Foundational changes soil the employment contract – Celestini v. Shopologix, 2023 ONCA 131

As employment lawyers, we find ourselves frequently reminding clients of the importance of regularly reviewing their employment contracts. There are a number of reasons for this. Changes in the law may render previously enforceable provisions invalid. Changes in circumstances may necessitate the addition of new or different clauses. Or, as the recent case of Celestini v. Shopologix Inc. ("Celestini") exemplifies, significant changes in the employment relationship may render provisions in an existing contract no longer enforceable.

In Celestini, a key issue was whether the "changed substratum doctrine" applied to render unenforceable a termination provision contained in an employment contract between a former employee and his employer. The changed substratum doctrine is a judge-made legal doctrine that applies where there has been fundamental expansion to an employee's duties after the contract was made, such that the substratum (or foundation) of the contract has disappeared or substantially eroded. In such a case, it may not be fair to enforce a contractually agreed to restriction on the employee's entitlement to notice of termination.

Below we explore in more detail the facts of this case, and the important takeaways that may be gleaned by employers and employees alike.

Facts:

Mr. Celestini was a co-founder and the original Chief Executive Officer (CEO) of Shopologix in 2002. In 2005, the shares of Shopologix were purchased by a venture capital firm, resulting in Mr. Celestini stepping down as CEO, and instead accepting a role as Chief Technology Officer (CTO). At that time, he signed a written employment contract (the "2005 Contract") which, among other things, stipulated the organization could dismiss him without cause by providing him with one month's written notice and continuing his base salary and group health coverage for 12 months. He would also be entitled to a pro-rated bonus for the portion of the year he worked up to termination.

In 2008, Mr. Celestini's role and compensation significantly changed. With respect to his role, Mr. Celestini was assigned substantial new work duties, including new managerial duties, sale duties, international travel, infrastructure responsibilities, and financing duties. Mr. Celestini and Shopologix also entered into a new Incentive Compensation Agreement ("ICA") that materially changed his bonus arrangement from the 2005 Contract. Importantly, Shopologix did not mention or ratify the 2005 Contract when the ICA was agreed to.

In 2017, Mr. Celestini was terminated without cause. He was provided with his entitlements under the 2005 Contract, including 12 months of base salary and health insurance coverage, and payment of his pro-rated bonus for the portion of 2017 he had worked.

Mr. Celestini sued for wrongful dismissal, claiming the termination provision in the 2005 Contract was not enforceable, and he was entitled to reasonable notice of termination based on the common law.

Summary Judgement Decision:

The motion judge sided with Mr. Celestini.

He found that the termination provision in the 2005 Contract was not enforceable based on the changed substratum doctrine. Specifically, he relied upon the following factors:

• Mr. Celestini's duties changed substantially and fundamentally over the course of his employment. This was the case despite his job title not changing.
• Reinforcing this were the substantial changes to Mr. Celestini's compensation as a result of the ICA. His compensation increased by about 173% over the course of his employment.
• Shopologix did not mention or ratify the 2005 Contract when Mr. Celestini agreed to the ICA. If Shopologix wished to continue to rely on the terms of the 2005 Contract, it ought to have ratified it.
• The 2005 Contract did not expressly provide that it would continue to apply notwithstanding any changes in Mr. Celestini's responsibilities. The wording of the contract, that Mr. Celestini would perform duties "reasonably assigned to him", was not sufficiently clear to allow Shopologix to make fundamental changes to the CTO role while preserving the termination provision.

As the termination provision in the 2005 Contract was found to not be enforceable, the motion judge held that Mr. Celestini was entitled to 18 months of reasonable notice, including pay in lieu of bonus over the reasonable notice period. The total award was over $400,000, on top of the amounts already provided to Mr. Celestini.

Court of Appeal Decision:

Shopologix appealed on a number of grounds, including contesting the motion judge's application of the changed substratum doctrine, and challenging the finding that Mr. Celestini was entitled to pay in lieu of bonus during the notice period. Mr. Celestini also cross-appealed. He argued that the motion judge incorrectly deducted from his damages award the pro-rated 2017 bonus payment that he received on termination.

The Court of Appeal rejected Shopologix's appeal. It upheld the motion judge's finding that the changed substratum doctrine applied. Further, the motion judge correctly held that that the terms of the ICA did not oust Mr. Celestini's common law entitlement to damages for the loss of his bonus over the reasonable notice period.

The Court of Appeal allowed Mr. Celestini's appeal in part. It found the motion judge should not have deducted the pro-rated 2017 bonus already paid to Mr. Celestini from his damages award. The pro-rated bonus award was for the period of 2017 which Mr. Celestini worked, whereas his damages award was intended to compensate him for the lost opportunity to earn bonus over the 18-month notice period following his dismissal. However, the Court of Appeal found Shopologix had actually over overpaid Mr. Celestini for his pro-rated 2017 bonus, and thus the amount of the overpayment should be deducted from the damages award.

Overall, the Court of Appeal ruled in favour of Mr. Celestini and increased his damages award by nearly $40,000.

Takeaways:

While the facts of this case may be on the more extreme side, it is not uncommon for an employment relationship to change and evolve over time. When such changes do occur, it is important to consider whether the terms of any contract governing the relationship should also be updated and changed. For example, Shopologix potentially could have avoided this nearly half a million dollar damages award had it confirmed the 2005 Contract would allow for such changes, or, alternatively, re-ratified the 2005 Contract at the time of rolling out the changes.

It also serves as a good reminder that potentially outdated language in a contract or bonus plan may prove fatal to an employer. Here, because the ICA did not comply with the current requirements to successfully oust the common law entitlement to bonus during the reasonable notice period, Mr. Celestini was entitled to receive his full bonus entitlement. This was a significant component of his hefty damages award.

For employers, this is yet another cautionary tale of the importance of checking your contracts on a regular basis. For employees, this case highlights that contractual restrictions on your entitlements are not always enforceable. Either way, we recommend reaching out to a member of our team to discuss your employment rights and obligations.