Employment Law Implications When Buying or Selling a Business

Generally, there are two basic methods for structuring the purchase and sale of a business. The purchaser can acquire the underlying assets of that business or the purchaser can purchase the shares of the corporation that owns the assets and operates the business.

In most cases, the choice as to whether the acquisition will be by way of assets or shares is decided based on a variety of strategic legal, tax, and business considerations. Lawyers routinely advise clients about the advantages and disadvantages of each method. Whether the deal is structured as a share purchase or an asset purchase (or some combination of the two) it is critical to determine how the purchaser will assume or avoid the employment-related liabilities of the business.

When a business is being sold, both the vendor and the purchaser must carefully consider and address the employment issues that can arise. As discussed below, a thorough evaluation of potential employment issues is an important part of the due diligence process because the existence of hidden employment liabilities (which rarely appear on the balance sheet) can have a significant impact on the financial viability of the transaction.

Unionized Workplaces

If a business is a unionized workplace, the Ontario Labour Relations Act, 1995 (“LRA”) provides the overall legal framework that governs the relationships between trade unions, employers, and employees. Among other things, the LRA sets out that the purchaser of a business, as a “successor employer” is, until the Ontario Labour Relations Board otherwise declares, bound by any collective agreement by which the vendor is bound.

Share Purchases

With regard to non-unionized workplaces, a share purchase does not change the status of the employment relationship between the employees and the corporation. Canadian courts have made it clear that the sale of a company’s shares is merely a change of shareholders; the company continues to exist as it did prior to the share sale and the employees remain employed by the same legal entity. Therefore, the purchaser will inherit all of the target company’s employees and their respective entitlements.

The extent of the ongoing employment obligations will likely affect the negotiated purchase price in a share transaction. The purchaser may negotiate for the vendor to terminate certain employees prior to closing of the share transaction, thereby placing financial responsibility on the vendor as a pre-closing matter. In some cases, the vendor, understandably, would negotiate against this, and negotiate for the purchaser to take all employees as part of the share transaction. Most commonly, it is only the family members of the vendor that are terminated or resign prior to closing, and the remaining employees are kept as is, as the purchaser would usually desire them to carry on the business.

In a share transaction, if the purchaser wishes to change any of the employees’ terms of employment, it must negotiate with the individual employee and provide new consideration for the changes. Any unilateral amendment without additional consideration and employee acceptance may constitute a constructive dismissal, entitling the employee to wrongful dismissal damages against the purchaser or the vendor or both.

Asset Purchases

In an asset purchase, the purchaser is not required to take the vendor’s employees. However, vendors should note that the sale of a company’s assets does not provide the employer with cause for discharge and reasonable notice or severance pay and the vendor is liable for such claims (subject to an employee’s duty to mitigate).

Given this, the liabilities associated with employee terminations are often the subject of extensive negotiations between the purchaser and vendor. To minimize its liability, the vendor typically will want the purchaser to hire its entire workforce and on the same terms and conditions, rather than choosing only select employees. If the purchaser does not wish to retain all of the vendor’s employees, the parties will negotiate so to apportion liability for termination costs.

Prior to closing, a purchaser will typically review the employees and the terms of their employment and make a determination about which employees it wishes to keep. To minimize termination liabilities, the vendor will want the purchaser to extend offers of employment on substantially the same terms and conditions. However, a purchaser may opt to provide a covenant for employment offers on terms that are “no less favourable in the aggregate than the terms the employee has with the vendor”.

Alternatively, the purchaser and vendor may agree that the purchaser will offer employment to all employees upon closing but that the purchaser will have a period of time following closing to operate the business and assess which employees it desires. If there are any employees that the purchaser does not wish to retain, the purchaser will dismiss those employees within the stipulated time frame and, unless the parties agree otherwise, will be legally responsible for any employee claims. For protection, the purchaser may seek to include a term in the agreement of purchase and sale that the vendor will indemnify the purchaser for certain costs associated with such termination(s). While this does not remove the obligation for payment from the purchaser as employer, the purchaser is able to seek reimbursement from the vendor.

The purchaser should be aware that section 9 of the Employment Standards Act, 2000 (“ESA”) holds that if the purchaser employs an employee of the vendor, the benefits that are contingent on an employee’s length of service, such as vacation, notice of or pay in lieu of termination and severance pay, are carried over to the employee’s employment with the purchaser. In other words, the ESA makes a purchaser presumptively liable for an employee’s full length of service with both the vendor and purchaser. This is sometimes referred to as the “successor employer doctrine”, which aims to prevent unfair outcomes for employees in asset transactions.

Successor employer rules apply if the purchaser acquires and continues to operate the vendor’s business as a “going concern”. Determining whether the assets and the workforce hired amount to a “going concern” is a factual analysis. The courts have considered a variety of factors such as: (i) Whether the assets were part of a functioning business prior to the transaction, (ii) whether the purchaser hired the vendor’s employees, (iii) whether the vendor’s employees continue working on substantially the same terms and conditions, (iv) whether the business activities continue uninterrupted after the transaction, (vi) whether the purchaser continues to operate the same type of business as the vendor, and (v) whether the business remained in the same location.

In certain circumstances, an employee may be hesitant to sign a new employment agreement with the purchaser. However, in most cases an employee who rejects an offer of employment from the purchaser will be deemed to have not mitigated their claim for damages and is unlikely to have a claim for substantial damages against the vendor. This issue gets more complicated where the purchaser extends employment on different terms than what was previously agreed upon with the vendor. For example, where a new offer of employment involves a reduction in pay or benefits, the employee should accept the position as part of their duty to mitigate, but may then bring a claim against the vendor for damages. Note that any income earned from the purchaser during the period of notice will be deducted from the employee’s damages. That being said, where the purchaser’s terms of employment constitute a demotion from the employee’s previous position with the vendor, the employee may not be required to accept that position as part of their duty to mitigate since employees are only required to use reasonable efforts to seek comparable employment.

Conclusion

When negotiating the agreement of purchase and sale of a business, the vendor and the purchaser must consider the complex legal issues that can arise in the employment law context. Both parties will want to fully negotiate strategic terms that will limit their employment-related liabilities and provide for a smooth transition of the business, no matter whether an asset or share transaction.