Executive Compensation Issues for Americans Transferring into Canadian Jurisdiction

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1 Executive Compensation Issues for Americans Transferring into Canadian Jurisdiction 01/11Reprinted from Metropolitan Corporate Counsel, November, 2000 by Stuart Aronovitch and Lori Price As the global economy continues to expand, many American corporations are placing American executives in positions in Canadian operations. Because there are significant differences between Canadian and US employment law, American corporations posting executives in Canada would be wise to conduct a review of the employment contract before the move takes place. Failure to do could result in costly and unpleasant litigation. While each situation should be looked at in its unique circumstance, this article will address several of the common pitfalls, including termination/notice period issues, noncompetition clauses, stock option issues, tax issues and immigration concerns. A. Notice Periods The concept of employment at will does not exist in Canadian jurisprudence. In Canada, employees can be terminated with no notice if there is just cause for the termination. Just Cause is very difficult to establish and typically cannot be proven unless the employee has committed a serious employment offence (fraud, embezzlement, etc.). Absent just cause, all employees must be provided with reasonable notice before their employment is terminated. Employers may, at their option, provide the employee with salary in lieu of notice. Provincial legislation sets out statutory minimum notice periods.2 However, courts typically award significantly more than the statutory minimum. What is reasonable depends on a variety of factors including the employee's age, length of service, salary, and position. The more senior the employee is, the more notice period the employee is entitled to. Unless a written employment contract defines a precise notice period, the parties are left trying to define what notice should be given, and, failing agreement, Courts will assess the amount. Senior executives with long service may be entitled to as much as 24 months' notice. Costly litigation can be avoided if the parties specify severance provisions in their employment contracts. B. Non-Competition Clauses It is common practice to require executives to sign non-competition clauses. Many businesses want to ensure that competitors do not benefit from the expertise of their former executives. Canadian courts will only enforce these provisions if they are deemed to be reasonable in scope. In assessing reasonableness, Courts will examine factors such as the breadth of the employment restriction, the geographical scope of the restriction and the length of time that the noncompetition provision continues to bind the former employee. Courts may also review the employment contract to see if appropriate consideration was given to the executive in exchange

2 for the non-competition agreement. This may be problematic if the executive was asked to sign the non-competition agreement after employment commenced. If the provision is found to be too broad in scope, then it will not be enforced. Canadian courts will not rewrite the provision or enforce a narrower restriction. As a result, if these protections are critical for Corporations, the scope of the covenants should form part of the employment contract so that consideration can be established. In addition, these provisions should be reviewed to ensure that they will be upheld by Canadian courts. C. Stock Options Issues As is the case in the US, issuing securities to employees is subject to securities legislation and consequently, needs to be considered by the Company. While regulatory provisions may differ between the provinces, there are some common principles. Generally, securities may only be distributed by a prospectus and traded by a registered dealer or pursuant to an exemption from these regulatory requirements. The grant of the option, the issuance of shares upon the exercise of that option and the sale of the shares acquired upon the exercise of that option are subject to these rules. Exemptions from prospectus and registration requirements are generally available 3 in most jurisdictions to permit a Company to both grant the option to an employee and issue shares to the employee upon the exercise of the option by the employee, provided the conditions of the exemptions are complied with. However, exemptions may not be available for all service providers. In those cases, applications to the appropriate securities regulator for an exemption order may be required to permit the issuance of the securities to the service providers. Further, when securities are issued pursuant to an exemption, they are generally not freely tradable, unless certain conditions, 4 including in most cases reporting issuer status, are met or pursuant to another exemption. Because US issuers do not tend to be reporting issuers for purposes of Canadian securities legislation, the shares acquired by employees upon the exercise of the option may not be sold unless pursuant to another exemption. Although certain jurisdictions do provide exemptions to permit trading of shares of US companies on US exchanges, not all jurisdictions have those exemptions and those that do require that certain conditions be met. It is important to review the Stock Option Plan to ensure that securities issued to a person resident in a province or territory of Canada complies with applicable securities legislation in that province or territory. D. Tax Implications Due to significant differences in the US and Canadian tax regimes, it is helpful if tax issues are considered before an executive is transferred to Canada. Tax ramifications associated with these moves are too numerous to review in the context of this article and will differ based on individual circumstances. However, because there are mechanisms to lessen tax implications, we recommend that tax advice be sought well in advance of a move.

3 E. Immigration Issues In many situations, the transferring executive may be entitled to the expeditious processing provisions of the North America Free Trade Agreement (NAFTA). In some cases it can take several weeks to several months to obtain an employment authorization to work in Canada. There are many immigration options. Two which are commonly used where companies operate on both sides of the border are business visitor and intra-company transferee. Visitors from the United States and many other countries may enter Canada, without an employment authorization, for up to ninety days to meet with their colleagues in Canada. These business visitors cannot, however, be employed in Canada. The distinction between being a visitor and being employed can be difficult to determine. In practise, it is the discretionary, subjective decision of the Immigration Officer at the desk at the time. The person seeking to enter Canada as a business visitor should be prepared to prove the reason for coming to Canada each time he or she seeks to enter the country. Care must be taken not to mislead the Immigration Officials as to the purpose of entry. If the Officer determines the individual will, in fact, be employed in Canada, but has sought entry on the basis that he or she is a business visitor, the individual could be refused entry or, worse, be found to have intentionally misled the Officer. The latter conclusion could interfere with the individual's ability to enter Canada on an ongoing basis. The second option often used where companies operate in Canada and the United States, is to transfer executives, senior managers or specialists under the Intra-Company Transferee provisions of NAFTA. The requirements are: 1. Employee is a US or Mexican citizen; 2. Employee has worked in a senior managerial, executive or specially-skilled position at the US or Mexican company for more than one of the past three years; 3. Employee has accepted a temporary transfer (usually three years or less) to a similarly senior position in the Canadian company; 4. The US and Canadian companies are affiliated as contemplated in the Canadian guidelines. Qualifying employees, with proper documentation, can apply for their authorizations at the port of entry. It is important to address immigration issues early, and in most cases, in conjunction with taking advice on tax matters. The last thing the company wants is to have its senior executive stuck at the border and unable to take up his or her responsibilities in Canada.

4 F. Quebec The principles canvassed above are generally similar to those applicable under Quebec employment law. As the province of Quebec is a Civil Law jurisdiction, many of these principles are codified in the Civil Code of Quebec. Below are some of the key features of Quebec employment law, particularly as they relate to the subjects covered above. - Notice periods and other recourses In the province of Quebec, as in other Canadian jurisdictions, an employer may terminate an employee for just cause without any obligation to provide notice. However, where a provincially regulated employer in Quebec terminates an employee without just cause or serious reason, the employee will be entitled to receive a reasonable notice or payment in lieu thereof, and may be eligible to exercise other statutory recourses to contest such termination. In determining a reasonable notice, the Quebec Courts consider essentially the same factors as those considered by the Courts in other Canadian jurisdictions. In the absence of exceptional circumstances, the Quebec Courts are generally reluctant to award more than 12 months' notice. In exceptional cases, the Courts have awarded up to 18 months' notice. Although the parties may agree in advance in an employment contract to a particular notice period, the Quebec Courts can nevertheless refuse to apply such provision and impose a greater notice period if, at the time of termination, the stipulated notice is considered unreasonable. Article 2092 of the Quebec Civil Code precludes an employee from renouncing their right to obtain compensation for any injury they suffer where insufficient notice is given or where the manner of termination is abusive. In addition to the reasonable notice requirement, there is a separate recourse available to certain categories of employees in the province of Quebec whereby they can challenge their termination and seek reinstatement. Section 124 of the Quebec Labour Standards Act, provides an employee who has at least 3 years of continuous service in the same enterprise and who demonstrates that they have been terminated without good and sufficient cause, may obtain a reinstatement order plus full back pay and/or other compensation. This recourse is not available to senior managerial pesonnel. - Non-Competition Clauses In order to be enforceable, such clauses must be reasonable in their scope and comply with article 2089 of the Civil Code of Quebec. This provision requires that non-competition clauses be stipulated in writing and in express terms, and that they be limited as to time, place and type of employment to whatever is necessary for the protection of the legitimate interests of the employer. It is essential that the duration of the restrictions and the specific territory and type of

5 employment limited thereby be expressly and clearly designated in the clause. Otherwise, the Courts will generally refuse to enforce the clause altogether. It should also be noted that an employer may not avail himself of a non-competition clause where he has terminated the employee without just cause or has himself given the employee such cause for terminating the contract. Even in the absence of a non-competition clause, employees owe a duty of loyalty to their employer. This duty is codified at article 2088 of the Civil Code of Quebec, and prohibits the employee from using confidential information obtained in the course of their employment following the termination of such employment. Article 2088 stipulates, however, that this duty subsists only for a reasonable period following the termination of employment. While article 2088 does not indicate what is meant by reasonable, this will depend on the particular circumstances of each case. 1. Stuart Aronovitch is an Associate with Fasken Martineau in Montreal. Lori Price is a Partner with Fasken Martineau in Vancouver. If you have any enquiries concerning the subject matter, please feel free to contact Mr. Aronovitch ((514) , - saronovitch@mtl.fasken.com) or Ms. Price at ((604) , - lprice@van.fasken.com) or any other member of the Labour Employment and Human Rights Group. 2. For the remainder of this paper, the comments contained herein are related to Provinces other than Quebec as those Provinces are under the Common Law. Specific considerations affecting these issues in Quebec (which is Civil Law jurisdiction) will be addressed as a final passage at the end of this article. 3. The securities legislation in each province and territory needs to be considered to confirm the availability of an exemption. 4. e.g. Conditions may include that the issuer of the securities would be a reporting issuer for a given period of time. As most US companies would not qualify as reporting issuer shares issued to employees would be subject to an indefinite hold and could only be sold pursuant to another exemption.