Businesses Beware: $600,000 in damages and other costly mistakes in fixed-term contracts

Many businesses opt for fixed-term contracts or independent contractor agreements believing that they can better manage their risk exposure. Some believe that using fixed-term contracts simplifies the process of ending employment without cause, as they can merely allow the contract to expire. Others view independent contractor agreements as a way to reduce both the risk of non-compliance with employment standards and the need for statutory deductions and withholdings. Combining both approaches and utilizing a fixed-term independent contractor agreement might also seem advantageous. Unfortunately, unless executed meticulously, any fixed term contract will actually expose businesses to significant risk.

Importance of a valid early termination clause

A recent ruling from the Ontario appeal court, Monterosso v. Metro Freightliner Hamilton Inc. (“Monterosso”), serves as a warning of the potential pitfalls of a badly executed fixed term contract. The court upheld a substantial damages award exceeding $600,000 in favor of a contractor whose 72-month contract was unceremoniously terminated after just seven months. The primary reason for this significant award was the absence of a valid termination clause in the contract.

The court’s judgment was unequivocal: the contract explicitly specified a fixed term without any provisions for early termination. Consequently, the contractor was entitled to compensation equivalent to what would have been earned during the remaining 65 months of the contract. The Court of Appeal also distinguished between employment fixed term contracts and contractor fixed term contracts, and accepted the business’s  submission that the contractor had a duty to mitigate the termination of the contract. However, ultimately the  business did not have sufficient evidence to prove the contractor’s failure to mitigate damages and the alleged modification of contract terms through email correspondence. A properly drafted early termination clause would have prevented this costly result. This case underscores the importance of meticulously drafting fixed-term contracts.

Failure to track expiration dates can be costly

Furthermore, employers must exercise caution when utilizing fixed-term employment contracts for extended durations or continuous work. Keeping track of the expiration date of a fixed-term employment contract can be challenging. If an employee continues to perform their duties beyond the contract’s expiry date, even for a day, the employment will have been inadvertently converted to indefinite term employment. This, in turn, renders the safeguards outlined in the written contract ineffective. Moreover, if an employer routinely renews fixed-term contracts, the court may perceive that it is an indefinite term working relationship, effectively nullifying the benefits of a fixed-term contract. This could potentially obligate the employer to significant termination payouts.

Contract worker vs. employee

Another critical risk for business lies in the possibility of contractors being reclassified as employees. It is imperative to understand that the determination of worker status hinges on the actual nature of the parties’ relationship. As explained in Keenan v. Canac Kitchens, the language contained within the contract cannot be relied on if in fact the relationship is that of employer and employee. If that is the case, even a well-crafted independent contractor agreement may not shield an employer from reclassification. Such reclassification can lead to severe financial consequences, including obligations for additional taxes, CPP contributions, EI premiums, vacation pay, overtime pay, and even termination and severance pay. Particularly in cases where such a working relationship has endured for several years, the financial burden on employers, both in terms of compensating workers and satisfying the Canada Revenue Agency, can be substantial, with limited recourse for indemnification from the employee.

Mitigating the risks

To mitigate these substantial risks, businesses must take proactive steps to ensure that their contractors genuinely meet the criteria for independent contractors. A written independent contractor agreement  clearly defining the nature and terms of the working relationship  must accurately reflect the actual practices and conduct of both parties involved. An enforceable early termination clause is indispensable.

For a fixed-term employment contract, businesses should first think about whether it is one of the situations to use a fixed-term contract instead of a permanent contract. For example, the employee is here for a specific project or to step in for a person on leave; second, the contract needs a valid early termination clause and is in compliance with applicable employment standards legislation; and Diligent contract administration, especially regarding expiration dates, is absolutely crucial.

The court, in Monterosso,  also clarifies that, although the burden of proof lies with the employer to demonstrate the worker’s failure to mitigate damages, there exists a reciprocal obligation on the part of the worker. When fixed-term independent contractor agreements are prematurely terminated in accordance with contract terms, workers may have a duty to actively seek and accept comparable income opportunities. Failing to do so can result in a reduction of their entitlement to damages.

While fixed-term contracts may serve as valuable tools for businesses requiring temporary or project-based work from independent contractors, businesses must recognize that such agreements can expose businesses to considerable liability and risk. businesses should consult with experienced employment lawyers before implementing fixed-term contracts.