Change of Control Agreements – Creating a Win-Win for Employer and Employee

A well-drafted employment contract outlines the requirements for ending the employment relationship. The “termination provisions” will usually provide for how much notice or payment in lieu of notice an employee is entitled to receive in the event of a termination of employment without just cause. Similarly, a written employment contract may stipulate the amount of notice that an employee must provide their employer should they wish to end the employment relationship.

In the absence of express terms, employers and employees are generally required to give reasonable notice when terminating employment. An employer may dismiss an employee, absent just cause, subject to statutory, common law, and any contractual requirements being satisfied. There is one very important caveat, however: The reason for the termination of employment cannot be discriminatory and contrary to human rights legislation, or contrary to other legislation that prohibits termination of the employment relationship in certain circumstances.

This article focuses on those instances where a business may be subject to a substantial change as a result of a purchase/sale of assets or business shares. In such cases, both employer and employee can benefit if a clear “change of control” clause is included in/added to the employment contract.

Understanding change of control agreements

A change of control agreement is often used by a business to encourage employees to continue on in their employment at least until the completion of a purchase, sale, reorganization, or other significant change in the business. As the term suggests, a change of control agreement contemplates what will happen should the business undergo a material change in ownership.

What constitutes a change of control is usually defined by the parties in the employment contract. Accordingly, a change of control agreement often sets out the types of events that will and will not constitute a change of control, and it may provide for a number of different triggering events, such as a change in share ownership or in the composition of the business’s board of directors.

A change of control agreement may be exercised either where the employee quits, or where the employer elects to dismiss the employee (without cause). In this way, it confers benefits to both parties. A typical agreement will set out that if the business undergoes a change of control, an employee will have a certain number of months in which they may choose to resign, and the company will pay the employee a lump-sum equivalent to a specified number of months of the employee’s base salary at the time the change of control occurred, in addition to any severance. The agreement will typically go on to provide for the same lump-sum payment should the employer be the party that wishes to terminate the employment relationship.

For the employer, a change of control agreement also provides senior executives with an incentive to remain loyal to the business at a time of uncertainty and vulnerability. A change of control agreement is typically found in the written employment contracts of senior management employees because of the unique role these executives play within the business, including their roles in strategic planning. Often such employees will be directly involved in the sale or transfer of the business that is contemplated by a change of control agreement. A CEO or a CFO will be more directly affected by a change of control of a business than other employees.

In Montreal Trust Co. of Canada v. Call-Net Enterprises Inc. (2002),[2] the Ontario Superior Court called the change of control agreement a “protective mechanism” for the business that promotes the retention of top executives and ensures their loyalty by providing a financial benefit to them as the company undergoes a significant change. In essence, the employee has a financial reward if they continue on in their employment until the sale has concluded.

Note: Where a company undergoes a change of control, the normal rules regarding entitlement to notice do not apply, as the change of control provisions usually expressly supplant other clauses regarding notice of termination.

A case study

Much of the litigation in the context of change of control agreements centres on whether or not a change of control has actually occurred, and, subsequently, whether or not the employee is entitled to the benefits and protections as defined in the agreement. These benefits may be substantial, so it is important to clearly identify the triggering events that will result in the employee receiving them.

A recent Ontario case highlights the importance of a well-drafted change of control agreement. In Fisher v. First Uranium Corporation,[2] the plaintiff (a former employee) asserted that certain changes in the membership of the business’s board of directors constituted a change of control sufficient to trigger the change of control agreement, thus enabling him to leave the company with his lump sum payment. Among other things, the agreement held that a change of control would occur in the event that “the incumbent directors cease to represent a majority of the members of the board.” Although both parties agreed that the board had undergone changes, they disagreed that the composition had changed such that the incumbent directors were no longer in the majority. After extensive analysis, the Ontario Superior Court found that the plaintiff’s position was not supported by the evidence.

What a change of control agreement should include

A change of control agreement may be included in the employment contract of a senior employee from the outset. Often, however, it is only when faced with the prospect of an actual change of control that an employer will draft a new contract of employment to address this uncertainty.

Whether created proactively or reactively, a well-drafted change of control agreement should include details on the following:

• The triggering event(s) that will constitute a change of control. Not every acquisition or purchase related to the business may be intended as a change of control of the business. The agreement should clearly spell out the events that will trigger the employee’s benefits under a change of control agreement, and, if necessary, draw a distinction between closely related events that do not constitute a change of control.
• The financial reward(s) in the event that the agreement is exercised.
• Any limitations on the compensation to which the employee is entitled. For example, it may be prudent to include a term that says an employee is entitled to a lump-sum payment in the event that they resign OR the employer terminates the employment relationship.
• The precise time frame in which a benefit may be used by the employee.

In addition, the change of control agreement may stipulate that an employee is limited in terms of the number of occasions when they may exercise a change of control agreement, and may provide for arbitration in the event of a dispute arising out of the agreement.

In summary

In the right circumstances, a properly drafted change of control agreement can provide a win-win situation for both parties.

Carman J. Overholt is a senior litigation lawyer and the founder of Overholt Law in Vancouver. He has extensive experience in employment law, labour relations law, and civil litigation, with a special focus on advising employers on resolving workplace disputes.

Victoria Petrenko is an articled student with Overholt Law in Vancouver, where she assists the firm’s lawyers on all aspects of labour relations law, employment law, and human rights law.

Footnotes

1. Montreal Trust Co. of Canada v. Call-Net Enterprises Inc., (2002) 57 OR (3d) 775 (ONSC).
2. Fisher v. First Uranium Corporation 2011 ONSC 7160.