Buying a Business

This post will explore some of the employment law issues that should be considered if you’re purchasing a business.  Employment law-related factors to review when selling or closing your business were covered in Part I.

This post focuses on businesses with non-unionized workforces.  Unionized workplaces have their own distinct issues that must be addressed when purchasing a business and a lawyer should be consulted regarding those as well.

Strong entrepreneurial spirits truly are critical components of any healthy economy.  Many people dream of being their own boss – directing the growth of a company and taking an active role in their own future prosperity while providing a product or service that they are passionate about.  Purchasing a business with an established business model and customer base can be a great way to give yourself a head start on these goals, but it’s essential to consider all of your possible risks and liabilities when doing so.  Completing a fulsome review of your potential employment law risks as part of your due diligence is the best first step to protecting your investment.  You can’t know what other actions will be helpful without taking this initial step. 

Termination Obligations

Unfortunately, possible employment law liabilities are often overlooked in this investigative phase.  Certainly, key information about employees (including wages) is disclosed, but an employer’s risk with employees goes far beyond regular payroll costs – especially if you may need to restructure your workforce after taking over.  Let’s be honest, this is common.  Employees inherited in a purchase can be incredible assets with a wealth of institutional memory, but it’s also entirely possible that the reverse may be true, or that the business may be overstaffed.  Perhaps unsurprisingly, new owners often find themselves contending with at least one or two employees in entrenched positions who are less than receptive to change.  Inaction on the part of management in this scenario isn’t desirable.  A new owner can’t bring their vision for the company to fruition without the right people in the right positions, so terminating some employees may be absolutely necessary.  New owners are often shocked to learn just how much terminating employees may cost them.

Employers have statutory obligations to employees on terminations.  Each province has its own regime (and some employees are regulated federally), but in Ontario, an employer can owe an employee up to eight weeks’ termination notice and up to twenty-six weeks’ severance pay as required by the Employment Standards Act.  These statutory entitlements are only the minimum that may be owed and, unless properly excluded by contract, an employee will also have a common law entitlement to reasonable notice.  This common law entitlement is inclusive of statutory amounts, but it can be much greater – with the commonly imposed soft cap for reasonable notice being two years.  It happens too frequently that we speak to employers who’ve restructured after purchasing a business with an eye towards reining in costs, only to find out that for each set of wages they’ve eliminated, they now have an employee immediately demanding months or years of pay.  You probably had a business plan and operating budget for your takeover.  This is not the type of surprise you want.

Share Purchase vs. Asset Purchase

How a business is purchased will have a major impact on the scope of the possible employment law risks.  A share purchase occurs when a purchaser acquires a controlling interest in the shares of a company.  In this scenario, all employees of the company will continue to be employees from one day to the next.  Although there has been a change in ownership, the contractual relationship for the employee is with the corporation – and it won’t have changed in the slightest just because of the change in ownership.  Those contractual relationships are inherited by the purchaser, so it’s important to know exactly what you’re getting.  Do employees have written employment agreements?  When were they last updated?  Do they limit employer obligations on termination?  Are the clauses that purport to do so enforceable?  Are there any current employees on a leave or past employees in litigation against the company? These are all questions that your employment lawyer can help you with so that you understand your risks and can properly seek to limit them as part of your purchase plan.

The potential contractual risks associated with inherited agreements (employment and otherwise) often influence a purchaser to pursue an asset purchase over a share purchase.  In an asset purchase, some, but not all, parts of a vendor’s company will be acquired.  This leaves the employment liabilities as the responsibility of the vendor.  While this can be a great way to avoid inheriting employment relationships you may not want, most purchasers need to retain some of the vendor’s employees.  Don’t just assume that entering into fresh agreements with employees of the vendor’s company will allow you to avoid these employment law risks as the successor employer doctrine can apply.

Successor Employers

The successor employer doctrine is intended to protect an employee from losing the benefit of their accumulated service due to a change in ownership that is out of their control.  Under the common law, when employment has changed as a result of a sale, service with the former employer will be recognized for the purpose of calculating entitlement to reasonable notice damages.  There are ways to contractually exclude this obligation and your employment lawyer can help you do so.

All minimum standards statutes in Canada also have some form of deemed continuous employment provision which acts to ensure there is no break in service from the old company to the new one when calculating various employee entitlements on terminations (as well as leave and vacation entitlements, among other things).  In short, an asset purchase is not a silver bullet for removing employment law risks on a business purchase.

If the target business is unionized, buyers will need to be particularly vigilant around inheriting liabilities. Labour relations legislation will typically deem all buyers to be the successor employer, whether a share or asset purchase.

Strategies for Minimizing Risk

There’s little doubt that employment law in Canada is employee friendly.  There are, however, a significant number of strategies that can be utilised to allow a prospective business purchaser to have far greater certainty about the employment relationships they’re entering.  Greater certainty equates to less risk.

Completing a review of the vendor’s employees and employment agreements (or lack thereof) will allow you to better assess the risks that you want or don’t want to incur.  A common result is that the purchaser will require the vendor to terminate specific employees in advance of closing and to remain responsible for the full cost of those terminations.

Purchasers with leverage in the deal may also be able to negotiate a split cost arrangement for employees who may need to be terminated within a short period of time post-closing.  The purchaser may have been convinced of the value of certain higher-risk employees by the outgoing vendor.  A split cost arrangement will require the vendor to put their money where their mouth is in that they’ll incur financial risk on the basis that they don’t expect that the purchaser will need or want to terminate certain employees.  As an example, the vendor and purchaser may enter into a deal whereby each would have to pay 50% of the termination costs (including legal fees) if the purchaser decides to terminate a certain employee within the first year of their control of the business.  These types of deals are not vendor-friendly and can be very tough to negotiate into a deal, but they can provide a lot of peace of mind for a purchaser who may otherwise be incurring substantial employment law risks.

New employment contracts can and likely should be prepared for the purchaser.  Don’t wait for a nasty surprise!

If you are purchasing a business be sure to ask your corporate lawyer if they’ve engaged an employment lawyer to complete a full review of the potential employment law liabilities.  If they haven’t, get in touch ASAP!