bonuses. Uncertainty can clearly be costly.

But not as costly in Quebec. In Quebec, notes Robert Bonhomme of Heenan Blaikie, "the case law is less generous. We have never, to my knowledge, had an award over 20 months. And we rarely go over 18 months." The reason for this disparity is precedent. According to Bonhomme, the bar was initially set at a lower notch by Quebec courts, whose awards were more modest, and the principle of stare decisis has meant that those decisions were followed. "From a legal perspective," adds Bonhomme, "there is no reason why it should be different. The same principles apply."

So how do executives in Quebec respond? "They work for national companies, such as Bell Canada," Bonhomme replies, thereby evading the limitations posed by the case law in Quebec. Or, they simply "negotiate a better contract" as a way out. Bonhomme explains that while there may be a disparity between the case law between Quebec and Ontario, "the contracts are the same in both jurisdictions." His observation that "executives are all negotiating contracts now," comes as no surprise.

"Having a fixed notice period is always a desirable thing from the employer's perspective," observes Allison Taylor at Stringer, Brisbin, who negotiates on behalf of employers. According to Taylor, where a typical notice period of 18 months is agreed upon, "it's expensive for the employer at the time of termination, but cheap in the end." But negotiating appropriate notice periods is only one incentive-albeit, an important one-for employers to enter into an employment contract. This alone does not account for their new de rigueur status.

According to Jason Hanson at Olser, Hoskin & Harcourt LLP, some companies perceive there to be a more serious issue at hand. "I think the investor community expects contracts, and expects contracts not only to deal with termination, but often primarily as a way to deal with other areas such as proprietary interests and non-competition. In other words, to invest in a knowledge-based company, the investor wants to ensure that the company owns the knowledge and has realistic and enforceable commitments from its executives." In fact, other proprietary interests can take priority to the extent that, as Hanson suggests, "you can have a situation where you have a written employment contract which doesn't address what people get on termination," though this scenario is less likely at the senior executive level.

Confidentiality agreements, in particular, are a major concern for the high-tech companies-it's this industry, after all, where executive-hopping is most pronounced. Colleen Dunlop at Emond Harnden notes that employers in this field face a particular challenge. "As much as high-tech is the industry that needs restrictive covenants the most, it's the most difficult area to get employees to sign them." The problem, according to Dunlop, is executive turnover. "It's got to be very specific to the technology," thereby ensuring that employees maintain a certain degree of freedom to pursue other opportunities. And, as Dunlop notes, the remarkable bargaining power executives in this arena are experiencing is forcing employers to comply.

And then there's the problem of enforceability. The courts are particularly sensitive toward non-competition agreements, making it difficult for companies who want to prevent employees from jumping ship to the competition, or from starting a competitive enterprise of their own. "There's a general feeling in the community that non-competition clauses probably aren't enforceable," notes James Hassell at Oslers, who advises his clients to be wary. But as with all restrictive covenants, if the employer is able to show that the covenant is 'reasonable', then the courts will be inclined to enforce a contract. The scope, duration and geographic boundaries of the restriction are all relevant in this assessment. The golden rule is that less is best.

This means that lawyers acting for employers are left to their creative devices to work around this judicial constraint. Enforceable or not, companies are insistent that these issues be addressed. For Hassell, one solution to this "very murky field" is to create a monetary incentive for the executive. Despite the courts' reluctance to enforce "non-competes", Hassell says, "we still put them in, but basically they're enforced through self-help rather than the courts. You tie the restrictive covenants into termination payments, for example. So if you're going to give a departing executive 24 months compensation, you pay it out over time and tie it to compliance with the non-compete." Other innovative solutions to the 'non-compete' dilemma include linking compliance to supplemental pension arrangements, which are particularly important to executives whose government pension plans are capped.

From the perspective of the executive, the employment contract is a tool designed for self-protection. What is wanted is an exit ramp when circumstances change-whether that is control of the company, conditions of employment, or an outright termination-and they want a 'golden parachute' in tow to cushion their landing. A golden parachute package is typically lucrative, comprised of a salary payment substantially in excess of what the executive would receive if the common law concept of payment in lieu of reasonable notice were relied upon, plus benefits, stock options and any other 'perks' the executive negotiates.

Change of control, according to Echlin at Borden Ladner, is of particular concern to executives. "We always provide for significant parachutes and safety nets, because the party hiring the executive may not be the party firing the executive." This is a very real concern for executives who find themselves without a job when the board changes. In these situations, however, the golden parachute is not solely designed with the executive's welfare in mind. "The rationale for a change of control clause," notes Echlin, "is that you want the executive to act in the shareholders' and the company's best interests in selling the company for the highest price. To do that, you want the executive to be unconcerned about his or her own job security." And again Echlin is right. Academic studies have repeatedly substantiated that CEOs encourage value-creating mergers and takeovers when they are protected, and they fight them when they are not.

The pace of organizational change today has meant that many executives are pulling the ripcord more than once in their career. This is particularly true in the oil and gas industry in Calgary. "There's a lot of consolidation going on in the energy sector," Jack Marshall, Q.C., at Macleod Dixon notes. "I can think of an example, a corporate counsel I know quite well, who got golden parachutes three or four times because of it." And as a result, Marshall says, the old 'stigma' that came with termination has disappeared. "It's not really considered to be a big black mark against your name-that's just what's happening in the industry."

Parachutes are also triggered, in many cases, when the executive resigns for "good reason"-something which is tantamount to a constructive dismissal. "This is an area that poses a great deal of interest and exposure to both the executive and the company," notes Jason Hanson. "The common law says that significant unilateral changes amounting to a repudiation of the employment contract results in a constructive dismissal, and the employee can quit and sue." According to Hanson, in today's business world, defining those circumstances which will or will not constitute a constructive dismissal is a crucial aspect of the employment contract. "We're seeing dramatic changes within organizations and changes in reporting lines, as a result of market pressures, competition, globalization, technology, divestitures of various businesses, and so forth," thereby exposing employers to significant liability depending on the wording of the contract.

Changes in control, circumstances constituting dismissal-these are pivotal issues for an executive entering into a new employment relationship. But the most sensitive issue during negotiations, from the employee's perspective, is options. If money talks, then options roar. "When I'm doing a termination package now, whether somebody is getting two years or three years of compensation isn't really the issue," says James Hassell. "The issue is the stock options-because that's where the money is." And because the value of the option is intrinsically tied to the point in time when the option vests, it is this issue that commands the most attention-both before and after the relationship is terminated.

According to Barry Fisher, the question of entitlement to stock options is the hottest issue right now for executives. The problem, quite simply, is drafting. If the stock option agreement reads, "Upon termination, your entitlement to any further stock options ceases, vested or unvested," it means something very different in Canada than in the US. As Fisher explains, "In America, that means what it says, because there's 'at will termination'-if you're fired on the fifth, that's your last day of employment and your stock options end." But in Canada, where we have the doctrine of reasonable notice, the language isn't quite so clear.

The Court of Appeal addressed the issue in the 1999 in Veer v. Dover Corp., where it was held that whether voluntary or involuntary, termination that extinguishes the right to exercise stock options must be "termination at law." What this means, according to Colleen Dunlop at Emond Harnden, is that "now individuals are entitled to any stock options that would have vested during the reasonable period of notice." This, according to Dunlop, "made it much more difficult for employers. You have to be very clear in drafting these agreements. Who's going to sign an agreement saying 'We can wrongfully dismiss you and your options will cease?'" Allison Taylor at Stringer, Brisbin agrees that now that the law is clearly settled on this issue, "it poses a problem for companies terminating people with a lot of money tied up in stock options. If you say to someone when you terminate them, "Your option plan ceases," and they don't agree, you can expect to be sued."

All of this is difficult to argue with when the executive is terminated without cause. But what about the underperforming executive who fails to meet last quarter's projected earnings? Would that justify termination for cause?

Not likely, according to Randy Echlin at Borden Ladner Gervais LLP. "Just cause is basically the capital punishment crime of employment law," according to Echlin. "It's got to be very serious. It's got to be harassment, it's got to be breach of fiduciary duties-those kinds of things. And the vast majority of judges will not find just cause for a mere dissatisfaction with performance in the workplace."

And, even in cases of clearly demonstrable underperformance on the part of the executive, it is unlikely that many employers would take a hard line. Practically every senior employment lawyer interviewed for this article was of the view that trying to penalize a failed CEO would only make it more difficult to recruit an outside successor. And for the cynics, of course, there's the log-rolling aspect that has to be factored in. As noted by a US executive, who requested anonymity, in a recent Fortune article on executive termination: "There is something to be said for the fact that most boards are composed of CEOs of other companies, and it is not lost on them, even though it may only be in their unconscious, that if they pay generously, maybe that will rub off on them."

Yet even in those rare cases where an executive has committed a "capital punishment" offence, few employers are brazen enough to allege cause, at least not publicly. "There's always at the high executive level a real sense of negotiating a result," according to Barry Kuretzky. "I mean, the last thing you want to do if you're a company is to say the CEO has been incompetent and the company has been mismanaged, unless you don't really value the stock price."

Barry Fisher agrees that termination for cause is best left untouched. "Cause isn't normally an issue in executive terminations, because you don't put your dirty laundry in public." When, on occasion, the issue of cause comes before Fisher in mediations, he likes to illustrate this point as follows: "Say you've got a public company and you discover that your CFO has been ripping you off for the last five years. I'll say to the employer, 'Well, just think of what winning looks like-the headline in the financial press is 'ABC Corporation successfully proves that its financial statements have been misleading for the past five years'-and that's winning!'"

There is little chance, then, that termination for cause will be alleged at the executive level. But despite this, many employers attempt to structure a sweeping definition in the employment contract of those events which will justify termination for cause. "I personally sometimes wonder whether it's worthwhile doing that," observes Jason Hanson. "You sometimes see very lengthy definitions of just cause in executive employment contracts and in the end result, you walk away thinking 'Well, that's pretty much what the common law says'."

Many lawyers don't recommend defining 'just cause' for this very reason. And to further add to the uncertainty, enforceability ultimately lies in the hands of the courts-where the end result can be a rude surprise. The recent Ontario Court of Appeal decision in Felker v. Cunningham is a perfect illustration of the hazy parameters of 'just cause'. Felker, while employed in a managerial sales position by Cunningham, pursued a business opportunity through a company he owned. The opportunity in question had already been considered and rejected by Cunningham's company. Four days before Felker makes his presentation for the opportunity, Cunningham learns of his actions and fires him. So now Felker doesn't have a job, and further, his proposal for the business opportunity is rejected. Was there just cause for termination?

The trial judge didn't think so, and awarded Felker the eight months notice he was entitled to under the terms of his employment contract. But the Ontario Court of Appeal disagreed, finding that Felker violated the duty of loyalty he owed as a "fiduciary employee". Felker was required, in other words, to disclose to his employer that he was engaging in activities in pursuit of another opportunity.

"I was shocked when that case came out," says Howard Levitt at Lang Michener in Toronto. "It's one thing to take a job with a competitor, but quite another to look for one." Chris Paliare at Gowlings points out that there are startling implications arising from the decision. "Does my assistant have to tell me that she's going over to McCarthys during her lunch hour to interview for a job? And if I learn of it, can I terminate her because she's looking for alternate opportunities while she's working for me?"

It is precisely this sort of counterintuitive unpredictability about litigation, and the predictably significant costs associated with such litigation, that fuel the demand for contractual certainty. Similarly, the need for certainty with respect to such important matters as proprietary rights, confidentiality, and change of control is self-evident. Yet, in securing certainty, companies run the serious risk of locking themselves into disastrous 'payment for failure' scenarios which quickly unfold into your basic shareholder relations nightmare.

The intense, often cross-border competition for executive talent and the upward pressure this exerts on compensation and pre-positioned termination payout provisions negotiated at a time when the executive is sought after but untested; the ballooning impact of options; the need for speedy closure when the decision to terminate is made and the impracticality of arguing "just cause"; all explain the growing practice of rewarding failure.

The anger that shareholders feel over these severance packages is understandable. Less frequently commented on is the anger that remaining employees, many of whom now face uncertain futures, feel. Imagine the employee morale at the Hudson's Bay Co. last year where the package to the former president and CEO Bill Fields, and his associate Ira Pickell, apparently exceeded the combined salaries of the company's entire senior management team. And put yourself in the position of the people at Mattel who now have to flog an extra 600,000 Barbie dolls a year for the next ten years just to cover off the pension portion of Jill Barad's $50 million package.

As a number of business commentators have asked, when these kinds of payments for failure are made, perhaps it is the board that should bear the brunt of the criticism and be shown the door. After all, it is the board that made the business decision regarding the executive. As the adage goes, why go after the monkey when you've got the organ grinder? This is what investors in the case of Jill Barad's severance package did. They filed suit against Mattel's board. But then, that's another story.

Jennifer Pink is a Lexpert staff writer.

Copied to clipboard