Honda v. Keays: Back to Baxendale for the Damages Formerly Known as Wallace
On June 27, 2008, the Supreme Court of Canada released its long awaited decision in Honda v. Keays, 2008 SCC 39. The trial and appeal decisions were controversial enough that many were expecting the Court to provide significant guidance on how to lawfully terminate employees with “invisible” disabilities. Instead, in a very unexpected decision, the Court took the opportunity to depart from twenty years of case law on bad faith damages in employment contracts in favour of returning to the approach taken in the nineteenth century stalwart, Hadley v. Baxendale. In doing so, the Court has not only disavowed the previously entrenched distinction of the employment contract, but it has also extinguished the progressive bargaining position terminated employees have enjoyed for over a decade.
Extreme facts lead to extreme law, and Keays had no shortage of either. Kevin Keays was a dedicated, “conscientious”, but disabled employee of Honda Canada who was terminated after fourteen years of service. Eleven years after he began working, Keays was diagnosed with chronic fatigue syndrome and went on disability leave. He returned to work a year later when his insurer determined he was fit to do so, and was then placed in Honda’s disability management program. Even with light data entry work, Keays’ absences continued. While the program permitted this to some extent, Honda became concerned once the medical notes he was required to obtain stopped being evaluative and instead became vague and self-reporting.
These notes led to a showdown with Honda asking Keays to submit to an examination by their in-house doctor, and Keays refusing to do so until he knew the exact purpose of the meeting. Exacerbating this was Keays’ decision to retain counsel out of fear of being fired, and Honda’s cancellation of his limited accommodation, allegedly out of reprisal. Finally, Honda sent Keays a letter stating that if he did not meet with their doctor, he would be fired. Keays refused, was fired, and then sued for wrongful dismissal.
The trial judge found Honda’s conduct to be egregious, reprehensible, and evidenced a “conspiracy” against Keays, who was awarded fifteen months notice, an additional nine-month extension for bad faith (“Wallace damages”), a costs premium fixed at $610,000, and a punitive damages award of $500,000—the largest in Canadian employment law history. Honda appealed, and at the Court of Appeal was successful only in reducing the punitive damages award and costs premium. The majority found the award “generous, but fair” with Goudge J.A. noting in dissent that the entire punitive damages award ought to have remained intact based on Honda’s conduct. Honda appealed again, this time to the Supreme Court of Canada.
Supreme Court’s Unexpected Decision
Writing for the majority, Bastarache J. did not offer the expected guidance on how employers should lawfully terminate disabled employees. Rather, he ignored this completely and instead took the opportunity to reformulate the rules on bad-faith damages in the employment contract. In doing so, the Court divested itself entirely from the Wallace damages approach, and unified the contract of employment with its commercial brethren under the principles of Hadley v. Baxendale.
The Damages Formerly Known as Wallace
It was previously clear employers had an obligation of good faith and fair dealing when terminating an employee, the breach of which could give rise to aggravated damages. This was enunciated in Wallace v. United Grain Growers,  3 S.C.R. 701, which recognized the significant power imbalance between an employer and an employee. This imbalance was especially pronounced during termination, when the employee was most vulnerable. In Wallace, the Court attempted to address this by compensating those subject to bad-faith conduct with aggravated damages in the form of an extension to the reasonable notice period. These damages became known as Wallace damages, and served the dual function of reprimanding employers who fell short of punitive damages, while also compensating employees for harm short of mental distress.
While Wallace damages quickly gained a reputation for being notoriously arbitrary, this same unpredictability empowered employees with bargaining power during severance negotiations. As a unique form of damages, “Wallace damages” also reflected the distinct status of the employment contract in Canadian law.
Unifying the Employment Contract and Bad-Faith Remedies under Hadley v. Baxendale
In Keays, the Court spent a great amount of time retracing employment contract damages in Canada, starting with Addis v. Gramaphone in 1909 (H.L.), before attempting to shoe-horn them all in under the auspice of Hadley v. Baxendale, a case that had nothing to do with employment law.
Rather than overturn Wallace, Vorvis v. Insurance Corporation of BC,  1 S.C.R. 1085, and other case law along similar lines, the Court attempted to pay homage to their principles by acknowledging that an employee will always suffer some degree of emotional harm upon termination, and that the bad-faith actions of an employer can also exacerbate this harm. By doing so, the Court was able to invoke Baxendale’s stipulation that only that which was in the reasonable contemplation of the parties at the time of contract formation could be compensable. The Court reasoned that in the employment context, at the time of contract formation both the employer and employee would have contemplated the psychological effects of bad-faith conduct. In the event an employer’s behaviour is particularly egregious upon termination and its effect on the employee causes more harm than the normal impact of termination contemplated by the parties, the Court reasoned this difference could therefore be compensable.
Under the Baxendale formulation, the Court has done three things. First, it has attempted to respect the vulnerabilities of employees noted in Wallace and Vorvis by continuing to offer relief for those who suffer harm from bad-faith conduct at the time of termination. Second, it has rescinded a century’s worth of case law that recognized the special significance of the employment contract. Finally, the Court has also taken away the very tools it previously gave to address bad-faith conduct. That is, in Keays the Court in no uncertain terms extinguished Wallace damages:
Damages attributable to conduct in the manner of dismissal are always to be awarded under the Hadley principle. Moreover, in cases where damages are awarded, no extension of the notice period is to be used to determine the proper amount to be paid. The amount is to be fixed according to the same principles and in the same way as in all other cases dealing with moral damages. Thus, if the employee can prove that the manner of dismissal caused mental distress that was in the contemplation of the parties, those damages will be awarded not through an arbitrary extension of the notice period, but through an award that reflects the actual damages.
As a result of this, Keays’ nine-month Wallace extension was extinguished, leaving him only with his original fifteen-month reasonable notice award.
What Are The Consequences of Keays?
As previously noted, the arbitrary nature of Wallace damages was perhaps one of its most significant, if unintended, qualities. Rather than risk having to pay a premium of anywhere from 20 to 60% over what the employee would regularly be entitled to, Wallace damages had the strong effect of facilitating settlement. In light of the power imbalance between employers and employees, this went a long way to helping employees realize their full entitlements at common law without having to resort to litigation. However, the Court was clear that Wallace is out and Keays/Baxendale is in.
Under the new regime, employees have lost their bargaining chip during severance negotiations. Now any claim for bad-faith damages must be advanced in the context of litigation, and employees must also prove the detrimental effects of any damages claimed. Further, unlike Wallace damages – which were highly speculative – the new Baxendale approach to bad-faith damages will be under the strict purview of the courts. This has the obvious advantage of reducing frivolous claims of bad faith, but at what cost? At least under Wallace there was an ominous cloud of arbitrariness hanging over employers that motivated them to adopt proper human resources practices. While Keays will undoubtedly save employers money during severance negotiations and allow them to perhaps be a bit more bullish when it comes to employee relations, it remains to be seen whether this will in fact be a good thing.