Employers take note: A weaker economy usually means more expensive terminations

When the job market is ebullient, employees tend to leave quietly when they are let go. They get another offer, move on quickly and litigation is usually more of a theoretical threat than a real one.

But when the market weakens, the equation changes — and not just for employees.

A downturn does not only increase job insecurity. It also increases the legal and financial risk for employers looking to reduce headcount. The irony is simple: the worse the economy, the more expensive the termination.

There are three reasons for this shift, the consequences of which employers are prone to underestimate.

1. Employees are far more likely to sue when jobs are scarce

In a strong labour market, a terminated employee who receives a modest severance package may decide litigation is not worth the time, cost or stress involved and simply move on quickly. In some cases, they are re-employed before the severance period initially offered even expires.

Why fight over notice when you already have a new salary coming in?

But in a weak job market, the calculation changes.

When comparable employment is difficult to secure, employees have a strong incentive to pursue their full legal entitlements — particularly where they have long service, senior roles or significant compensation. Why accept months of no income when a court would order your employer to pay you?

Absent a properly drafted employment agreement limiting liability, Canadian courts may award common-law notice periods up to 30 months.

That is not a rounding error. It is a material balance-sheet risk.

As a result, employers should expect more demand letters, more litigation and more aggressive legal positioning from terminated employees in a downturn. Cost savings achieved through layoffs are often offset by increased legal exposure.

2. Economic weakness tends to increase notice periods

Where there is no enforceable termination clause limiting entitlements, courts determine reasonable notice/severance based on a set of well-established factors: age, length of service, position and — critically — the availability of comparable employment.

That last factor is where the economy quietly enters the courtroom.

Judges are not blind to labour market conditions. In recessions or periods of sector-wide contraction, courts will extend notice periods/severance on the basis that re-employment takes longer.

We saw this dynamic during the COVID-19 downturn and again in the aftermath of the Great Recession. When hiring slows across entire industries, notice periods expand.

For employers, even a modest extension — one or two additional months per employee — multiplies quickly across a workforce reduction. What looks like straightforward cost-cutting can become materially more expensive than anticipated.

3. Mitigation is no longer a reliable safety valve

Dismissed employees have a legal duty to "mitigate" their damages by seeking comparable employment. Any income earned during the notice period is generally deducted from damages owed.

But in a downturn, mitigation becomes uncertain. Hiring freezes, layoffs across sectors and reduced mobility all combine to slow re-employment. Employers can no longer assume that mitigation will reduce their liability.

Compounding this is a practical burden of proof: if an employer argues that a terminated employee failed to mitigate, it must also demonstrate that suitable jobs were actually available. In a weak economy, that argument becomes increasingly difficult to sustain.

The result is straightforward. Employers are more likely to pay full — or close to full — notice/severance entitlements because the usual offsetting mechanisms are weaker.

The bottom line

Terminating employees is never a risk-free exercise. But in a deteriorating job market, it is measurably riskier and more expensive.

Employers who approach layoffs as a purely operational or financial decision, without recalibrating legal exposure for economic conditions, are often surprised by the outcome. What was expected to be a cost-saving measure can quickly become a litigation event with extended notice awards and legal fees.

Before issuing termination letters in a softening labour market, employers are well advised to take a hard look at their employment agreements, their litigation risk tolerance and the true cost of "saving" payroll.

In many cases, the savings are real. But so are the legal bills that follow.

Howard Levitt is senior partner of Levitt LLP, employment and labour lawyers with offices in Ontario and Alberta, and British Columbia. He practices employment law in eight provinces and is the author of six books, including the Law of Dismissal in Canada. Jenny Yu is an associate at Levitt LLP.