Unintended Consequences? Employment Standards Ruling May Undermine Bonus Pay Programs


This past summer, an Employment Standards Branch adjudicator ruled that a former employee was entitled to an award equalling 4% of the bonuses his employer had paid to him while employed. While the Branch will argue that the decision in Director of Employment Standards and Mr. Lube Canada GP Inc. (ER #163-052, July 30, 2010) is a logical interpretation of the Employment Standards Act, the decision will be surprising to most employers. Because the Mr. Lube decision is now being followed in similar claims by the Branch, employers now have an unforeseen liability arising from payment of bonuses to their employees.

In the Mr. Lube decision, a manager received nearly $70,000 in long-term incentive pay. Although he had already taken or been paid out for his full vacation entitlement at the time his employment ended, he made a claim for additional vacation pay solely on the basis that he received this incentive pay. The manager was successful in his claim and was awarded more than $2,800 for ‘vacation pay’. To add insult to injury, and based on the mandatory penalties payable for breaches of the Employment Standards Act, Mr. Lube was also ordered to pay a penalty for failure to pay that vacation pay (even though it did not believe or realize that the ex-manager was entitled to such payment).

Employment standards legislation is in place in all provinces and territories in Canada, and is designed to protect employee rights such as minimum wage, maximum hours of work, the right to vacation, pregnancy/parental and other leaves, and minimum notice of termination or pay in lieu of notice. As additional protection to employees, any employment contract terms that do not meet these minimum standards will be void.

One of the goals of employment standards legislation is to ensure that all earned wages are paid at the end of the employment relationship. In BC, the Employment Standards Branch and Tribunal handles employee claims for unpaid wages.

Typically, salaried employees never actually receive separate payments for vacation pay unless at the time the employee quits or is terminated they have earned but unused vacation, or if the employer has a policy of paying out all unused vacation at year end. (Because when salaried employees go on vacation, the employer simply maintains their regular salary while they are away.) The Mr. Lube decision requires employers to pay an additional 4% or 6% as ‘vacation pay’ (depending on whether the employee has less than 5 years service, or 5 years service or more) on top of the bonus pay, even though there may be no agreement or expectation from employees that they are entitled to such additional payment. Thus, if employers pay incentive pay bonuses, they will have to look at making changes to their bonus policies or plans if they want to avoid future liability for such extra payments. Unfortunately, for as long as this decision stands, or the Employment Standards Act remains as currently worded, there is no way to avoid past claims for vacation pay on bonuses paid, provided claimants file claims within the limitation period. (Note: there is a six month limitation period for making claims under the Employment Standards Act.)

Employment standards legislation with its minimum standards and penalties for breach serves a valuable role in protecting employee rights and ensuring that unscrupulous employers do not take advantage of vulnerable employees. However, those who originally enacted this legislation could not have anticipated this decision nor the consequences for those employers who have established generous bonus plans to reward employees for exceeding standard levels of productivity or efficiency.

Typically, the best kinds of incentive pay programs are those that are aligned with specific production and business targets. When the targets are clear and employees understand what they have to do to earn the bonuses, these bonus plans offer the greatest opportunity to positively influence behaviours that are good for the company. Conversely, where bonus plans are not tied to specific production or efficiency targets, and are said to be ‘discretionary’, then the plans do not have what human resources managers call ‘line of sight’ – employees do not see a direct relationship between their efforts and the potential bonus or reward.

Over the past few years there have been a number of Employment Standards decisions dealing with claims made by ex-employees for unpaid bonuses. Most of these decisions have dealt with whether or not the bonuses fall within the definition of wages, and if they did, whether such ‘wages’ were earned at the time the employee was terminated. The Employment Standards Act defines “wages” to include money that is paid or payable by an employer as an incentive and relates to hours of work, production or efficiency, but does not include money that is paid at the discretion of the employer and is not related to hours of work, production or efficiency.

In the Mr. Lube decision, there was no dispute that the bonuses paid fell within the definition of wages, so the manager claimed vacation pay based on section 58 of the Employment Standards Act (which sets the minimum percentages of wages that have to be paid to employees as vacation pay, depending on their years of service).

Until or unless the Mr. Lube decision is overturned or the Employment Standards Act is amended to fix this anomaly, there are a few things an employer can do to mitigate future claims for vacation pay:

  • factor in the liability of vacation pay when determining the calculation of any discretionary components of bonuses payable for each employee;
  • pay the vacation pay (4% or 6% of the incentive pay) in a lump sum at the time the employee takes their vacation for the year following the year the incentive pay was earned; or
  • restructure incentive pay programs or policies so they do not fit within the Employment Standards Act definition of “wages” (i.e. do not tie payments to hours of work, production or efficiency).

Because the Mr. Lube decision was decided and is being followed at the adjudicator level within the Employment Standards Branch, it is not reported and so not yet widely known. Thus employers are just starting to come to grips with the effect this ruling will have on their incentive pay programs. We expect that one reaction will be to eliminate incentive bonuses tied to production or efficiency, in favour of discretionary bonuses that employees cannot influence with their own efforts, nor expect at all. While that response will deal with the legal risk, it will, unfortunately, undermine the effectiveness of the bonus plan to enhance business results because employees will no longer have the same incentives to achieve superior performance. The result will be a loss to both businesses and employees.