Payroll costs are typically among the most significant expenses of most businesses. Employees who have provided service to a business for a substantial period of time often represent a store of experience and a degree of loyalty that is difficult to replace. However, past service also represents a potentially large future liability in termination and severance costs if it is necessary to bring the employment relationship to an end. Careful planning and good negotiating strategies will help the purchaser of a business strike the right balance to achieve its business objectives.

When Purchasing Assets…

From the purchaser’s perspective, one of the advantages of structuring an acquisition as an asset purchase, rather than a share purchase, is its ability to easily focus negotiations on which employees of the vendor it wishes to retain in the purchased business. Unlike a share purchase, where the purchaser acquires the entire business of the target corporation, including all of its employee relationships, the purchaser in an asset purchase transaction has the opportunity, subject to negotiation, to “handpick” the employees that it wishes to retain in the purchased business. However, it is not entirely a “free throw” for the purchaser, because excluding employees from the transaction will normally increase the vendor’s liabilities and affect the vendor’s valuation of the deal, either explicitly or implicitly.

In a carefully written asset purchase agreement, the purchaser should have no liability to the employees it chooses not to retain, and those employees can only look to the vendor for compensation relating to the termination of their employment. The careful purchaser and its legal counsel will require that, no later than immediately prior to the closing, the vendor terminate and pay all termination and severance pay, plus all common law entitlements, to those employees of the purchased business which the purchaser does not intend to retain.

Purchasers who decide to assume some, or all, employees after the closing should be aware of Section 9 of the Employment Standards Act (Ontario) which states:

“If an employer sells a business or a part of a business and the purchaser employs an employee of the seller, the employment of the employee shall be deemed not to have been terminated or severed for the purposes of this Act and his or her employment with the seller shall be deemed to have been employment with the purchaser for the purpose of any subsequent calculation of the employee’s length or period of employment.”

In other words, if the purchaser retains an employee of the vendor at the closing of the transaction, all prior time spent by the employee with the vendor will be deemed to be time spent in the employment of the purchaser for the purposes of calculating the severance, termination  and common law obligations of the purchaser. This can have the effect of creating some potentially onerous obligations for the purchaser, especially in connection with those employees who were employed in the purchased business by the vendor for a significant period of time.

There is a common yet mistaken, belief that if the vender terminates the employees and pays their required termination and severance to the date of closing, the purchaser can essentially “reset” the employees’ length of service and treat them as new hires with no past service. However, Section 9 above “deems” the employee’s employment not to have been terminated or severed for the purposes of the Employment Standards Act (Ontario), so this strategy will not be successful.

Consequently, the purchaser must carefully consider which employees it wishes to employ in the purchased business after the tranaction is complete, bearing in mind the potential impact on the purchase price.  If the purchaser is unsure at the time of closing about retaining certain employees, it should consider negotiating a probationary period of, for example, six months to work with such employees with the provision that vendor will be responsible for all termination and severance costs related to those employees not retained by the vendor after the probationary period. Although these types of clauses are difficult to negotiate, the possibility should not be overlooked.

When Purchasing Shares…

For tax reasons, individual vendors of private companies in Canada will often insist on a share sale. Share transactions are significantly more complex for purchasers, and the treatment of the employees of the corporation is no exception, because all of the pre-closing employment relationships and legal obligations will remain with the corporation under the purchaser’s control and ownership after closing.

The purchaser can insist, in a well constructed share purchase agreement, that the vendor cause the corporation to terminate all or certain employees of the business, and obtain full and final releases from such employees. Recognizing that some employees may be unwilling to give releases in time for closing, the Purchaser has to consider accepting the vendor’s indemnity and/or negotiating a sufficient holdback of the purchase price to protect itself against claims of terminated employees.  The purchaser of shares will, if prudent and careful, be much more involved in the termination of the employees before closing and in the process taken by the vendor to settle the employees’ claims. A purchaser may even push the vendor to cause relatively generous offers of settlement to be made to the employees to minimize the number or size of potential employee claims against the Corporation.

Although the purchaser of shares can therefore achieve a result which is substantially the same as if assets had been purchased, the process tends to be more difficult to negotiate and monitor, and will usually include a significantly higher reliance on post-closing indemnities from the vendor.

Other Employment Related Issues

The foregoing is but one of many employment related issues which arise in business acquisitions. Other issues include termination or continuation of benefit plans and pension plans, occupational health and safety and workers’ compensation issues, tax withholding compliance and compliance with human rights legislation, including the potential for unwittingly acquiring a business with systemic harrassment issues and compliance with duties to accommodate. These are all dealt with in well drafted purchase agreements, and should also be the subject of the purchaser’s due diligence before closing.

For more information, contact David Bleiwas or Laila Parvez by phone at (416) 368-0600 or by email at dbleiwas@businesslawyers.com or lparvez@businesslawyers.com.

© Morrison Brown Sosnovitch LLP, 2009 All rights reserved.