Employment lawyer explains how enforceable promissory notes can cause reputational damage
Promissory notes, typically used to facilitate loans or compensation in the form of shares, can create legal and financial challenges when disputes arise between employers and employees.
A recent Ontario Superior Court decision ruled in favour of the employer in a high-profile decision, but the case still serves as a warning to employers, as it highlights the balance between contract obligations and employee rights to freely decide where they wish to work.
“There's two principles at play,” says Andrew Monkhouse, managing partner of Monkhouse Law.
“On one hand you can say, ‘Well, look, adults should be able to be held to agreements that they signed’… On the other hand, though, hopefully, as Canadian society, we can all agree there's also a principle that indentured servitude should not form a part of our labour market.”
The case centres on a vice president and investment advisor who received a $1.6-million recruitment bonus from his employer when his employment contract changed due to a merger. The employee signed a promissory note agreeing to repay the loan in equal annual instalments over 10 years.
When he left the company before the 10 years was up, after being found guilty of insider trading, the employer sued him for $461,000, the remaining balance on the note.
Enforceability of promissory notes as signing bonus
At the heart of the case was whether the promissory note, which was amended during the merger and transfer of employment, was valid and enforceable.
The employee argued that the note was not enforceable due to a lack of consideration — a legal term meaning that something of value must be exchanged between parties to form a valid contract. However, the court disagreed, stating the recruitment bonus and other benefits provided to the employee as part of his employment package were sufficient consideration for the promissory note to be enforceable.
"It is a good idea, if you’re going to be lending employees money — even if it’s to buy shares in your company or related company — to get a promissory note. And to be clear on what the terms of that promissory note are," says Monkhouse.
He emphasizes the importance of ensuring that promissory notes are properly structured and clearly understood by all parties involved.
“There is a heavy onus on companies in terms of enforcing complex structures, and so it’s important to make sure that all the T’s are crossed and I’s are dotted, to make sure that that’s all done correctly."
Promissory notes, while effective for incentivizing long-term employment, can backfire if not properly drafted, he says. The defendant sold most of the shares he purchased with the recruitment bonus at a significant loss, receiving only $143,466 for shares originally valued at $1.6 million.
Despite this, he was still held liable for the balance of the loan, with the court stating, "Courts ensure that there is consideration for a contract, but the court is not concerned with the adequacy of the consideration."
Another critical issue in the case was the employee’s attempt to offset the amount he owed with unpaid previous bonuses. He claimed he was entitled to $320,000 in bonuses that had not been paid, but the court found that his claim was statute-barred — meaning he had waited too long to pursue legal action.
‘Golden handcuffs’ of promissory notes
Monkhouse points out that while promissory notes are effective if used properly, employers should be aware of non-monetary repercussions if they go sideways, as tying employees to large financial obligations if they leave a company can create a sense of entrapment.
“It really does give them, you might say, golden handcuffs, but they aren't even golden handcuffs, because in this case, the value ended up being significantly less for the shares. So, a recruitment bonus turns into having to pay hundreds of thousands of dollars for the privilege of leaving a company,” he says.
In this case, the shares the employee purchased were worth significantly less than the original loan, leaving him with a large debt to repay. Monkhouse points out how although the employer may be contractually in its right to demand repayment, that might not always be the right choice from an HR perspective.
“While it might be a short-term benefit to seemingly trick people into coming and working for your company with the promise of lots of money, when you then combine that with a requirement to pay that back if they leave, and also sue them for quitting and say that they owe you what would be in many parts of Canada a house-worth of debt for leaving, that has reputational aspects — and also, I would imagine, damaging morale aspects on other employees who work for you.”