Don't Forget About the Employees during an Asset Sale

When buying or selling a business in Ontario, it is critical to consider the employment law implications of the transaction. During any business acquisition, lawyers routinely advise clients on the relevant legal, tax, and business considerations. But too often this excludes timely, comprehensive thought about the employees affected by the transaction. This oversight can be costly.

Early in their negotiations, vendors and purchasers need to be alive to the costs of employee entitlements and which party will be responsible for those costs. Infamous costs include termination pay and severance. But calculating these can depend on complicated interactions between statute, contract, and common law. And all the while, there are other liabilities that may be more costly to the transaction—or even fatal—such as whether key employees are bound by enforceable non-solicitation and non-competition clauses. No one wants to buy a business (or sell one subject to a large performance-related holdback) only to have all the key employees quit, solicit the business’s customers, and start a competing business.

We review the critical considerations and the employment law related risks and liabilities that arise in the context of an asset transaction

The Differences between a Share Purchase and an Asset Purchase

In Ontario, the rules governing the obligations to employees on the sale of a business largely stem from the Employment Standards Act, 2000 (the “ESA”), the Agreement of Purchase and Sale, any existing employment contracts and the common law (laws determined by judges and the Courts).

Share Purchase

In a share purchase, because the corporate employer is unchanged, there will be no change in the obligations and liabilities attached to the business, including obligations to employees. If an employee is terminated as part of the share purchase transaction, termination obligations will remain with the business acquired, except to the extent these obligations are assumed and satisfied by the vendor pursuant to the Agreement of Purchase and Sale. Indemnity provisions are a matter for negotiation between the vendor and purchaser.

In Ontario, termination pay cannot be less than the amount specified in the Act. If termination pay is not limited by contract, the courts may determine the termination pay owing to an employee based on the common law requirement of reasonable notice of termination or pay in lieu of reasonable notice. Courts typically award far higher amounts of termination pay than the minimum amount set out in the Act.

Asset Purchase

In an asset sale, a purchaser can choose which assets (and liabilities) it wants to assume. If a set of assets constitutes a “going concern” and the vendor transfers them to the purchaser, the employer’s identity changes from the vendor to the purchaser. By contrast, in a share purchase, ownership of the business transfers, but the corporate identity, and so that of the employer, stays the same.

For employment law, this change in the employer’s identity is key. The change in an asset sales triggers key considerations that come with various liabilities. The question of which party is responsible for these liabilities ultimately revolves around who bears responsibility for the vendor’s former employees.

Subject to the Agreement of Purchase and Sale, in an asset purchase the purchaser can choose whether or not to offer employment to some or all of the vendor’s employees. Purchasers should be aware that if an employer sells a business and the purchaser employs an employee of the vendor employer, the employment of the employee would be deemed to be continuous for the purposes of the Act.

This means that if a transaction is considered a ‘sale of a business’ under the Act, that the purchaser inherits the prior service of the employee. Depending on the employee’s length of service, this may significantly increase termination pay entitlements of the employee.

It is not always a given that an asset purchase qualifies as a ‘sale of a business’. Some key factors in determining if a sale of a business took place includes analyzing: the value of the assets sold as a percentage of the business; whether the purchaser continues the same type of operation as the vendor; and whether the purchaser continues at the same location as the vendor.

Terminations, Offers of Re-employment, and Potential Liabilities

Employment contracts cannot unilaterally be assigned to a new employer. A vendor cannot simply order its employees to keep working for the purchaser.

As a result, either the vendor needs to terminate its employees and pay all related entitlements, or the purchaser needs to negotiate an offer of continued employment with the employee, and the employee needs to accept it. Note that where an employee accepts an offer of continued employment, the common law, and the ESA deem the purchaser the “successor” employer, liable to the employee for all employment-related entitlements. A successor employer effectively assumes these liabilities from the vendor. While properly crafted offers can waive the common law entitlements—or place those liabilities with the vendor—the ESA entitlements are obligatory. 

Thus, the central question becomes which party will bear responsibility for accrued and future employment liabilities. Vendors will generally want the purchaser to hire all its employees and assume the associated liabilities. Purchasers will generally want the vendor to pay severance, wipe all liabilities off the books, and limit the future entitlements of any employees that they rehire.

As employment liabilities can be costly, the vendor and purchaser should openly negotiate how they will share them. It is essential to settle these matters early in the negotiation process—preferably when the parties are negotiating the letter of intent (“LOI”). Although the terms of an LOI can change in later phases of the purchase and sale, it will be hard to insert such costly terms at the end of the negotiation.

For those interested, the last section of this article provides more detailed explanations for some of the key liabilities that may arise in the above negotiations.

How do you address these liabilities?

To fully address the employment liabilities cautioned above, the information underpinning them should be acquired as early as the due diligence stage. This disclosure permits the parties to negotiate how they will share the costs.

Step 1: Understand the extent and scope of the liability of the key liabilities:

• How many employees are there?
• What is their age, their position, and the nature of their role?
• How many years of service do they have?
• Do they have enforceable employment contracts?
• What are the terms of their employment, whether in their contracts or at common law?
• What are their estimated severance entitlements at common law, under their contracts, and per the relevant legislation?
• Are there any “key” employees whose skills or knowledge are essential to the business being bought?
• Have those key employees been made aware of the transaction, and are they interested in continuing with the new employer? If so, under what conditions?
• Are the key employees subject to enforceable non-solicitation or non-competition agreements? If not, will losing them undermine the value of the transaction?

Step 2: Once the scope of liabilities is determined, the parties need to work cooperatively to answer two determine which employees will or will not receive an offer of continued employment from the purchaser?

Terminating Employees / Not Offering Continued Employment

For employees that will not receive offers of continued employment from the purchaser, the parties need to arrange for their termination and appropriate notice and/or termination payment. In these cases, key considerations include:

• Whether the employees will receive working notice of the termination or pay-in-lieu of working notice. The length of the notice and the amount of pay-in-lieu largely depends on the terms of an employee’s written contract, and the employees age, seniority, nature of their role and the availability of alternative comparable employment. In some cases, if an older employee has substantial tenure and no employment contract limiting their common law rights, that employee could be entitled to up to 24 months of notice or pay-in-lieu.
• How to minimize the negative impacts of a mass termination. Mass terminations can be a blow to morale for the employees who are staying on. They can also impact goodwill. In the situations, thought should be given to how the terminations will be messaged. For example, key employees who are not being terminated should be reassured that their positions are secured.
• Whether any of the employees receiving accommodations under human rights legislation or are otherwise on a protected leave of absence from their work (e.g., medical leave, parental leave, and so on). In some cases, the law may prohibit the vendor from terminating these employees. Depending on the situation, such actions may even constitute discrimination, which could give rise to unique liabilities.

If an employee is not offered employment, the vendor will be liable for termination pay owing unless reasonable notice of termination has been provided. For this reason, vendors negotiate for the inclusion of a term in the Agreement of Purchase and Sale requiring the purchaser to offer employment to all employees on substantially similar terms and conditions.

If a purchaser knows that it will not hire certain employees, it will want an indemnity or some allocation of costs for termination from the vendor.

If the employee refuses an offer of employment by the purchaser and the term and conditions of the offer were substantially similar to those provided by the vendor, the employee would likely have no common law claim for termination pay against the vendor or the purchaser. This is because the employee will likely be deemed to have failed to mitigate his or her damages by accepting alternative employment. However, the employee will still be owed his or her minimum termination pay under the Act.

Offering Continued Employment with the Purchaser

When a purchaser decides to hire one of the vendor’s employees, the key consideration is whether they will do so on the existing terms or implement new ones. In some cases, the existing terms may be adequate, and no action will be needed. But in most cases, the purchaser will want new terms of employment, for example, by changing the location of work, limiting entitlement to notice of termination, or imposing more useful non-solicitation and non-competition clauses.

The issue is that imposing unilateral changes to the fundamental terms of a contract may give rise to a “constructive dismissal”. In the face of a unilateral change, employees may quit rather than accept the change. In these cases, though the employee quit, they can sue for damages—the employer is seen as rejecting the existing employment relationship, and thus terminating the employee.

Triggering a constructive dismissal is a common pitfall, but there are at least three ways to avoid it: offering a signing bonus, providing notice of the change, or negotiating an assessment period.

Option 1: Signing Bonus

The first approach that vendors and purchasers can employ to avoid the risk that the employee will sue one or both for constructive dismissal, is to obtain the employee’s consent to the changes through a signing bonus. Consent from the employee to keep working on the new terms is not enough—they are technically not getting anything “fresh” from the bargain and so it is not a valid contract—there is no “consideration”. Usually, the “fresh” consideration for new terms will be a signing bonus. This will be a new benefit that secure the new terms. A signing bonus also has the added value of enticing the employee to accept employment.

Option 2: Working Notice of Change

The second option for the purchaser is to negotiate with the vendor to give the employee notice of the transaction and thus the change of terms, such that they are effectively being given working notice of their termination. This satisfies the duty to provide notice. While this approach costs less in the short term, it may be less desirable overall, as it depends on properly gauging the notice period, having enough time before the transaction to give the notice, and may will almost invariably cause friction in the workplace.

Option 3: Assessment Period and Negotiation of Liability between Vendor and Purchaser.

A final potential option for the vendor and purchaser is to negotiate an assessment period, during which the purchaser will assess the employee’s suitability for the role. If the purchase decides not to employ the person, they would then be liable for such things as severance and termination pay. The parties may negotiate holdbacks or other terms to account for these risks.  

General Employment Law Considerations

Ending an employment relationship can be costly for any employer. When asset sales force these costs to the fore, the liabilities multiply, and it can be fatal to forget the employees. Both vendor and purchaser should address these risks as early as possible. Engaging corporate and employment lawyers who know these risks during the due diligence stage is crucial to mitigate these risks by ensuring the agreement fully addresses them.

As part of the due diligence process, a purchaser should consider the following items early in negotiations:

• What employees, if any, will the purchaser wish to retain? Are there enforceable employment contracts in place and if so what are the terms of employment? It is prudent  to gather a full list of all employees with their compensation, job title, length of service  and status clearly outlined.
• What party will bear the costs of termination of any employees? This will largely depend on whether the transaction is a share or an asset purchase. This issue can have a major financial impact.
• Is there any accrued and unpaid vacation pay owed by the vendor to the employees? Will this be adjusted on closing?
• Are there any outstanding employment liabilities of the vendor? This would require investigating if there are claims under various statutes such as the Pay Equity Act, the Occupational Health and Safety Act, the ESA and the Workplace Safety and Insurance Act, 1997.
• Purchasing a business is a complex transaction. This article has only addressed some of the issues that need to be taken into consideration from an employment perspective. When considering selling or purchasing a business in Ontario, we recommend engaging legal counsel early in the process. This will help avoid unwanted surprises that may result in increased costs or unnecessary delay.

Key Liabilities in an Asset Sale

1. Termination Notice and Severance. In Ontario, employees have a right to notice of termination and, if applicable, severance pay, under the ESA. With no contract stating otherwise, employees are also entitled to reasonable notice of termination at common law, based on age, length of service, seniority of the position, and the availability of comparable employment.
2. Statutory Entitlements. Under Ontario’s employment statutes, employees are entitled to various benefits, including vacation pay and job-protected leaves. An employee who continues their employment with a successor employer can expect to receive these entitlements. This means vacation pay and time will depend on the employee’s tenure with the vendor. It also means any employee on leave at the time of the transaction can expect to return to the position they had at the time of their leave, or a comparable one. Similar considerations will apply for those on leaves related to a protected ground under the Human Rights Code (“Code”), such as a disability or family status.
3. Statutory Obligations and Violations. Ontario has several statutes that create obligations and liabilities for employers if breached. These include the ESA, the Code, the Pay Equity Act, the Workplace Safety and Insurance Act, 1997, the Occupational Health and Safety Act (“OHSA”), and the Pension Benefits Act. Obligations under these statutes include the need to establish committees, accommodation plans, and workplace policies. Violations could lead to orders against the employer, which may continue against the purchaser. And many of these can, in turn, create personal liability for directors and officers for employment-related debts and judgments. Purchasers want to ensure that any policies and procedures its adopting from a vendor comply with Ontario Law.
4. “Key” employees. These employees are part of the “know-how” of the business. They understand how it operates, represent the company’s goodwill, or control the books of business that make the operation possible. Purchasers should be especially cautious of key employees. For example, suppose the key employees do not accept new employment. This can damage the purchaser by devaluing the business or working for a competitor.
5. Employment Contracts. On top of various statutory or common law entitlements, each employee’s contract may contain different rights and obligations unique to that employee. For many purchasers, employee contracts will have terms affecting the most critical aspects of the existing employment liabilities. They may modify obligations around confidentiality, intellectual property, non-solicitation, and non-competition. They are therefore vital to review for any employee, but especially key employees. Contracts may also contain terms modifying common law entitlements such as reasonable notice or compensation rights to bonuses and shares.

Special Thanks to my Co-Authors William McLennan, Alexander Levy, Alessandro Perri and Houser Henry & Syron LLP