Selling your business? Employee entitlements may catch you out

Negotiating employee entitlements in the sale of a business can be tricky and it’s important for sellers to be aware that out of the proceeds of sale they may be responsible for employee entitlements.   

Employee entitlements can include:  

– annual leave   – long service leave  
– sick & carers leave   – parental leave  
– redundancy pay   – termination pay   

How are employee entitlements dealt with under the REIQ Business Sale Contract?

The REIQ Business Sale Contract (3rd Edition) is commonly used in Queensland for business sales. Standard Condition 18 (“SC18”) of that contract adopts, in effect, the following procedure:

  1. The Seller is to have listed the respective periods of service of each employee as at the date of the contract (“the Listed Employees”) – see our comments under “Disclosure” in the example below;

  2. The Buyer is to notify the Seller in writing prior to completion, of the names of the Listed Employees that the Buyer proposes to employ (“the Buyer’s Intended Employees”) – for the reasons that become apparent below, it is important this step is actually taken (and in our experience, it is often a step that is missed by the parties);

  3. The Buyer must offer each of the Buyer’s Intended Employees employment in accordance with SC18.3 (a) to (e). As a consequence:

    1. The Seller remains responsible for any employee entitlements for any of the Listed Employees, who are not the Buyer’s Intended Employees (that is, any of the Listed Employees whom the Buyer has not notified the Seller that the Buyer intends to employ);

    2. If the Buyer fails to make an offer of employment to any of the Buyer’s Intended Employees, the Buyer becomes responsible to the Seller for any redundancy payment the Seller must make to that employee. This is why it is important to ensure the Buyer is required to notify the Seller of the Buyer’s Intended Employees.

    3. Each employee to whom the Buyer makes the offer of employment, which is accepted, becomes a “Transferring Employee”;

    4. Each employee to whom the Buyer makes the offer of employment, which the employee does not accept, remains the responsibility of the Seller.

  4. At Completion, the Seller is to give the Buyer, details of all entitlements as at Completion for each Transferring Employee (“the Transferring Employees’ Entitlements”) and then:

    1. there is an adjustment to the purchase price for the amount of 70% of such Transferring Employees’ Entitlements (the rationale being the buyer will receive a tax deduction when those entitlements are paid); and

    2. the Buyer then takes on responsibility for the Transferring Employees’ Entitlements.

  5. Interestingly, in that adjustment of the purchase price for the Transferring Employees’ Entitlements:

    1. the Seller agrees to reimburse the Buyer 70% of the pro rata accrued value of long service leave for all Transferring Employees with 5 years or more service; whereas

    2. subject to the express terms of the employment agreement, the relevant Transferring Employees would not be entitled to receive payment for the pro rata long service leave (if their employment was terminated) until such time as the employees had completed seven years of service.

    Accordingly, this adjustment adjusts for long service leave which might never come into fruition. Depending on the number of employees, a seller may wish to vary this condition as it can potentially represent a significant cost to the seller, depending on the number of long serving employees.   

    SC18 is the default position under the REIQ Business Sale Contract and (of course) is subject to negotiation. 

    Leaving aside what are accrued entitlements (which shall be explored in a future article,) how does this SC18 operate and what impact does it have on the seller and ultimately how much the seller will be responsible for out of the proceeds of sale?

    An example

    Seller agrees to sell Seller’s painting business to Buyer. Seller has four employees: Ms A, Mr B, Mrs C and Mr D.   Buyer has decided to keep on board Ms A, Mr B and Mrs C only.  Unfortunately, Buyer does not want Mr D.

    Disclosure

    Seller provides Buyer with a list of employees and their periods of service (SC 18.1) in item Y of the Business Sales Contract.  A cautionary note: there are confidentiality concerns about disclosing this information and increasingly sellers are reluctant to do so without:

    • a pre-contractual confidentiality deed in place; or

    • agreeing on the sales contract to provide the entitlements information after the signing of the contract (although of course surely the buyer needs to know that information before it can ultimately agree on the purchase price).

    Confidentiality and privacy issues in business sales will be explored in future articles. 

    Notice of choice of employees

    Buyer notifies Seller that Buyer proposes to employ Ms A, Mr B and Mrs C (SC18.2).  Any offer of employment to these employees must satisfy the conditions set out in SC 18.3.

    Consequences of failing to make an offer of employment

    Buyer is under no obligation to offer employment to any employee, however as above, there are different outcomes for both Seller and Buyer on the basis that:

    1. If Buyer fails to make an offer of employment to Mrs C who was included in the notice served under SC18.2 (and assume that is the case), under SC18.5 Buyer will be responsible to pay for any redundancy payments due to Mrs C if her employment is terminated by Seller on completion or within 12 months after completion.

    2. Buyer does not include Mr D in the notice served under SC18.2, in that Seller will be responsible at completion for all entitlements due to Mr D.

    Making an offer to the employees recognising prior service

    SC18.3 contemplates that the employment offer made by Buyer recognises prior service, so there is continuity of employment and benefits. 

    Probably the most common scenario (and one perhaps favoured by buyers as it results in a lower purchase price) is to adjust the purchase price to allow for the employee entitlements Buyer is taking on.  

    Unless some other percentage is agreed in the contract, the purchase price will be reduced by an amount equal to 70% of the entitlements due to Ms A and Mr B (provided they accept Buyer’s offer of employment) such as sick leave, annual leave and long service leave if either of those employees have five years or more service with the business (SC18.8).  

    What if Buyer wishes to offer employment without recognising prior service?

    If Buyer would prefer not to recognise prior service, this would be a point of negotiation and to amend SC18.3 accordingly. The benefit to Buyer is that Buyer can retain experienced employees with the added benefit of resetting the clock in respect of certain/some entitlements.

    This can be a complicated area requiring proper legal advice to understand the consequences – we recommend Seller and Buyer seek specific legal advice before negotiating any such amendments.

    Ms A declines the offer of employment from Buyer

    What if Ms A declines the offer of employment from Buyer?  Of course, the employees are not obliged to accept the offer of employment from Buyer.

    This possibility is something that needs to be considered by the Seller, as Seller will be responsible at completion for all entitlements due to Ms A.

    What if it’s a share sale rather than a business asset sale?

    So far as employee entitlements are concerned, as there is no change in their employer, all entitlements are kept “as is” without the need to make the adjustments at completion of the business sale as outlined above.

    Takeaways

    It’s important that sellers are aware that out of the proceeds of sale they may be responsible for employee entitlements if the buyer decides they don’t want to take on existing employees. A buyer is under no obligation to take employees and the employees are under no obligation to accept the offer from the buyer  – either way, the seller is responsible for employee entitlements in respect of those employees. 

    Employee entitlements should therefore be considered early in the negotiation of a business sale as part of a meaningful discussion between the seller and the buyer. 


    Disclaimer:
    Reliance on content the material distributed is general information only. The information supplied is not and is not intended to be, legal or other professional advice, nor should it be relied upon as such. You should seek legal or professional advice in relation to your specific situation.