Shareholder Rights are Not Employment Rights

Summary

It is the terms of an Equity Agreement, Shareholders’ Agreement or Stock Plan that determine employees’ rights with respect to shares. The common law relating to compensation for breaches of a contract of employment (i.e. reasonable notice) does not apply to shares where there is a distinct agreement.

Recent Case Law

Some executives have both an employment agreement and a shareholder’s agreement. The employment agreement, which can be written or implied, will define how much notice an executive gets and what entitlements are owed during the notice period. At the same time, an executive may have a separate equity, stock or shareholder agreement defining their rights and obligations vis-à-vis any investments the executive has with the employer.

A question arises: can the shareholder agreement limit executive employees’ rights to stocks, equity, investments etc. over the reasonable notice period? The answer is yes, an employee’s shareholder rights are distinct from common law entitlements or employment contractual entitlements to reasonable notice.

Employee Shareholder Rights Are Not Employment Rights

A recent case, Mikelsteins v Morrison Hershfield Limited, determined if an executive employee was entitled to an increase in the value of shares of his employer, along with a share bonus or dividend attached to the shares, through the period of reasonable notice. The employee, Mr. Mikelsteins, had an employment contract and a shareholder agreement with his employer. The employment agreement entitled him to 26 months reasonable notice, but the shareholder agreement said that the employer could buy back his shares for their present value within only 30 days after the termination date, and thus no dividends would be owing over the 26-month notice period. Mr. Mikelsteins sued: The issue was this: Was the executive entitled to the share dividends that would have accrued during the 26-month notice period or not?

At the lower court, Justice Nakatsuru found that the executive was entitled to the share dividends over the 26-month notice period based on the common law theory that the employee must be in the same position they would have been in had they served their period of reasonable notice (see Paquette v. TeraGo Networks Inc.).

The employer appealed, and the Court of Appeal overturned the lower court decision, holding that contractual rights differ from common law employment rights. There is a difference between what a dismissed employee is entitled to as damages in lieu of common law reasonable notice upon termination of the employment contract and what the employee is entitled to under the terms of more specific contracts:

[19]      … the terms of the Shareholders’ Agreement are clear. Once the shareholder’s “association with the Corporation and its Affiliates ceases by reason of termination by the Corporation of his/her employment with the Corporation” a process is triggered whereby the shareholder’s shares will be repurchased either by the corporation or the existing shareholders. The Shareholders’ Agreement expressly provides that the corporation becomes entitled to repurchase the shares 30 days from the date the shareholder is “notified of such termination” by deeming the shareholder to have delivered a Transfer Notice as at that date. Where the corporation elects to purchase the shares, this in turn fixes the valuation date for the shares.

The next issue was whether the 30-day repurchase clause in the Shareholder Agreement was void on account of s. 60(1)(a) of the Employment Standards Act, which makes it illegal to reduce an employee’s wage rate or alter any other term or condition of employment during the notice period. However, this argument failed. The Court of Appeal found that a Shareholders’ Agreement is not a term or condition of employment. Therefore, it could not be void by way of the Employment Standards Act:

[13]      Turning to the central issue, in my view, the motion judge erred in concluding that Mr. Mikelsteins was entitled to compensation in respect of his shares calculated at the end of the notice period. He did so by improperly conflating Mr. Mikelsteins’ entitlement to compensation arising from the breach of his contract of employment with Mr. Mikelsteins’ contractual entitlements respecting his shares. Mr. Mikelsteins received his shares pursuant to the Shareholders’ Agreement. It is the terms of the Shareholders’ Agreement that determine Mr. Mikelsteins’ rights with respect to those shares. The common law relating to compensation for breaches of a contract of employment does not apply to Mr. Mikelsteins’ entitlements regarding his shares.

Thus, the law is this: An employer may displace the common law right to share compensation over the common law reasonable notice period with a written shareholder agreement. An employee is essentially the exact same thing as any outside investor in terms of their shareholder rights. There is no special status for being an employee and a shareholder.

On a related note, this case answers the question: When is the trigger date for an employer’s right to repurchase shares of a terminated employee? The answer is the date of termination, not the end of the reasonable notice period.