The Effects on an Employment Contract When an Employee’s Duties Change: The “Changed Substratum” Doctrine

We regularly recommend that employers include termination clauses in their employment agreements. These clauses set out the amount of notice, or pay in lieu of notice, an employee will be entitled to if their employment is terminated without cause by the employer. The intention is to provide the employer with some certainty about what it will cost if the decision is made to terminate an employee on a without cause basis. However, it is important for employers to understand that simply including this type of clause in an employment agreement at the beginning of employment may not provide the desired level of certainty and protection should changes be made to the employee’s duties over time.

The “changed substratum” doctrine applies where there have been fundamental changes to the employee’s duties after the employment contract was made, such that the “substratum” (or foundation) of the contract has disappeared or substantially eroded. In such circumstances, courts will conclude that the contract could not have been intended to apply to the changed role ultimately occupied by the employee.

In the recent decision of Celestini v Shoplogix Inc., 2023 ONCA 131 (“Celestini”), the Ontario Court of Appeal discussed the “changed substratum” doctrine, finding that there had been such fundamental changes to a terminated employee’s duties that the termination clause in his original employment agreement no longer governed his entitlements upon termination.

Facts

In 2017, Shoplogix dismissed Mr. Celestini from his employment on a without cause basis. Upon termination, Shoplogix took the position that Mr. Celestini’s rights were governed by an employment contract signed in 2005. The 2005 contract provided that, upon a without cause termination, Shoplogix would pay Mr. Celestini’s base salary and continue his group health insurance for 12 months, and would make a pro-rated payment for his annual bonus accrued up to termination.

Mr. Celestini took the position that, by 2017, the termination provisions relied on by Shoplogix had become unenforceable because the substratum of the 2005 contract had disappeared or been substantially eroded due to a material change in his duties. Accordingly, Mr. Celestini claimed that he was entitled to common law damages for wrongful dismissal, arguing that the reasonable notice he should have received was substantially greater than 12 months, and the resulting damages for lost salary, benefits, and bonus he would have earned in the notice period would significantly exceed the amounts payable on termination under the 2005 contract.

The lower-level court which first heard the case concluded that Mr. Celestini’s responsibilities fundamentally and substantially increased over the course of his employment. As such, the substratum of his 2005 contract disappeared making the termination clause in his 2005 contract no longer enforceable. Mr. Celestini was therefore entitled to common law damages in the amount of 18 months of salary, benefits, and bonus.

The Ontario Court of Appeal’s Analysis

Shoplogix appealed the decision of the lower court. The Ontario Court of Appeal dismissed Shoplogix’s appeal.

The Court began their analysis by summarizing Mr. Celestini’s employment history at Shoplogix. Of note:

• Mr. Celestini was one of Shoplogix’s co-founders, and he originally served as its Chief Executive Officer (“CEO”);
• In 2005, Mr. Celestini stepped down as CEO and was given the position of Chief Technology Officer ("CTO"). The 2005 contract provided that Mr. Celestini would be employed as CTO and would report to the CEO;
• In 2008, Mr. Celestini and Shoplogix entered into a bonus plan for management-level employees. It significantly changed Mr. Celestini's compensation from the bonus arrangements in the 2005 contract. Additionally, Shoplogix did not mention or ratify the 2005 contract when the new bonus plan was agreed to;
• Also in 2008, a new CEO was appointed. The new CEO instituted dramatic changes including a drastic reduction in the number of senior management personnel. This caused Mr. Celestini's workload and responsibilities to increase substantially. These new responsibilities included: managing important aspects of sales and marketing; directing managers and senior staff who were reassigned to report to him; travelling to pursue international sales; handling all the company's infrastructure responsibilities; and soliciting investment funds.

Shoplogix attempted to argue that the “changed substratum” doctrine could not apply to Mr. Celestini. First, Shoplogix argued that the doctrine required there to have been fundamental changes to an employee's duties arising from a promotion; the doctrine could not be properly applied to an employee who was always a senior executive and who, since the commencement of the contract, held the same job title. Second, Shoplogix argued that the changes were incremental, and not sufficiently dramatic or fundamental to justify nullifying the 2005 contract.

The Court rejected Shoplogix’s two arguments, holding that a change in the employee’s title was not required for the “changed substratum” doctrine to apply and rejecting the notion that the doctrine only applied to non-executive employees. In addition, the Court agreed that Mr. Celestini’s duties had changed substantially and fundamentally since commencing employment.

Further, the Court found that the 2005 contract did not include a provision which expressly stated that the contract’s terms continued to apply “notwithstanding any changes to Mr. Celestini’s responsibilities, which otherwise may have averted the application of the substratum doctrine in this case”.

Takeaways

Celestini serves as a useful reminder to employers. Whenever significant changes are made to an employee’s duties, responsibilities, or compensation structure, they should be documented as a change to the employment agreement, and it should be specified which provisions of the original employment agreement continue to apply. Correspondingly, it is beneficial to consider including language in an employment contract which provides that a termination provision (amongst other pertinent provisions) will continue to apply notwithstanding any of these aforementioned changes. Doing so can avoid triggering the “changed substratum” doctrine.

McLennan Ross can provide legal advice to companies and individuals as it relates to changes in an employee’s duties, and whether the “changed substratum” doctrine has been engaged. Please reach out to our Labour and Employment Practice Group with any questions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.