What is an Employee Loan Agreement?
An employee loan agreement is a type of legal document that is created between an employer and employee, in which the employer loans money to the employee. There are several reasons for doing this, and it can come in many forms. The agreement itself will act as a legally binding contract, and will outline all of the details of the transaction. The amount that the employee is borrowing and the interest will be outlined in this agreement , along with the payment plan and schedule. Most employee loan agreements will also include a clause for what happens if the employee separates from employment before the loan has been paid off. This type of agreement will benefit employers by allowing them to control who is able to borrow money from the company, and will allow them to prevent financial losses should an employee break the contract. Like with any type of loan, the employee will also have the option to enact additional terms if agreements are made between both parties.
Major Components of a Loan Agreement
The key components of an employee loan agreement will often be consistent to those contained in a traditional loan agreement. However, in the context of an employee loan, it is also important to consider what obligations a company may have, and how those obligations may impact the likelihood of repayment.
Like traditional loan agreements, employee loan agreements will include: a statement identifying the amount of the loan being made, the interest rate, the repayment terms, and the consequences and/or remedies that will result if the employee fails to abide by the loan agreement. It is vital that all terms of the agreement be clearly spelled out, including default provisions. However, in the case of employee loans, it is also essential that employer lenders consider whether the employee loan will be binding given the employment relationship and whether the employee may be facing personal or financial obstacles to repayment (i.e. pre-, post-termination, etc.). In this respect, it is critical for employer lenders to include language addressing the consequences of failing to repay the employee loans, including what the employee can expect if s/he does not repay the loan by the specified date.
Employers also need to keep in mind that in-house counsel may be held personally liable for the enforcement of an employee loan agreement. Accordingly, it is also essential when drafting an employee loan agreement that legal counsel is aware of the risks surrounding the consumption of alcohol, drugs, gambling, etc. by employees seeking loans in order to adequately inform employers of their potential exposure and help them decide whether to enter into the proposed lending arrangement.
All of these considerations will impact how an employer lender structures its employee loan agreement.
Overview of Legal Considerations
When drafting an employee loan agreement, employers must be cognizant of their obligations under the the Provincial Employment Standards Act ("ESA") as well as the applicable federal tax rules and regulations, as described below.
Unlike at common-law, there is no equivalent good faith duty on an employer to negotiate with the employee and to ensure that the provisions of the loan agreement are fair or reasonable. What this means, among other things, is that the employer may unilaterally impose its own terms for repayment of the loan, taking into account the provisions of the ESA, as set out below.
(i) Minimum Wage
Pursuant to section 23(1) of the ESA, an employer is prohibited from reducing an employee’s wages except as permitted by the regulations. Therefore, if a loan repayment will result in the employee receiving a net pay lower than the minimum wage prescribed by Ontario Regulation 285/01, General (General Regulation), the employer will be in violation of the ESA. Where a net pay deduction, such as a loan repayment, will result in an employee receiving less than minimum wage (currently $14.25/hour), an employer may not deduct from wages without express written consent from the employee, as required pursuant to section 11 of the General Regulations.
For example, for a loan repayment of $100.00 the employee should be compensated an extra hour (or hours) of regular time at the employee’s regular applicable minimum wage, whichever is greater. In this case, the employer would have to pay the employee an additional 7 hours at the $14.25 rate of pay, resulting in a total wage expenditure of $114.25. If a loan repayment arrangement would result in the employee receiving less than minimum wage, the employer must pay the employee a rate of pay that will ensure that the net pay resulting from the loan repayment is equal to or greater than minimum wage.
(ii) Deductions from Wages
Pursuant to the ESA, an employer is prohibited from making unauthorized deductions from an employee’s pay. Sections 13 and 15 of the General Regulation govern the situations in which an employer may recover money from an employee’s wages. Section 13 provides as follows:
Limitation on deductions from earnings
13. No employer shall make a deduction from the earnings of an employee unless the deduction is required or permitted by a statute, regulation or court order, or is made with the employee’s written authorization. O. Reg. 289/01, s. 15.
Section 15 of the General Regulation provides that no employer shall deduct the value of damage to, or loss of, the property or money of an employer or of a person other than the employer unless,
(a) the loss or damage is caused by negligence or otherwise by the employee’s performance of his or her duties under the employment, including duties requiring the exercise of skill or care;
(b) the loss or damage is caused by the employee’s misuse of the employer’s property or money if the employee was given control, custody or safekeeping of it as part of his or her duties;
(c) the employee has, before the loss or damage occurred, expressly or by implication, agreed to so reimburse the employer; or
(d) the employee subsequently has expressly or by implication agreed to so reimburse the employer. O. Reg. 289/01, s. 13.
If the deductions from the employee’s pay go beyond the limited exceptions in sections 13 and 15 of the General Regulation, such as for interest and late payment penalties for a loan, the employer may be in violation of the ESA.
(iii) Administrative Monetary Penalties
An employer’s failure to comply with the ESA can result in Administrative Monetary Penalties (AMPs) assessed against the employer under the ESA. Pursuant to subparagraphs 137(1)(8)(ii.) and 137 (1)(9)(v.) of the ESA, the Registrar may suspend the use of license of an employer for non-payment of over $10,000 to the Ministry of Finance with respect to the amounts deducted from wages for statutory income tax, Employment Insurance and Canada Pension Plan contributions.
Any fines or penalties imposed by Canada Revenue Agency for failure to remit deductions from employee wages under the Income Tax Act do not alleviate an employer from a contravention of the ESA. For instance, employers are prohibited from making deductions from wages to cover the costs of any health or other benefit plan, unless such deduction is otherwise mandated under the Income Tax Act or other federal statute (ESA s. 13). Thus, an employer who fails to remit an employee’s Pension Premiums owing under the Canada Pension Plan and is subject to on-going penalties from the Canada Revenue Agency for such failure, remains liable for administrative monetary penalties for a contravention of the ESA with respect to the underlying contraventions of the general prohibition on deductions from wages pursuant to section 13 of the ESA and contraventions of the limited exceptions in section 15 of the General Regulations. Thus, although an employer is only permitted to deduct an amount from the employee’s wages that is authorized by statute, regulation or court order, such as the Canada Pension Plan and Employment Insurance payments, the employer must still ensure that it reports and remits such amounts to the relevant government agency in full and on time, in order to avoid and mitigate further liability.
Advantages for Employers and Workers
The benefits for employers of having an employee loan agreement can be significant. Such agreements encourage employees to stay with the company longer; allowing for the recovery of the loan before the employee departs. They can subsidize a one-off purchase of equipment or help to pay for a training programme that may benefit the company. Through an employee loan, the employer has the ability to increase the employee’s salary while keeping the funds off the payroll, thus reducing associated tax and national insurance costs for the next two years, assuming that the employee does not repay the loan (the SC36 requirements are met) and the employer does not otherwise reimburse the employee.
For employees, of course, the benefits are equally clear. An employee can make a one-off purchase of an asset, on which they do not have to start paying back for up to 12 months. This gives the employee time to determine if there are any restrictions in place and if there aren’t, decide whether they are actually interested in purchasing the item. An employee may have only been offered an opportunity to take an asset after 4 years of being with the company and after he/she has decided he/she wants it, but because of his/her immediate cash flow issues cannot afford it. The employee loan agreement has enabled the employee to transfer the asset as his/her own liability and so, in such circumstances, has enabled the employee to obtain the asset on the same basis as that available to other employees in the company.
Creating an Effective Loan Agreement
When drafting an effective employee loan agreement, there are a few best practices to keep in mind. First and foremost, use clear language and simple terms. Remember, you will have to enforce the agreement with your former employee if he or she moves on to another company or industry, and therefore, you want to make sure the agreement is clear and legally enforceable.
Second, negotiate the terms of the loan with your employee before the loan agreement is finalized and executed. Take the time to ensure that both you and the individual fully understand the terms set forth in the document.
Finally , always confer with legal counsel before executing any employee loan agreement. Because they are unique and raise different issues, such as: (a) confidentiality requirements; (b) the ability to seek mediation and/or arbitration of disputes; and (c) the right to attorneys’ fees in the event of a loan default or breach of the agreement, you want to make sure such an agreement is enforced in the proper context.
Frequent Pitfalls to Avoid
Common mistakes to avoid with employee loan agreements are not taking the time to ensure the terms of the loan and repayment process are well-defined and documented. This is particularly important where a loan may impact the employee’s financial situation such as when a loan is lumped as taxable income in the same year as its repayment. These situations can have unintended tax consequences that could have been avoided had the documentation clarified the intent of the parties.
There can also be misunderstanding regarding the purpose of the loan agreement and the corresponding loan documents. For example, employer/lenders sometimes use a loan agreement to establish an employment-conditional loan, which may require the employee/borrower to pay back the value of the loan if the employment ends prior to the specified repayment schedule. This type of loan arrangement does not require a loan agreement and should be documented through issuance of a promissory note or the incorporation of terms into the loan documents.
Illustrations and Templates
The previous section of the guide touched upon provisions that are almost always necessary to include in each agreement, but there are also more complex terms that you can customize for your own employee loan situation. In addition to the clauses we covered earlier in this article, your employee loan agreement may also include terms such as:
You can find examples and templates of employee loan agreements on a wide variety of legal websites and forums. One example of such a website is Free Legal Documents, which provides a basic agreement template that you fill in with information about yourself and your employee . While you should certainly look through different agreements and see what others have included in their documents, be careful about using an existing agreement without doing thorough research. Companies providing free templates may not have reviewed them thoroughly for legal compliance or accuracy. Regardless of the source of any legal documents, you should always review the files with a lawyer. It is worth the investment to work with an attorney so that your document is completely firm and guarantees all necessary components are included. Templates are generally a great help for any agreement you would need to use frequently. If you’re ever short on time, such a document can be a lifesaver. Remember, though, that every situation is different. When in doubt, seek professional assistance.