Vacation Pay on Incentive Compensation: A Hidden Liability in Canadian M&A

6 Min Read By: Andrew Bratt, Sara Josselyn

In Canadian mergers and acquisitions (M&A) transactions, especially those involving the purchase of shares, the issue of unpaid vacation pay to employees on incentive compensation (such as commissions and bonuses) is often overlooked during diligence—yet it has the potential to lead to significant post-closing liability.

Understanding the Issue

In Canada, provincial employment standards legislation requires that employers pay vacation pay to employees on all remuneration earned, where remuneration is comprised not only of base salary, but also incentive compensation like bonuses, commissions, and other performance-based earnings. Despite the statutory requirement, many businesses overlook this obligation as it relates to payments on incentive compensation. This may occur for a variety of reasons:

  1. Lack of awareness. There appears to be a misconception that vacation pay is payable only on base salaries, and that any “extras” such as commissions, bonuses or other performance-based earnings do not trigger any vacation pay entitlements.
  2. Incorrect interpretations of employment law. Even among those who understand that incentive compensation may attract the payment of vacation pay, there is a common misunderstanding that vacation pay is not payable on incentive compensation if such compensation was paid at the company’s discretion. This is analysis is, unfortunately, only partly true. Generally speaking, vacation pay is payable on all wages—including incentive compensation like commissions and bonuses—unless the incentive compensation payments were (i) wholly at the discretion of the employer, and (ii) not related to hours, production, or efficiency. In other words, if bonuses are discretionary but are tied in any way to hours, production, results, or efficiency (i.e., performance), such payments are regarded as “wages” for the purposes of employment standards legislation and attract vacation pay requirements. 
  3. Administrative oversight. It is conceivable that a company’s human resources, administrative, or accounting function is not set up in a way that contemplates the payment of vacation pay to employees on the portion of their wages tied to their performance-based earnings.

The Current Landscape

In recent years, there has been a noticeable and steady rise in class action litigation against Canadian employers for failing to pay vacation pay on employees’ bonuses and commissions. Consistent with employment standards legislation, workers in various sectors are increasingly challenging their employers’ compensation practices, arguing that vacation pay should be calculated on total earnings, including bonuses and commissions, rather than just their base salary.

A key example of this growing trend is the ongoing RBC class action lawsuit,[1] one of several proposed class actions targeting banking and insurance companies for unpaid vacation pay on incentive compensation, with more than a billion dollars at stake. In RBC, the plaintiffs are arguing that their vacation pay entitlements should have factored in all performance-based earnings (including commissions and bonuses), not just base salary.

Ongoing class actions like RBC are noteworthy because their outcome has the potential to set a precedent that could open the floodgates for similar claims across Canada—whether by way of further class actions or individual claims. Regardless, the Canadian legal landscape is shifting as workers are increasingly seeking to ensure they are being compensated fairly and in line with employment standards legislation, with claims regarding vacation pay entitlements as the most recent example. This growing trend reflects broader shifts in labor rights advocacy and a heightened awareness of employees’ statutory rights in Canada.

Relevance to M&A

From an M&A perspective, it is imperative to ensure that proper diligence is conducted to confirm that the target has been historically compliant with its vacation pay obligations. If Canadian employees have previously been deprived of their vacation pay entitlements, a buyer could be on the hook for significant post-closing liabilities if the noncompliance comes to light. Courts are reluctant to deprive employees of their legal entitlements, so a buyer’s exposure can become material very quickly insofar as it may involve the correction of past underpayments (or nonpayments) dating back to an employee’s date of hire. Given that incentive compensation is often a key component of employee compensation packages, the financial impact can be substantial.

Cross-Border M&A Implications

In cross-border M&A transactions involving a Canadian parent and a US subsidiary, complexities can arise regarding vacation pay obligations, especially when Canadian employees are temporarily working in the US. While US law typically governs employees of a US subsidiary, Canadian employment standards—including in respect of vacation pay entitlements—may still apply to Canadian employees working in the US on secondment or temporary assignment.

For example, if a Canadian employee is working in the US part of the year, there may be uncertainty regarding whether such employee’s vacation pay is calculated under Canadian or US law. Although US vacation policies differ significantly from Canadian standards, it is crucial for Canadian employers to ensure compliance with both US and Canadian vacation pay obligations during the employee’s assignment in the US. Failure to do so could expose the company to liability if vacation pay is not correctly calculated or paid in line with Canadian employment standards.

Mitigating the Risk

For both buyers and sellers in an M&A transaction, understanding the potential risks for unpaid vacation pay on incentive compensation is crucial. Sellers should ensure that their HR and payroll practices are in full compliance with Canadian employment standards before entering into negotiations. A thorough due diligence process should include a review of vacation pay accruals and payments, particularly as they relate to performance-based incentive compensation.

For buyers, it is essential to work with legal advisors who are familiar with the nuances of Canadian employment law and the risks associated with noncompliance with Canadian vacation pay requirements. For M&A deals that have a cross-border component, buyers should conduct thorough due diligence to identify any potential vacation pay liabilities for employees working in both countries. In particular, buyers should diligence the target’s vacation pay accruals to ensure that they have been properly documented, even for employees temporarily working in the US, to mitigate the risk of post-closing exposure.

Engaging in early discussions about these potential liabilities can help structure the deal in a way that minimizes exposure for the buyer, including by way of addressing the concern in the employment representations and warranties, or including a specific indemnity regarding exposure for historical noncompliance. A buyer may also opt to procure representations and warranties insurance as a risk mitigation tool, but it should be aware that insurers in the Canadian market are live to the issue, and so buyers should be prepared to address any potential risk during underwriting.

Conclusion

The issue of unpaid vacation pay on incentive compensation is an often-overlooked risk in Canadian M&A transactions, despite that the issue has the potential to result in a significant post-closing liability. It is imperative that transacting parties conduct fulsome diligence to identify whether there is any exposure, and to address this issue proactively.


  1. Cunningham v. RBC Dominion Securities, 2022 ONSC 5862 (CanLII).

By: Andrew Bratt, Sara Josselyn

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