Less is More – “Loyalty Incentives” Upheld

Author: Dean Crawford, KC

Canada’s big five banks and the financial planning industry will benefit by paying close attention to the difference between a “loyalty incentive” and a restraint of trade, as canvassed thoroughly by the Ontario Superior Court in Levinsky v. The Toronto-Dominion Bank2013 ONSC 5657.

Levinsky, a managing director with TD Securities Inc., resigned his employment and then challenged the enforceability of the forfeiture provisions in the bank’s Long Term Compensation Plan. Under the plan, Levinsky received Restricted Share Units as part of his compensation, which cliff-vested after three years, i.e. they did not mature until three years after grant, as opposed to other plans under which RSUs vest on a three-year rolling basis. The plan also provided for immediate forfeiture of unvested RSU’s upon resignation.

Levinsky contended that the forfeiture provisions amounted to a restraint of trade, as their intent was to discourage employees from working for a competitor.

The court rejected that argument, finding based on the terms of the plan and other evidence that the plan was designed to incent employee loyalty. As forfeiture was not tied to working for a competitor, the clause at issue did not operate as a restraint of trade.

The decision contains an enlightening and thorough review of authorities from Canada, the UK, Ireland, Singapore, Australia and the U.S. After reviewing these decisions, the court summarized the law as follows:

I conclude that in examining a clause in an employment contract which operates to forfeit deferred compensation upon or following the cessation of the contract, a court must assess whether the clause, on its face or in its practical operation, ties the forfeiture of compensation to the event of termination or whether it ties it to the employee’s conduct following the end of his employment. If the forfeiture results simply from the cessation of the employee’s service, without more, the clause does not operate in restraint of trade because it does not fetter the employee’s ability to choose where he or she wants to work next. Of course, a court must inquire into the circumstances under which the clause came into force to ensure that it was not the product of unfair dealing or bargaining.

Even if the forfeiture results simply from the cessation of employment, the court must examine the terms of the deferred compensation plan to ascertain whether or not the employee possessed any vested rights in the deferred compensation. The forfeiture of vested compensation would necessitate an inquiry into whether the forfeiture constituted a penalty, an analysis similar to that undertaken by Rivard J. in the Nortel Networks v. Jervis case.

(at paras. 81-82)

Applying this law, the court characterized the clause as a form of “loyalty incentive, not a restraint of trade.”

The court also considered whether Levinsky had any vested rights to deferred compensation, noting the forfeiture of vested compensation (even if not a restraint of trade) is still subject to review as to whether the forfeiture constituted a penalty. On this point, the court held that the terms of the plan clearly spelled out that the right to have the value of the RSUs paid out did not vest until three years after the date of grant.

The lesson from this case? Less may be more. While employers may be tempted to combine non-compete clauses with forfeited compensation, doing so will subject such clauses to the traditional reasonableness analysis, whereas forfeiture provisions on their own may be seen as simply “loyalty incentives.”