Buyer Beware: Liability Associated With Employees in Asset Deals

Employee Liabilities & Assets

Imagine the following scenario:  You are the owner of New Corporation Ltd.  New Corporation Ltd. is expanding, and has purchased the assets of ACME Inc.  Congratulations! 

ACME Inc. had a number of employees who all agreed to stay on with New Corporation Ltd. after the closing of the asset purchase.  Most of those employees fit in nicely with New Corporation Ltd., but some do not.  In particular, you realize one month after the transaction has closed that one of your employees, Jane, is not a good fit for New Corporation Ltd.  Jane is a 64 year old manager.  She was employed with ACME Inc. for over 35 years. 

What should you do?  Should you terminate the employee?  If you terminate the employee, what happens then?  Do you have to pay severance?  How much does New Corporation Ltd. have to pay this employee upon termination? Is this a contingency you – or your lawyer – should have carefully considered when negotiating the transaction with ACME Inc.?

A situation similar to this hypothetical was recently addressed by Ontario’s Court of Appeal in Manthadi v. Asco Manufacturing, 2020 ONCA 485.  In this decision, the Court clarified a purchaser’s potential common law liability arising from asset purchase and sale transactions. 

Employment Standards Act, 2000 Considerations

With the exception of industries that are federally regulated, in Ontario, an employee’s minimum entitlements are governed by the Employment Standards Act, 2000 (“ESA”).  Under the ESA, an employee’s length of service with the purchaser and the vendor are stitched together for the purpose of calculating these entitlements. These include the employee’s entitlements to vacation, notice of termination and termination pay, and severance pay. 

As Jane’s length of service with ACME Inc. is to be considered for ESA purposes, New Corporation Ltd. would be liable to provide Jane with 8 weeks advance written notice of termination or termination pay.  Jane would also be entitled to an additional payment known as statutory severance equivalent to 26 weeks if the employer’s annual payroll was equal or greater than $2.5 million.

The ESA only provides for an employee’s minimum entitlements.  In the absence of an enforceable and sufficiently clearly drafted termination clause in the employment contract that effectively limits an employee’s entitlements upon termination, an employee is entitled to common law reasonable notice of termination or pay in lieu of that reasonable notice. 

Common Law Considerations

In virtually all cases, an employee’s common law notice entitlement upon termination is greater (and often, considerably greater) than their minimum entitlements under the ESA.  The amount common law reasonable notice to which an employee is entitled depends on a number of factors, including the employee’s length of service, their age, their position, and the availability of similar employment having regard to the employee’s experience, training and qualifications. 

Generally, older and more experienced employees who have a significant length of service with the employer are entitled to more notice than younger employees in less senior positions who have enjoyed less service time.  In most cases, the employee’s length of service with the employer is the factor that is given the most weight in a court’s analysis of a dismissed employee’s common law notice entitlement. 

Prior to the acquisition of ACME Inc., Jane, as a senior employee who has enjoyed 35 years of service with her employer, would be entitled to a common law notice period of approximately 24 months, or the monetary equivalent of their remuneration over that notice period. 

At common law, employment contracts are not automatically assumed by the purchaser in an asset sale and purchase transaction.  The length of service with the vendor is not “stitched together” with the service of the purchaser as it is under the ESA.  At common law, the employees of the vendor are deemed to have been terminated by the vendor and a new employment contract is formed between the purchaser and the business’s employees. 

As the employee is deemed to have terminated the vendor, the vendor would be liable for the employee’s entitlement to common law notice of termination.  However, a dismissed employee has the legal duty to mitigate their losses by making reasonable efforts to secure another opportunity to maintain their income and position in the industry.  An employer will not be held liable for losses that the employee could have reasonably avoided during the notice period through their mitigation efforts.  As the Court of Appeal noted in Manthadi, the legal requirement for an employee to mitigate the damages arising from the termination of their employment puts employees like Jane who are offered the opportunity to continue their employment on substantially the same terms with the purchaser find themselves in a bind:

Long-time employees are placed in a difficult position when their employer sells the business as a going concern and the successor employer offers to employ them on an indefinite basis. The difficulty is due to the duty to mitigate. Ordinarily, long-time employees who are terminated without reasonable notice can expect a substantial payment of damages in lieu of notice. Terminated employees, however, have a duty to mitigate their damages. Employees terminated by the sale of a business often have no realistic option other than to accept the offer of a new contract of employment with the purchaser if such is offered. If they are subsequently terminated by the purchaser, the new start date of their term of service weighs in favour of a shorter notice period than had the business not been sold.

Jane had been employed for only one month before New Corporation Ltd. decided to terminate her.  This would tend to weigh in favour of a shorter common law notice period entitlement.  However, in Manthadi, the Court of Appeal clarified that length of service is only one of the factors to be considered in the analysis of an employee’s common law notice entitlement.  The value of the Jane’s experience with ACME Inc. must also be taken into consideration.  The Court of Appeal suggested that this factor will be accorded more weight in these circumstances.  Though the common law does not recognize the employee’s relationship with the vendor and purchaser in the context of an asset transaction as being continuous, the Court of Appeal also recognized that weighing an employee’s experience may ultimately result in the employee being entitled to the same common law notice period:

 The court is able to recognize, under the rubric of experience, the equivalent of all or some of an employee’s service with the vendor employer in order to arrive at a fair result.

The fair result need not devalue the employee’s past service. The notice periods awarded in [other successor employer wrongful dismissal cases] were no less than had length of service been used as the yardstick. The appropriate notice period is assessed taking into consideration all of the circumstances.

Thus, in some circumstances, the amount of common law notice to which an employee is entitled could approach, or even equal, the amount of notice they would have received if their length of service with their previous employer was recognized.  It is this liability for common law notice of termination, particularly for long-service employees, that both sellers and purchasers of businesses will wish to avoid.

Strategies to Avoid Assumption of Liability

Sellers or purchasers of businesses can seek to reduce their exposure to liability through timely and proper disclosure of the employment aspects of the business, careful consideration of the business’s relationship with its employees, the negotiation of appropriate provisions in the asset purchase and sale agreement, and proffering new employment contracts to the employees with properly drafted and enforceable termination clauses.  

At KMB Law, our Corporate/Commercial and Employment Law Groups are experienced in working together to strategically navigate employment issues arising from the purchase and sale of a business.  Should you have any questions regarding this article, or any aspect of your business, please do not hesitate to get in touch – we’re here to help.