Employers Beware: Cost-Cutting Strategies May Cost You in Court

The economic impacts of COVID-19 have caused many employers to explore ways to reduce their expenses.

A recent decision from the Court of Queen’s Bench of Alberta – Kosteckyj v Paramount Resources Ltd, 2021 ABQB 225 (“Kosteckyj”)provides a stark reminder of the risks involved in reducing employee compensation, including potential liability if the compensation change is found to constitute a constructive dismissal.

The Law on Constructive Dismissal

Constructive dismissal can arise in one of two ways:

  1. an employer breaches an employment contract through a unilateral change that a reasonable person in the circumstances of the employee would conclude substantially changes the essential terms of the employment contract, or
  2. an employer’s conduct would lead a reasonable person to conclude that the employer no longer intends to be bound by the terms of the employment contract.

If an employee is constructively dismissed, they can either accept the constructive dismissal and continue their employment under the new terms, or treat the employment contract as repudiated and sue the employer for wrongful dismissal.

The Facts in Kosteckyj

In Kosteckyj, the plaintiff employee (the “Employee”) worked as an engineer for a publicly-traded energy company (the “Company”). On March 27, 2020, shortly after COVID-19 was declared a public health emergency in Alberta, the Company announced a Cost Reduction Program.

The Cost Reduction Program involved salary reductions, suspension of the Company’s RRSP contributions and a delay/cancellation of the Company’s bonus program. As a part of the Cost Reduction Program, the Employee’s base salary was reduced  by 10% and she lost her entitlement to RRSP contributions and a bonus payment (the “Compensation Reduction”).

There was no express or implied term in the employment contract allowing the Company to make the Compensation Reduction unilaterally. Further, the Company did not seek the Employee’s consent to the Compensation Reduction.

On April 22, 2020, shortly after the Cost Reduction Program was announced, the Company terminated 15% of its workforce without cause, including the Employee.

The determination of whether the Employee was constructively dismissed as a result of the Cost Reduction Program, prior to her subsequent termination without cause, was relevant as it affected the potential damages the Company owed to the Employee.

The Court’s Ruling on Constructive Dismissal

The Court held that, although the Cost Reduction Program was a legitimate business reaction by the Company to the economic realities of COVID-19, the Compensation Reduction significantly affected the Employee and amounted to a breach of her employment contract.

In considering the effect of the Compensation Reduction, the Court took note not only of the salary reduction, but also the cancelled RRSP contributions and bonus suspension. Although the base salary reduction was only 10%, the Court calculated that the overall reduction in the Employee’s total compensation was in the range of 16.65% to 20%.

On this basis, the Court held that the Compensation Reduction substantially changed the essential terms of the employment contract, which ultimately amounted to a constructive dismissal. Therefore, the Court held that the Employee’s damages were to be calculated based on her compensation prior to the Compensation Reduction.

Key Takeaways for Employers – Impact of COVID-19

Employers may have strong economic reasons to impose cost-cutting compensation reductions or other changes to employment terms due to the impacts of COVID-19 and the state of the energy industry. However, an employer’s economic rationale for making such changes will likely have minimal impact on a court’s analysis of whether a constructive dismissal occurred.

The Court in Kosteckyj referred to the turbulent economic conditions caused by COVID-19 in the Employee’s favour in finding that the Employee was not obligated to decide if the Compensation Reduction amounted to constructive dismissal in the 25 days between its announcement and her eventual termination without cause. In doing so, the Court rejected the notion that the Employee impliedly accepted the changes during that time period.

The negative impacts of COVID-19 and the energy industry on the employer’s business did not appear to cause the Court in Kosteckyj to reduce the amount of the damages award.

Recommendations for Employers

Since constructive dismissal is based on a unilateral change to employment terms, employers should take the following steps to reduce the risk of potential constructive dismissal claims:

  1. incorporate terms into employment contracts that allow employers to make unilateral changes to employment terms;
  2. seek their employees’ written consent to any new employment terms; and
  3. understand the potential range within which changes to employment terms can be made without triggering a constructive dismissal.

In addition, employers must be mindful that even if an employee agrees to a new contract or a change in employment terms, the employer must ensure there is sufficient consideration (i.e. exchange something of value) in order for the agreement to be legally binding and enforceable.

These steps will not always eliminate the possibility of a constructive dismissal claim, but they are effective strategies to significantly reduce an employer’s risk.

We recommend employers seek out legal advice prior to implementing changes to compensation or other employment terms. Our labour and employment team understands the pressures employers face and the difficult decisions some employers have to make in current economy. We are here to provide practical legal advice and answer any questions employers may have.

Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.