Changed Substratum Doctrine Nullifies Termination Clause, The Lawyer’s Daily (March 16, 2023)

(this article originally appeared in the Lawyer’s Daily on March 16, 2023)

By Nikolay Y. Chsherbinin

The “changed substratum” doctrine is an integral part of employment law. The doctrine provides that if an employee enters into a written employment contract that specifies the notice period for a dismissal, its terms may be held unenforceable if, over the course of employment, the employee’s responsibilities and status has significantly escalated. The doctrine applies only to cases where there have been fundamental expansions, as opposed to reductions, in the employee’s duties after the original employment contract was signed. The rationale behind the doctrine is that with promotions and increased responsibilities the substratum of the original employment contract has disappeared, and the termination provisions in the employment contract should be nullified. A recent employment case that delved into the workings of the doctrine is Celestini v. Shoplogix Inc., 2023 ONCA 131. There, the Court of Appeal for Ontario reaffirmed that for the doctrine to apply a promotion with a change in title is unnecessary; instead, a determinative question is whether there were actual increases, of a fundamental nature, in the duties and degrees of responsibility of the employee.

In Celestini, Shoplogix was founded in 2002. The plaintiff, Stefano Celestini, was one of its co-founders, and he originally served as its CEO. In 2005, a venture capital firm purchased some of the shares in Shoplogix. Subsequently, Celestini stepped down as CEO and was given the position of chief technology officer (CTO), reporting to a new CEO. On May 17, 2005, Celestini and Shoplogix signed a written employment contract that contained, among others, the bonus and termination provisions. The termination provision entitled Shoplogix to dismiss Celestini without cause by giving him one month’s written notice and continuing to pay his base salary for 12 months from the date of dismissal, as well as to pay an amount equal to the bonus he received in the prior year, prorated for the period of the current year up to dismissal. At the time the parties entered into the employment contract, Celestini’s role as CTO involved certain duties, which focused on transferring product and corporate knowledge within Shoplogix. In 2008, the parties entered into an Incentive Compensation Agreement (ICA), a bonus plan for management-level employees, which significantly increased Celestini’s compensation from the bonus arrangements in his employment contract. The ICA neither mentioned nor ratified the terms of the original employment contract. On March 2, 2017, Friedman Canada Inc. acquired all of Shoplogix’s shares and dismissed Celestini, without cause. Following the termination of his employment, Shoplogix diligently paid Celestini’s contractual entitlements due to him at dismissal.

Nevertheless, Celestini sued for wrongful dismissal. Relying on the changed substratum doctrine he successfully argued that fundamental changes had occurred in his employment responsibilities since 2005, making the terms of his employment contract unenforceable. His action was adjudicated by means of summary judgment, which both parties sought.

The motion judge granted summary judgment in Celestini’s favour and assessed his entitlement to damages at common law based on an 18-month notice period. In support of his decision, the judge concluded that although Celestini’s CTO job title remained the same, the actual role he was asked to, and did, fulfil fundamentally changed over the course of his employment. Specifically, he found that Celestini received new tasks, such as: sales, marketing, employee-management, travelling to pursue international sales, financing and handling all the company’s infrastructure responsibilities. None of which formed part of the CTO’s responsibilities at the time the parties entered into the employment contract 12 years earlier.

In light of these significant changes, which were accompanied by substantial increases in Celestini’s compensation, the motion judged found that the substratum of his employment contract disappeared and that its termination provisions should no longer be enforced as they could not have been intended to apply to Celestini’s role at dismissal. On the point of intention, the motion judge found that the employment contract did not feature a term which expressly states that its terms continue to apply notwithstanding any changes to Celestini’s responsibilities. The absence of such a term turned out to be a proverbial Achilles’ heel for the company.

Shoplogix appealed. It argued that the motion judge incorrectly expanded the doctrine, because the doctrine could not be properly applied to an employee who was always a senior executive and who, since commencement of the employment contract, held the same job title. The Court of Appeal disagreed that a change in title is required. It reminded that the determinative question of whether the “employee’s level of responsibility and corresponding status has escalated so significantly” is one of substance, not form. Consecutively, while it may be relevant that the employee was given a new title, it is simply one contextual factor to be considered. The Court of Appeal added: “[m]ore important is whether there were actual increases, of a fundamental nature, in the duties and degree of responsibility of the employee. If there were, the employee was for all intents and purposes ‘promoted’, given their escalated status, even if the assigned title did not change. Put another way, where the duties and responsibilities are fundamentally increased, the meaning of the job title is redefined as if a new job title were given.”

Celestini exemplifies that an employer-employee relationship may evolve in a fundamental way after the date of the signing of the employment contract. Given such a prospect, the doctrine recognizes the potential inappropriateness and unfairness of applying the contract’s termination provisions to circumstances that were not contemplated at the time of contracting.

From a practical perspective, Celestini offers a number of helpful tips and insights that prudent employers and their advisers should keep in mind. Specifically: (a) the doctrine can only be invoked in cases of expansions rather than reductions of the employee’s duties (because the latter would simply amount to a breach of employment contract by means of either constructive dismissal or demotion); (b) to obviate the existing contractual language the expansions of duties must be fundamental and not incremental; (c) the doctrine equally applies to an employee who began in a non-executive role and who was always a senior executive; (d) for the doctrine to apply a promotion with a change in title is unnecessary; and perhaps most importantly (e) the application of the doctrine may be averted if a written employment contract expressly provides that its provisions, including its termination provisions, continue to apply even if the employee’s position, responsibilities, salary and benefits change; and (f) the original written employment contract may also have continuing force even if there have been substantial changes in the employment’s duties or compensation, by virtue of the parties entering into one or more subsequent agreements, if the parties ratified its continuing applicability when changes to the terms of employment occurred.