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Employment & Labour

The cost of terminating employees when a business is sold

By Doug MacLeod

When a business is sold the cost of terminating unwanted employees can significantly impact the sale price. The purchaser does not want to pay the cost of terminating long service employees, and the seller doesn’t want to incur termination costs which reduces the net sale price.

General rules on termination pay obligation when a business is sold

1. Under the Employment Standards Act (the ESA)

A section in the ESA states that when a business is sold an employee’s service with the seller is deemed to be service with the buyer when the buyer subsequently terminates the employee. So if an employee worked five years with the seller and is terminated six months later by the buyer then the buyer owes the employee five weeks notice of termination; not one week notice.

2. At common law

Unless the buyer stipulates otherwise, an employee’s service with the seller is taken into account by the courts when determining common law reasonable notice of termination when the buyer subsequently terminates the employee.

How the seller of a business can reduce termination costs

If you are thinking of selling your business over the next two to three years then a great way to reduce termination costs is to make sure that all of your employees have signed an employment contract with an enforceable termination clause. This clause can significantly reduce your termination pay obligations for employees you are required to terminate as a condition of the sale.

Existing employees can sign an employment contract but managing this process can be very tricky. We help sellers navigate this legal and HR minefield.

How a purchaser of a business can reduce termination costs

If you are buying a business then a great way to limit liability for termination pay for the employees you inherit from the seller is to require them to sign an employment contract with an enforceable termination clause.

We help buyers prepare employment contracts for the seller’s employees that address employee benefits, vacation, termination pay and other terms of employment that are of interest to the seller’s employees. This is especially important for key employees who are critical to the continued success of the business.

Lessons to be learned:

  1. The cost of terminating long-term employees can be significant. In fact, in some cases, I have seen termination costs eat up most of the sale proceeds.
  2. To avoid this situation, termination costs can be reduced by including a termination clause in an employment contract. These contracts can significantly benefit the seller.
  3. Often one of the key challenges for the seller is convincing the buyer to take on all employees on substantially the same terms and conditions of employment. We help our clients with this issue.
  4. On the other hand, one of the key success factors in a sale of a business for the buyer is retaining certain key employees. Negotiating a “fair” employment contract with these employees can be difficult because these employees have so much bargaining power. We help our clients with this negotiation.
  5. Sellers and buyers can benefit from speaking with an employment lawyer well in advance of the sale of a business.

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