Severability Clauses in Employment Contracts, The Law Times (October 30, 2017 at p 7)

In general, courts interpret employment contracts differently from commercial contracts, mainly because of unequal bargaining power between employers and employees and the importance of employment in a person’s life. Some employment contracts include severability clauses, which are designed to reform an illegal term by bringing it within the legally tolerable range. In North v. Metaswitch Networks Corporation, 2017 ONCA 790 (“North”) the Court of Appeal for Ontario considered a vexing issue of whether a severability clause can be used to repair the illegality in the termination clause. The court unequivocally resolved that a severability clause cannot have any effect on clauses that have been voided by the Employment Standards Act, 2000 (“ESA“). The court also clarified that whenever a termination clause violates the ESA, the severability clause is not void but, rather, it is inoperative because there is nothing to which it can be applied.

In North, North’s employment with Metaswitch Networks Corporation was governed by a written employment contract, which included termination and severability clauses. The former purported to limit North’s entitlements at dismissal to the statutory minimums contemplated by the ESA, while the latter intended to sever any provision that a court would find to be illegal and enforce the remainder of the contract. Following his dismissal, North took a position that the termination clause was contrary to s. 5(1) of the ESA because it provided that payments in lieu of notice are to be based on his “base salary” only, whereas his earnings consisted of salary plus commissions. By excluding commissions, Metaswitch contravened the employment standards set out in ss. 60 and 5(1) of the ESA. Section 60 prohibits employers from reducing regular wages during a statutory notice period, while s. 5(1) forbids them from contracting out of that employment standard. The term “regular wages” includes wages that have been held to include commissions. Ultimately, North asserted that he was entitled to receive termination compensation based on common law.

Metaswitch’s position was that if the termination clause was illegal, then the offending sentence should be excised from the contract using the severability clause. The parties sought to have the issue of the applicability and effect of the severability clause determined by the court on an application under Rule 14 of the Rules of Civil Procedure, where the determination of rights depends on the interpretation of a contract.

The application judge accepted that the sentence in the termination clause had the effect of excluding payment of commission to which North was entitled and, therefore, contravened the ESA. In interpreting and giving effect to the severability clause, the application judge adopted the court’s reasoning in Oudin v. Centre Francophone de Toronto Inc., 2015 ONSC 6494 and excised the offending sentence but left the rest of the termination clause to be enforced.

On appeal, the court found the application judge erred in law by merely severing the offending sentence rather than voiding the entire termination clause. It reaffirmed, relying on the Supreme Court of Canada’s judgment in Machtinger v. HOJ Industries Ltd., [1992] 1 S.C.R. 986 and its recent judgment in Wood v. Fred Deeley Imports Ltd., 2017 ONCA 158 that where a termination clause contracts out of even one employment standard, a court is to find the entire termination clause to be void and unenforceable. This interpretation encourages employers to draft contracts that comply with the minimum requirements of the SA, and it extends protection to as many employees as possible.

In North and Oudin, the motion judges engaged in the gap-filling exercise of an employment contract that contained a perceived lacuna that needed modification. Since severability turns on the intent of the parties, reliance on a severability clause to fill a gap that arises from the excision of the illegal term not only mimics the parties’ bargain but dictates the substituted term closest to the hypothetical bargain. Therefore, the courts’ reliance on the severability clause effectively rewrites or reads down the offending provision, thereby producing the deleterious effect the Supreme Court of Canada warned against in Machtinger — employers will be incentivized to contract out of the ESA by including a severability clause to save the illegal term in the event that an employee has means to challenge the contract in court.

In addition, this gap-filling exercise is punitive, because it effectively eliminates an employee’s right to benefit from the contractual interpretation that gives the greater benefit to him or her. North is a glaring example. There, having excised the offending sentence from the termination clause, the application judge concluded, relying on the remaining wording of the clause, that: “the parties’ intention was to comply with the ESA,” thus denying North his common law right to reasonable notice. The court overruled the application judge’s conclusion, stating: “because the termination clause is void it cannot be used as evidence of the parties’ intention to comply with the ESA.” Hence, the common law applies.

North is an important decision. By eclipsing Oudin, it clarified the law and solidified the rule that contractual terms that are voided by the ESA cannot be interpreted through the application of a severability clause to provide for the minimum standard imposed by the ESA.

North serves as yet another reminder that the enforceability of the termination clause turns on its wording, which the courts will scrupulously dissect in order to ensure the clause complies with the ESA. If it fails do so, then the employee would be entitled to reasonable notice of termination.