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Severance Pay on the Purchase and Sale of a Business

Severance pay obligations to employees can be a substantial yet often overlooked obligation in the context of a purchase and sale of a business. Whether an asset sale or share sale, the vendor and purchaser must address severance pay issues before consummating a transaction. In this post, we will discuss some of the common structures that are employed in business transactions.

The manner of sale has an impact on where the obligations for severance pay reside. As such, we will start by assessing share sales vs. asset sales.

Share Transaction

When the shares of a company are sold, employees of the vendor are not terminated from their employment. The identity of the corporation does not change with the sale of shares; as such, the rights and obligations of the employer do not change unless the share purchase agreement specifically addresses these issues.

If the purchaser does not wish to take on the employees of the vendor, it must ensure in the share purchase agreement that the vendor is obligated to terminate the employment of those employees prior to sale and pay any required severance obligations. This will release the purchaser from any obligation to pay severance to employees of the company that they do not wish to keep on.

Asset Transaction

In the context of some or all of the assets of a corporation, other issues may arise. The contract of employment cannot be assigned from one employer to another. As such, upon the sale of a business, where the employment of the employee is not continued with the vendor, the contract of employment must be terminated and an employee can enter into a new contract with the purchaser. In this case, the employee relinquishes recognition of tenure or seniority with the previous employer.

If the employee declines an offer from the purchaser, they are deemed to have failed to mitigate their damages, negating a wrongful dismissal claim.

Recognizing Past Service

Where a purchaser in an asset transaction expressly recognizes the past service of the employee in its new employment contract, no issue arises. If the purchaser recognizes such service, the vendor would have no further liability.

Courts now generally presume that an employee will be credited for past service with the former employer for the purposes of calculating reasonable notice of termination unless an employment contract specifically indicates to the contrary.

How Do Purchasers Avoid Liability?

A purchaser can avoid liability for employees’ prior service and severance obligations by requiring the vendor to provide notice of termination before the purchaser hires the employees. In an agreement of purchase and sale, the purchaser should include an indemnification clause for any future termination payment for the employees, or the portion attributable to their pre-sale service.

In addition, the purchaser can advise the employee in a contract of employment that their years of service with the vendor will not be recognized.

A number of complex issues arise in the context of a purchase and sale of business specifically with respect to severance pay obligations to employees. If these matters are not sufficiently addressed, a business purchaser can be found liable for substantial obligations that were not accounted for at the time of purchase, thereby making the transaction uneconomical. Accordingly, it is important that severance pay issues are addressed prior to entering into a business purchase and sale.

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