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Pay increases may be smaller than planned

By Yosie Saint-Cyr, LL.B., Managing Editor at HRinfodesk.com---Canadian Payroll and Employment Law News, January 2009

According to our last HRinfodesk poll that asked participants, Responding to the weakening economy, do you intend to scale back planned salary increases for 2009? out of 369 respondents, 34.69% (128) are being cautious and contemplating smaller pay increases for employees in 2009 than originally planned. A reason pay raises may be smaller is that organizations may be focusing on cost-cutting and efficiency to cope with a tougher business environment and tight money. Business analyses such as those coming from the Conference Board of Canada say that employers who scale back planned pay increases were unlikely to meet much resistance from employees who feel fortunate to have jobs in the current economic environment.

However, 26.02% (96) of respondents are not planning to scale back salary increases, and intend to implement what was initially planned. Some organizations have even commented that they plan to provide larger raises to their better-performing employees. This in the hope of retaining their top talent, filtering out low performers and ensuring productivity and employee morale remains steady amidst economic crisis.

Nonetheless, some organizations are still not sure what action to take (24.12% (89) regarding 2009 pay increases. It may be because they are not yet sure what direct impact the weakening economy will have on their businesses.

Interestingly enough, 11.92% (44) have decided not to give any salary increases in 2009, while 3.25% (12) don't usually provide employees with yearly salary increases.

The following tables summarize the information received from the 369 organizations who responded to the HRinfodesk poll. This commentary also provides an overview on pay related communication and the legal implications of reducing compensation.

What are others saying?

In a similar poll, Morneau Sobeco's latest 60 Second Survey of 168 employers across Canada states that 48% of respondents said they intended to adjust pay increases downwards by at least one-half of 1% of pay compared with the pay increases they had planned earlier in the fall, while 14% planned to freeze 2009 pay across the board.

Among the respondents who indicated pay increases would be lower, 63% planned to apply the reduction to all non-union employees across the organization, while 9% planned to apply it only at certain job levels, and 27% said the impact would vary on a person-by-person basis. The remaining 1% planned to apply the reduction only in certain office locations or provinces.

Forty-one percent of Ontario employers polled said that there was no significant change to their planned 2009 pay increases, compared with 77% of Atlantic Canada employers, 51% in Quebec and 56% in Western Canada. The difference may be due to the larger manufacturing sector in Ontario, which appears to be the hardest hit, according to the report.

More than four in 10 Canadian companies are planning to implement staff cuts and revised merit payments over the next year, according to a survey.

Watson Wyatt's survey of 138 companies suggests that 44% of companies have made or are planning layoffs, while 42% are revising merit payments for 2009. Merit budgets are anticipated to decrease by an average of 39% to 2.5%, a significant decrease from previous projections of 3.5%. Additionally, 41% of respondents have already stopped or will freeze new hires while 31% confirmed they have already made or will be going through organizational restructuring.

“Although there is a high level of uncertainty in the market, employers are cautiously moving forward to deal with the challenges of the economic downturn,” says Liz Wright, compensation practice leader for central Canada at Watson Wyatt Worldwide. “However, while measures such as workforce reduction and cost controls may be necessary in some instances, companies should maintain a balanced approach that includes actions such as enhanced employee communications to retain critical talent and boost employee morale and confidence.

Pay-related communication

Although some collective agreements, employment contracts or workplace policies guarantee some form of annual pay increases, there are no statutory requirements to provide annual increases to employees. However, most employees expect them.

Your duty as an employer when the company decides to scale back or freeze annual increases is managing expectations and communicating clearly and honestly with employees.

Employees can get worried when they do not know or understand what is going on in their workplace, or why an effected change is required. Regular communication with your employees can answer questions, dispel rumours and avoid misunderstandings.

For example, when employers include in their employment contracts the following clause, they are in a sense guaranteeing some form of annual pay increase.


Salary: The annual salary of the (Title) is $ _____ for the first year.

The annual salary will be increased by ___% effective on (date).


Salary increases will be negotiated to take effect at the beginning of each renewal period.

Deciding to freeze or reduce salary increases under this circumstance can be construed as a reduction in compensation. This results in a breach of the employment contract.

Lawyer Earl Altman notes to employers seeking to reduce compensation costs: employers must obtain the employee's consent, or provide adequate notice to the employee. Employers seeking to reduce compensation must give the employee in question the same amount of notice of that reduction as the employee would be entitled to for the termination of his or her employment. Employers should be particularly cognizant of using overly aggressive methods in seeking to convince employees to accept such reductions, as these may attract additional damages should the employee sue.

Reducing compensation

When an employer unilaterally and significantly reduces an employee's compensation, which constitutes a fundamental breach of the employment contract, the employee can consider himself or herself constructively dismissed and is entitled to damages for a wrongful dismissal.

In reviewing case law, the courts recognize that employees consider compensation to be one of the most critical terms of an employment contract. Consequently, reductions in compensation or changing the structure of compensation will be considered as involving an essential term of the employment contract.

Look at this case: David Farber's position had been eliminated in the course of a restructuring. He had been offered a job transfer with a completely different compensation package. Farber had previously enjoyed a secure base salary. Under the new structure, his base would be reduced significantly and much of his compensation would be at risk in the form of a commission structure. Farber refused the change and sued. While the litigation was based on Quebec's Civil Code, the Court's definition has been completely accepted in all common-law jurisdictions:

Where an employer decides unilaterally to make substantial changes to the essential terms of an employee's contract, and the employee does not agree to the changes and leaves his or her job, the employee has not resigned, but has been dismissed. Since the employer has not formally dismissed the employee, this is referred to as “constructive dismissal”. By unilaterally seeking to make substantial changes to the essential terms of the employment contract, the employer is ceasing to meet its obligations and is therefore terminating the contract.

The 1997 decision of the Supreme Court of Canada in Farber v. Royal Trust is still considered the leading authority on the issue. In the case, Royal Trust was able to prove that Farber would ultimately have been able to earn more under the new compensation structure. Nonetheless, the court found that, by putting Farber's compensation at risk, Royal Trust had constructively dismissed him. Straight reductions in compensation in the range of 10 to 20 percent have been determined to constitute constructive dismissal.

Consequently, whenever an employer is contemplating a unilateral change, two questions have to be answered:

a) Does the change involve an essential term of the employment contract?

b) Is it substantial?

The most effective tool to prevent constructive dismissal claims is a properly drafted employment contract. A written contract that defines the expectations, rights and obligations of the parties, and expressly reserves the employer's right to change the employee's terms and conditions of employment will be of tremendous value to the employer.

A written contract can provide clear evidence that the parties anticipated a great deal of flexibility in the way that the employment relationship would evolve over time.

Even if an employee was initially hired on a handshake basis, it may not be too late to “get it in writing”. It is, however, tricky to ensure that a contract signed after an employee starts work is valid. Employers should seek legal counsel if they want to get their existing employees to sign written employment agreements. In general, if an employee is being promoted, or given a bonus or a salary increment, this presents the employer with an opportunity to obtain a valid signature on a new employment contract.

In many cases, an employer does not have a contractual right, and will not be able to obtain the employee's agreement in writing to implement unilateral changes. However, it is important to return to the basic concepts of wrongful dismissal. Wrongful dismissal involves the actual termination of an employee without providing sufficient working notice or compensation in lieu of that notice. Constructive dismissal entitles an employee to treat a change in the employment relationship as if it were an actual dismissal.

Consequently, in the case of constructive dismissal, an employer may wish to reduce its exposure by providing actual written working notice of changes that will be implemented in the future. The period of notice should be roughly equivalent to what an employee would receive if there were an actual termination. By giving an employee advance notice of the negative changes, the employee has time to consider whether to continue to work (working notice) or find other employment.

In 2008, the Ontario Court of Appeal set three options before employees faced with this type of behaviour by their employer. The Court held that the employee could:

1. Accept the change in the terms of the employment agreement. If he or she does so, the employment will continue under the new terms;

2. Reject the change and sue for constructive dismissal; or,

3. Clearly reject the change. The employer can then respond by terminating the employee with proper notice, and then offer the employee a job on the new terms.

In the face of rejection, the employer has two choices:

1. It can advise the employee that his or her refusal to sign the contract will result in the termination of his or her employment and then offer him or her new employment on the new terms. This termination would trigger the termination provisions of the employment contract providing for payment of two years' salary;

2. Alternatively, the employer can accept the employee's position and allow him or her to continue his or her employment under the existing terms.

When taking such a drastic step, make sure your lawyer reviews the new terms and the steps taken and to be taken before proceeding.

During a re-organization, there may be minimal or no financial difference to the employee. A good communication plan will help explain changes and will encourage employees to cooperate.

Lawyer Howard Levitt states that employers should consider the following before acting:

1. Ascertain the terms of any original contract of employment

2. Avoid unilateral action to reduce an employee's income, giving rise to a constructive dismissal

3. Give sufficient notice of any proposed reductions in pay or time

4. Introduce employment agreements for new staff that let you adjust hours and pay to meet changing economic conditions with minimal notice.