KerrLaw Logo JAMES D. L. KERR
CLIENT MEMO
TO:           Business Clients FROM:   James D.L. Kerr Lawyer
            17 – 151 Merton St.
            Toronto
, Ont., M4S 1A7
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E-mail: jkerr@kerrlaw.ca
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            Certified Specialist Civil Litigation
DATE:      April 28, 2006
updated   May 24, 2008
RE:          Estimating Employee Termination Costs on the Sale of a
                   Business


When a business is sold, it is typical that some, and occasionally all, of the employees will be terminated either by the seller before closing or by the buyer after closing. Terminated employees or, in the ordinary course, entitled to compensation. The amount of that compensation and who will bear the cost is a material consideration in many sales of businesses.

A discharged employee is normally entitled to compensation under either the Employment Standards Act (the “ESA”) (enforced by filing a claim with the Ministry of Labour) or under the common law (judge made law enforced by suing for so-called wrongful dismissal). The employee’s entitlement is quantified with reference to the amount of notice of termination the employee should have received under the applicable law ("working notice"). If the employee has not received sufficient notice, then the employer must make payment in lieu of notice.

There is a substantial disparity between the amount of notice, or lieu pay, to which an employee is entitled under the ESA vs. the common law. The ESA specifies the employee’s entitlement precisely as follows: after an initial probationary period of three months during which an employee can be terminated without notice, employees are entitled to one week of notice for each year worked to a maximum of 8 weeks; where notice has not been given, the employer must make payment to the employee of an amount equal to the wages the employee would have earned during the notice period; the ESA calls this “termination pay”. In the case of larger employers having annual payrolls of $2.5 million or more, employees with 5 years or more service are entitled to an additional payment of 1 week's pay for each year of service to a maximum of 26 weeks; the ESA calls this “severance pay”. The maximum payment any employee can receive under the ESA is 34 weeks wages.

ESA entitlements are minimum entitlements and judges are entitled, under common law contract principles, to impose higher obligations on employers. Common law obligations are typically in the range of one months' notice or pay in lieu of notice (called “wrongful dismissal damages”) for each year worked to a maximum of 24 months. This is by no means a rule of law, however, and the amount can vary depending on factors such as the age of the employee and whether or not the employee was, in the first instance, “head-hunted” into the position.

Under common law (but not under the ESA), employees have a corresponding obligation to make reasonable efforts to lessen the impact of the termination by seeking comparable alternate employment (referred to as the obligation to "mitigate"). To the extent that a terminated employee earns wages elsewhere during the notice period, that amount is deducted from the employer's obligation to make payment in lieu of notice.

The buyer and the seller of a business must decide who will bear the termination costs; this is usually dealt with in the purchase/sale agreement.

If the buyer retains an employee after the closing of the purchase, then section 9(1) of the ESA provides as follows: “If an employer sells a business or a part of a business and the purchaser employs an employee of the seller, the employment of the employee shall be deemed not to have been terminated or severed for the purposes of this Act and his or her employment with the seller shall be deemed to have been employment with the purchaser for the purpose of any subsequent calculation of the employee’s length or period of employment.” Accordingly, the buyer becomes responsible for the full length of the employees tenure in the business when calculating termination and/or severance pay.

As a result of a 1986 Ontario Court of Appeal case called Addison v. M. Loeb, the common law rule is now similar to section 9(1) of the ESA. Under common law, however, the buyer has a reasonable amount of time (usually measured in months) to decide whether to employ the “inherited” employee. If the buyer continues to employ the employee beyond a reasonable length of time, the buyer becomes responsible for the full length of the employee’s tenure in the business and the corresponding termination costs. If, however, the buyer terminates the employee within a reasonable length of time after closing, then the termination costs fall back on the seller.

For more detail on non-union employment law in Ontario, go to my web site at www.kerrlaw.ca, click on “Client Memos” and read “Employment Law - Ontario (non-union)".

Ball Parking the Risk:

The minimum exposure to the buyer or seller, depending on who is assuming the termination costs, will be the amount determined under the ESA.

The more onerous exposure will be the employee’s common law entitlement (plus litigation costs if the employee sues).

As mentioned above, common law entitlement typically averages about 1 month per year of service to a maximum of 24 months per employee, modified by a number of other factors. Common law exposure is, therefore, incapable of precise determination unless and until a judge rules on the matter at the end of a trial. A pre-estimate of exposure must, accordingly, be an estimate.

When determining common law entitlement, the employee is entitled to damages for loss of all forms of compensation (such as health benefits, company car, bonuses, stock options and pension entitlement that would have vested during the notice period, and the like). The typical average becomes distorted at shorter and longer durations of employment and where older employees are involved (usually over 50 years of age). For reasons that appear more related to sympathy than the law, no employee ever seems to get less than 3 months severance from Canadian courts no matter how short the duration of employment. Employees having very long tenures (say, 12 years or more) tend to get exaggerated awards as do employees over the age of 50. In addition, employees treated harshly on termination will be entitled inflated damages (the so-called “Wallace factor”)

To “ball park” the exposure to common law damages, I recommend the following approach:
 

  1. Allow for a minimum of 3 months per employee;
  2. Set the average upper end by allowing 1 month of wages per year of service to a maximum of 24 months' wages (the "notice period");
  3. If the employer was  providing group health benefits to the employee, add  the employer's monthly premium cost to the amount determined under paragraph 2; if the terminated employee purchases replacement health insurance or incurs actual health costs that would have otherwise been covered by the employer’s benefit plan, then the employee is entitled to those costs as an alternative to payment of the employer's premium cost; payment for lost group health benefits can be completely avoided if the employer continues the employee's coverage throughout  the notice period;
  4. Add in an allowance for other fringe benefits the employee was receiving (such as car allowance, cell phone, employer pension contributions or employer RRSP contributions) at replacement value and other non-monetary forms of compensation (such as the value of lost stock options); this may vary from employee to employee; 
  5. For senior or older employees, gross-up the total amount determined under paragraphs 1 through 4 by 25% (but not exceeding the maximum of 24 months);
  6. For employees who will likely find a new job within the notice period, reduce the total amount by  20%.

If compelled to negotiate with employees, do not expect to settle out of court for less than of the estimated entitlement plus an allowance for legal fees (which will vary depending on how far the employee has had to go to obtain the settlement but will typically be from $500 to $2500).

Note as well that common law settlements embrace and include the lesser ESA entitlement.


DISCLAIMER: The foregoing is not intended to be a comprehensive guide to the applicable law. General Client Memoranda and mailings from James D.L. Kerr ● Lawyer are intended to inform clients and acquaintances with respect to current issues that may be of interest to them. Memos are current to the date shown on the Memo. The law is constantly changing, however, and for that reason a Memo may not be completely accurate after it's stated date. Where circumstances warrant, the advice of a lawyer or other qualified professional should be obtained.

2006 James D.L. Kerr