In this article, we will explore the key legal considerations when terminating a business before its sale. These include compliance with contractual obligations, shareholder agreements, employee rights, intellectual property protection, and adherence to local laws. Properly addressing these areas in Ontario context can help avoid legal penalties and ensure a smooth transition.
A Collaboration between Trudy Seeger (part 1-3, 5-6) and Tony Wong (part 4, 7)
Terminating a business before its sale is a complex decision that carries a range of legal implications. Whether the termination is planned as part of a strategic exit or driven by unforeseen circumstances, it’s essential to navigate the process with a clear understanding of the legal obligations involved. Mishandling the closure can lead to disputes, financial liabilities, and long-term legal repercussions.
Topics Will be Covered in This Post:
1. Contractual Obligations
Contracts are the lifeblood of any business, and terminating operations before a sale can impact various parties with whom the business has legal agreements. It is critical to carefully review all contractual obligations, such as:
Vendor and supplier contracts: The business may have agreements for the delivery of goods or services. Early termination could result in penalties, breach of contract claims, or fees for unfulfilled obligations.
Customer contracts: Service-based businesses, in particular, may have outstanding customer contracts. These must be settled according to their terms, whether by completing existing obligations or reaching mutually acceptable settlements.
Leases: If the business leases commercial property, ending operations early could breach the lease. Many leases have exit clauses that specify the consequences of terminating early, which may involve paying out the remainder of the lease term.
Loan or debt agreements: Businesses that have taken on debt may face challenges in settling loans early, and some agreements may include specific clauses that activate upon closure.
Before terminating the business, it’s advisable to consult legal counsel to ensure all contracts are reviewed and to negotiate settlements or amendments if necessary.
2. Shareholder Agreements
For companies with multiple owners or investors, shareholder agreements (or partnership agreements) play a critical role in determining how the termination and potential sale of assets should proceed. Shareholder agreements typically outline:
Rights of first refusal: These clauses may require that shares or business assets be offered to existing shareholders before they can be sold to external parties.
Exit strategies: Shareholder agreements often include provisions for business termination, such as how assets will be divided, how debts will be settled, and who will oversee the process.
Voting requirements: Terminating a business before sale may require shareholder approval, typically through a vote. It's essential to adhere to the voting procedures outlined in the shareholder agreement, including any required thresholds for approval.
Ignoring or misinterpreting shareholder agreements can result in disputes, litigation, and potential liabilities for company directors or officers.
3. Employee Rights
Terminating a business before sale has significant implications for employees, and it’s important to handle their rights with care. Depending on the jurisdiction, employees may have certain protections in the event of business closure, including:
Notice periods: In many countries, employers are required to give advance notice before terminating employment. The WARN Act in the U.S., for example, mandates that businesses with more than 100 employees provide 60 days' notice before mass layoffs or closures.
Severance pay: Some employees may be entitled to severance packages, particularly if their employment contracts stipulate such payments upon termination.
Pension and benefits: It's important to ensure that employees receive any accrued benefits, such as retirement contributions or unused vacation time, according to employment laws and contracts.
Unemployment compensation: In many jurisdictions, employees laid off due to business closure are eligible for unemployment benefits. Employers may be required to facilitate or provide documentation to assist former employees in applying for these benefits.
Office furniture: During the closure process, businesses may liquidate assets such as office furniture, which can also impact employees who rely on their workspace for productivity.
Failure to properly address employee rights can result in wrongful termination lawsuits, fines, and penalties. Consulting with an employment lawyer before initiating the termination process is crucial to ensure compliance with local labor laws.
4. Additional Employment Law Considerations for Ontario Employers
For Companies in Ontario, there's some additional considerations.
Relevant Articles You May be Interested In:
A. Director Liability in Ontario
Directors may be personally liable for wrongfully terminated damages in some situations.
In Abbasbayli v. Fiera Fine Foods Company, 2021 ONCA 95, the Ontario Court of Appeal recently clarified that corporate directors may be held personally liable for unpaid wages and vacation pay in a wrongful dismissal proceeding.
Section 131 of the Ontario Business Corporations Act (OBCA) provides that directors of a corporation are personally liable for 1) six months’ wages and 2) vacation pay up to a year if:
the corporation is sued and execution is returned unsatisfied; or
the corporation is involved in certain insolvency proceedings and the employee’s claim has been proved.
Section 248 of the OBCA provides a remedy against oppression, which is conduct that is unfairly prejudicial or unfairly disregards the interests of any security holder, creditor, director, or officer of the corporation.
A Court might find that a director who attempts to avoid employment law liabilities for wrongful termination claims along with valid claims from other creditors by forming a new business with the same key workers and directors in both companies. An employee who has a valid unfair termination claim is considered to be an unsecured creditor of the former employer, who has standing to claim oppression.
B. Continuity of Employment
1. Type of Sale
When two parties enter into an agreement or contract regarding the sale of business, the type of sale decided on will dictate the employers’ obligations to the employees.
i. Share Purchase
In a share purchase, the purchaser buys all of a company’s shares and essentially steps into the shoes of the pre-existing owner. The employee’s employment continues under both the common law and the applicable employment standards legislation.
ii. Asset Purchase
In an asset purchase, unlike share purchase, the purchaser to the sale DOES NOT have to retain all of the seller’s employees. The employees not retained by the purchaser is deemed to be terminated by the seller.
2. Continued Employment under Provincial Legislations and Common Law
For those in a Unionized workplace, the collective agreement will remain in effect after a change of ownership regardless whether it's a share purchase or an asset purchase.
i. Statutory Considerations Under Employment Standards Act
For those in a Non-Unionized workplace, the continuity of employment provisions in Part IV of the Employment Standards Act dictates that where there is a sale of a business and 1) an employee of the seller is hired by the purchaser, or 2) where there has been a change of contractors for building services and an employee of the replaced provider is employed by the new provider, the employee’s length or period of employment with their previous employer is treated as if it had been employment with the new employer concerning rights under the Employment Standards Act, that are determined by length or period of employment, i.e., vacation, pregnancy, and parental leave, domestic or sexual violence leave, critical illness leave, crime-related child disappearance leave, child death leave, notice of termination or pay in lieu, severance pay, organ donor leave and reservist leave.
Section 9(1) of the Employment Standards Act provides for continuity of employment for an employee when there is a sale of a business if the purchaser employs an employee of the seller.
In the case of a sale of a business where an employee terminated by the seller is not hired by the purchaser within the 13-week period set out in s. 9(2), the seller must provide termination pay, and severance pay, where applicable, to the employee.
Where a purchaser does employ the seller’s employees following a sale in accordance with s. 9 but later terminates their employment, there is no pro rata division of liability for termination pay and severance pay between the seller and purchaser. However, the purchaser may be able to sue the seller civilly.
It is important to note that s. 9 of the ESA:
Does not obligate the purchaser of the business to hire the seller’s employees; and
Allows the employee to reject an offer of employment from the purchaser and to instead treat the sale of the business as a termination by the seller.
The purchaser is not obligated to hire the seller’s employees whether they are currently working, on lay-off, sick leave, a leave of absence or workers' compensation.
The employee is under no obligation under the ESA to accept employment with the purchaser and their refusal does not disentitle them to termination notice, or pay in lieu or severance pay. This is so even if the purchaser is offering the same terms of employment or reasonable alternative employment.
ii. Practical Examples Under S. 9 of the ESA
Example 1:
John worked in Company A for 10 years. A sale of business happened, and John continued to work for the new owner, Company B, for 1 year before being terminated. John is deemed to have worked for Company B for 11 years for the purpose of computing termination pay, severance pay, vacation pay, etc., under the ESA.
Example 2:
Mary worked in Company A, a property management company for Building B, for 10 years as a live-in superintendent. Company C was then awarded the new property management contract for Building B, and Mary continued to work for Company C as a live-in superintendent for Building B for 1 year before being terminated. Mary is deemed to have worked for Company C for 11 years for the purpose of computing termination pay, severance pay, vacation pay, etc., under the ESA.
Example 3:
James worked for Ashley in Company A for 10 years, and he was terminated before the sale of business. 10 weeks later, James was hired by Tom, the purchaser who acquired the assets of Company A. One year after being employed by Tom, James was terminated. Since 10 weeks is less than the 13 weeks gap under Section 9(2) of the ESA, James is deemed to have worked for Tom for 11 years for the purpose of computing termination pay, severance pay, vacation pay, etc... under the ESA.
Please note that under ESA, there's no duty to mitigate, nor there's any provision allowing deduction of amount pay by Ashley to James at the time of termination. Tom, however, may be able to sue the seller, Ashley, civilly, as long as Ashley has a contractual obligation to reimburse Tom, and the statutory limit to sue hasn't expired.
Click here to contact HTW Law - Employment Lawyer for assistance and legal consultation.
iii. Considerations Under Common Law
1. Contractual Obligations
It sometimes happens that the sale contract between the seller and the purchaser will contain a provision obligating the purchaser to offer employment to some or all of the seller’s employees.
However, if the seller, relying on the contract, does not provide notice of termination to its employees but the purchaser does not end up making an offer after all, it is the seller who is responsible for the termination pay and severance pay, since it is the one who terminated and severed its employees' employment. There is no basis in the ESA for holding the purchaser liable, despite what was in the sale contract, although the seller may be able to sue the purchaser civilly for breach of contract.
2. Successor Employer
When the employment contract contains no enforceable termination provisions, an employee has the option of suing under common law for wrongful dismissal and requesting reasonable notice instead of collecting termination money, vacation pay, and severance pay, if applicable, under ESA.
Similar to Part IV of the ESA, under common law, while determining reasonable notice of termination, the Court frequently considers an employee's experience obtained while working for the former owner.
For instance, in Manthadi v. ASCO Manufacturing, 2020 ONCA 485, the Court of Appeal considered the common law of successor employment, analogous to Part IV of the ESA as stated above. The Court of Appeal decided that the full length of employment (across successive employers) should be considered in determining the applicable notice period.
3. Duty to Mitigate
Unlike Part IV of the ESA, there's a duty to mitigate under the Common law.
If an employee sues for wrongful dismissal and seeks reasonable notice for termination instead of receiving termination pay and severance pay under the ESA, and the employee failed to accept a job with the same terms of employment or a comparable position reasonably analogous to the employee's previous position, there might be a reduction of damages due to failure in making reasonable and diligent effort to mitigate the damage.
5. Intellectual Property Protection
When terminating a business before sale, protecting intellectual property (IP) is a priority, as IP assets may still hold significant value, even if the business is winding down. The following steps can help protect IP during and after termination:
Assess ownership and transferability: Ensure that all IP assets, such as patents, trademarks, copyrights, and trade secrets, are properly documented and owned by the business. If a sale of these assets is anticipated, confirm that they are transferable to a new owner without restrictions.
Renew IP registrations: Before terminating the business, renew any expiring patents, trademarks, or copyrights to maintain their protection. This ensures that the IP remains enforceable, whether sold or retained by the business owners.
Non-disclosure agreements (NDAs): If employees, contractors, or third parties have access to confidential information or trade secrets, it’s essential to review existing NDAs. Ensure that all sensitive business information remains protected even after the business is dissolved.
Sale or licensing of IP: If a buyer is not found for the business as a whole, consider selling or licensing individual IP assets to generate additional value. Ensure that any sale agreements are properly drafted to avoid future disputes over ownership.
Neglecting intellectual property considerations can lead to the loss of valuable assets, weakening your legal position in the event of a sale.
6. Compliance with Local Laws and Regulations
Terminating a business is governed by a variety of local, state, and national laws, depending on the jurisdiction. Some key areas to address include:
Dissolution filings: Businesses are often required to file formal dissolution paperwork with the appropriate government authorities to legally terminate the entity. This typically involves submitting final tax returns, paying any outstanding taxes or fees, and filing articles of dissolution.
Tax obligations: Ensure that all tax obligations, including payroll taxes, sales taxes, and corporate taxes, are settled before the business is dissolved. This includes filing a final tax return that reflects the business's termination.
Licenses and permits: Any business licenses or permits should be canceled or transferred, and any fees associated with those licenses should be paid. Failure to do so can result in fines or penalties.
Environmental and regulatory compliance: If your business operates in a heavily regulated industry (e.g., healthcare, manufacturing, or finance), ensure that you meet all regulatory obligations before closure. This includes managing hazardous materials, closing any ongoing investigations, and ensuring proper record retention.
Compliance with local laws can help avoid future legal challenges, including claims from creditors, employees, or government agencies.
7. Conclusion
Terminating a business before a sale is a complex process that requires careful attention to legal, financial, and operational matters. Properly addressing contractual obligations, following shareholder agreements, respecting employee rights, protecting intellectual property, and adhering to local laws are all crucial steps to ensure compliance and avoid legal penalties. By working closely with legal and financial advisors, business owners can navigate these challenges effectively, safeguarding valuable assets and setting the stage for a smooth transition. It's also important to maintain effective communication tools during the process, such as office whiteboards, to ensure all stakeholders are aligned and informed throughout the termination.
You may want to consult with an experienced employment law firm, such as HTW Law, to learn about the DO and Don't in employment law context to ensure that all angles are covered as an employer.
On the other hands, as an employee you MUST be made aware of your legal entitlements in a sale of business / change of business ownership context to safeguard your employment rights.
Speaking with an employment lawyer who understands the nuances of employment law in Ontario in light of a change of ownership will go a long way. If you are in doubt, it's essential that you reach out for help as soon as possible right away.
Click here to contact HTW Law - Employment Lawyer for assistance and legal consultation.
Author Bio:
Trudy Seeger is a seasoned freelance content writer with extensive experience in crafting insightful articles for prominent legal blogs and websites. He specializes in creating content that simplifies complex legal topics, ranging from personal injury and employment law to contract disputes and intellectual property. With a keen focus on how legal developments impact businesses and individuals, Trudy has a proven track record of delivering well-researched, engaging, and informative legal content.
Staff Writer - Tony Wong