Canada: Top 10 Issues For Employers, Issue #8: Employment Considerations In Business Transactions

This is the eighth instalment in our Top 10 Issues for Employers series, focusing on employment considerations in business transactions. Specifically, this instalment discusses key employment and labour issues that a prospective buyer (Buyer) of a business (Target) should be alert to before and after entering into a deal.

OVERVIEW

It is essential to a successful transaction that a Buyer learn all it can about its Target. This includes an understanding of the employment and labour aspects of the Target's business. Such information is key not only to completing the due diligence process (for the purpose of identifying potential employment and labour-related liabilities), but, if the deal is consummated, to prepare for the integration of the Buyer and the Target.

PRELIMINARY CONSIDERATIONS

Share Deal vs. Asset Deal

One of the very first considerations for a Buyer is whether a proposed transaction will be structured as a share deal or an asset deal. Many factors may play a role in this decision, including tax and corporate considerations. As the names suggest, in a share deal, the Buyer is purchasing the shares of the Target, while in an asset deal, the Buyer is purchasing particular Target assets. From an employment and labour perspective, the distinction is critical.

In a completed share deal, for employment purposes, the Buyer steps into the shoes of the Target. The result is that the Buyer will automatically inherit all of the Target's employment-related liabilities, unless specific carve-outs are agreed to in the share purchase agreement. It also means that while new employment agreements will not be necessary to retain current employees (their employment will transfer automatically), the Buyer will inherit the terms of the existing employment contracts.

On the other hand, in an asset deal, a Buyer is better able to pick and choose — through negotiation with the Target — which assets it is prepared to purchase and which liabilities it will leave behind. Because employment of non-union employees will not transfer automatically (outside of Quebec), it will be necessary as part of the transaction to extend offers of employment to those non-union Target employees whose services the Buyer wishes to retain.

Scope of Due Diligence

A Buyer will also need to consider what employment-related material of the Target it wishes to review. The depth of due diligence a Buyer will wish to conduct varies, but in essence, a Buyer will want to identify any material employment-related liabilities.

General areas of interest typically include, but are not limited to: (1) an employee census; (2) collective bargaining agreements; (3) employment agreements; (4) independent contractor agreements; (5) severance, retention or change of control agreements; (6) employee compensation plans; (7) employment policies; (8) status of ongoing negotiations with unions and any recent labour organizing activity, strikes or lockouts; (9) any pending or anticipated claims or actions regarding employment and labour matters; and (10) information regarding workers' compensation and occupational health and safety.

RED FLAGS

A "red flag," as the term is used here, refers to an issue which may or may not ultimately harm a deal, but should be identified, flagged and its potential implications considered. Some typical red flags include:

Collective Bargaining Agreements

Whether a share deal or an asset deal, a Buyer will generally become bound by any collective bargaining agreement belonging to the Target pursuant to the successor employer provisions of labour relations legislation. This means the Buyer will inherit the underlying terms and conditions of such collective bargaining agreement. These terms and conditions may significantly restrict how the Buyer is able to run the Target's business post-closing. The substantive terms of the collective bargaining agreement, and when it expires, will therefore be of the utmost importance to a Buyer.

Misclassification Issues

Workers whom the Target has classified (and been treating as) independent contractors, may in fact be employees at law. Misclassification can give rise to potential employment and tax liabilities; and the greater the number of misclassified individuals, the more significant the liability.

Classification of workers as employees or independent contractors can be tricky and how the contract between the parties defines their relationship is not necessarily determinative. Therefore, a Buyer should not only review the independent contractor agreements themselves, but also investigate the day-to-day interactions between the parties.

Termination Provisions

Canadian employees can have significant entitlements to termination pay and in some instances severance pay as well, if their employment is terminated without cause. These entitlements arise both under employment standards legislation and the common law (or, in the case of Quebec, civil law).

It is therefore critical that a Buyer review any termination provisions carefully (or note the absence of them) in order to have a more accurate sense of what it may be required to pay out if it decides to terminate the employment of certain Target employees post-closing.

Change-of-Control Provisions

In some cases, an employee of the Target (typically an executive) will have negotiated a special entitlement — as a provision in his or her employment agreement or a standalone agreement — in the event of a "change of control," which is typically defined to include (1) the acquisition of control over the majority of the issued and outstanding voting shares of a business or (2) the sale, transfer or other disposition of all or substantially all of the assets of a business to a third party.

Depending on how the provision is structured, a transaction (and what occurs post-closing) may very well trigger a potentially substantial payout to that employee. With a "single trigger" change-of-control provision, the employee will typically receive a payout simply because a change of control occurred. With a "double trigger" change-of-control provision, the employee will typically receive a payment over and above what he or she would normally receive following a without-cause dismissal if such dismissal occurs within a defined period of time following a change of control.

If such liabilities exist, it is important to identify and quantify them so that they can be allocated or otherwise addressed during negotiations between Buyer and Target.

Restrictive Covenants

Employees are the heart of a business and often a significant part of the Target's value that a Buyer is paying for in a transaction. A Buyer will want to ensure that certain key employees will be bound by post-termination restrictive covenants (i.e., non-solicitation and/or non-competition covenants). These covenants, however, are often difficult to enforce. A Buyer will therefore want to know if such covenants exist and understand how likely they are to be enforceable.

Pending Litigation

Individual employment claims, particularly involving senior employees, may be a source of considerable liability, as are occupational health and safety prosecutions, which carry significant fines. Even lower-value claims — if there are enough of them — can add up significantly and be evidence of recurring non-compliance with the law. A Buyer will want to be aware of all pending and anticipated employment-related claims and/or grievances against the Target.

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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.