By Howard Levitt and Stephen Gillman

For all the positive attributes to employee ownership, there are some obvious and often unconsidered drawbacks

As is often the case, proper planning is key to avoiding financial liability.

Giving employees a chance to own shares in the businesses has been trending lately, but it is not a new concept.

Employee ownership plans date back to the early half of the nineteenth century, when mostly large corporations began setting aside stock to supplement their workers’ retirement incomes. Eventually, pension plans emerged as the primary vehicle for workplace retirement savings, but some employee ownership plans remained, as they were seen to align the economic interests of employees and employers.

A notable American study showed that, by the early 2000s, there were more employee owners than private sector union members.

While Canadian employers have lagged behind their American counterparts in embracing employee ownership, a number of domestic companies do offer them, including Magna International, Friesens, PCL Construction and Golder Associates Inc.

Businesses that offer employees the opportunity to own a piece of the company benefit by attracting and retaining top talent, engendering a high level of employee engagement and creating a built-in incentive for increased worker output.

However, for all the positive attributes to employee ownership, there are some obvious and often unconsidered drawbacks. For instance, the ongoing share repurchasing obligations can cause cash flow issues as companies need to keep large reserves on hand in the event they need to dismiss employee shareholders. In the same vein, employee ownership may also act as a hindrance to firing low performing or otherwise problematic employees whose stakes in the company amount to a sizable price tag in the event they are dismissed and demand the company buy back their shares.

From an employment law perspective, the chief hazard materializes once the relationship ends. Canadian courts routinely award significant six to seven figure sums to dismissed employees with lingering ownership interests where the bulk of their wrongful dismissal damages come from the cash value of the shares they once held. For example, in a recent wrongful dismissal decision, the court awarded $1.8 million in damages, the vast majority of which was the fair market value of the former employee’s stock options, because the terms of the shareholder agreement were not clearly communicated.

Still, all is not lost for businesses that offer employee ownership plans and hope to avoid the downside risks.

A recent decision by the Alberta Court of Appeal in Spartan Controls considered a clever example of an employee ownership arrangement that evaded the usual scrutiny of the court. The plaintiff was a long-tenured employee who participated in a share ownership plan. As a shareholder, the plaintiff received regular profit-sharing payments, which were calculable upon the number of shares he held at any given time. Under the terms of the shareholder agreement, the company carved out the right to buy back the plaintiff’s shares at any time, the only pre-condition being that he receive 90 days’ notice.

Of particular importance was that the company ensured that the shareholder agreement was entirely distinct from the plaintiff’s employment contract.

Upon dismissing the plaintiff on a without cause basis, the employer also provided 90 days’ notice under the shareholder agreement that it would be buying back all of his shares. The plaintiff contested the enforceability of the shareholder agreement and opted to sue for wrongful dismissal. In doing so, he claimed that he was entitled to profit sharing payments for the entirety of his nearly two-year notice period.

The lower court, and later the Alberta Court of Appeal, disagreed and held that he was only entitled to profit-sharing payments for 90 days, not for the entire duration of the notice period. Both levels of court remained steadfast in the plaintiff’s right to retain shares and thus receive profit-sharing payments governed by the terms of the shareholder agreement, which had no connection to his actual employment contract nor the work he performed at the company. Rather, his entitlement to profit sharing payments was made in his capacity as a shareholder, not as an employee.

A rare outcome, but refreshing for businesses who wish to enrich productive employees while limiting payments to those workers who are less so.

The key takeaway from this decision is that employers can stave off significant liability when offering ownership plans by carefully constructing and deploying employment contracts and other agreements related to actual ownership in the company.

And while skillfully crafted termination clauses and clear language restricting equity entitlements upon dismissal is a good starting point, it is prudent for a company to seek out advice from a practitioner who is not only apprised of the law but of the unique unique circumstances of the workplace and industry.