Due diligence for employee entitlements during sales of business

When it comes to buying or selling a business, there is no shortage of matters requiring your attention. From negotiations about the purchase price or stock-in-trade, making and receiving representations, or understanding whether there are any hidden liabilities, all of these are essential components that make up a sale.

However, one of the most commonly forgotten about considerations has to do with the entitlements of existing employees of the business. While it may be a condition of the sale that all existing employees, sometimes including the current owner, become employees of the purchaser, this has far reaching consequences that sometimes are not realised until months or years after the acquisition.

While each sale will have its own complexities, here are five of the most commonly forgotten or misunderstood concepts in sales of business.

1. Make sure you obtain any existing employee records for transferring employees

Under Fair Work laws, when a transfer of business occurs the seller is required to provide copies of any employee records to the purchaser. These records are important not only to ensure that they are available upon receiving a valid request for their production from an employee, but also so that the purchaser has a clear picture of the state of the workforce.

For example, if there is an individual flexibility agreement in place between the seller and one the transferring employees, this may transfer across with the employee to the purchaser. An individual flexibility agreement (or “IFA”) can be used to vary parts of a modern award or enterprise agreement, such as when work is able to be performed or when breaks are required to be taken.

An employee under an IFA can be no worse off under an IFA than their modern award or enterprise agreement. Because of this, the purchaser may find some of the compromises agreed to by the seller to be unappealing and seek to revert the employee back to more standard conditions of employment.

Some of these documents may be disclosed during the due diligence phase of the sale, however it is important that all employee records are obtained during the transfer.

2. Decide whether or not to recognise service

It is possible to not recognise an employee’s prior service with the seller for the purposes of:

• whether they have met the minimum employment period (commonly known as the probation period);
• annual leave;
• notice of termination; and
• redundancy pay.

Importantly, you must inform an employee before their employment commences if you decide not to recognise their prior service.

In some states you are also able to not recognise service for the purposes of long service leave, however in others you may have no choice. Personal/carer’s leave (i.e. sick leave) will always be carried across with a transferring employee.

There are various commercial implications with respect to whether or not to recognise service. At a basic level, if annual leave is not recognised it will need to be paid out by the seller rather than transfer to the purchaser as a liability.

Depending on the size of the business, redundancy pay may also be a factor. In most sales of business, all employees of the seller will essentially cease their employment and recommence with the purchaser. This means that a termination of employment technically will have occurred. This type of termination is fairly typical of a redundancy situation because the seller no longer requires the employees to perform work for their company.

However, there is an exclusion that provides redundancy pay will not be payable if (amongst other things) the purchaser decides to recognise service. This of course means that if the purchaser ever needs to make an employee redundant, the liability will also take into account the employee’s prior service with the seller for the purposes of the calculation.

3. Check leave balances and whether to adjust the purchase price

If you decide to recognise service, an adjustment should almost always be made for employee entitlements that will transfer across, including annual leave and notice in lieu of termination. If your state or territory requires long service leave to be recognised, this may also factor into this assessment.

It is alarmingly common for an employee to transfer across who is approaching, but has not yet obtained, an entitlement to long service leave, and the purchaser suddenly become liable for in excess of 2 months’ wages for the employee.

4. Make sure that the business is compliant

As a starting point, any historical non-compliance of the seller does not rest with the purchaser in a sale of business. However, if the purchaser simply adopts the seller’s historical non-compliant practices, this can quickly create issues for the purchaser in its own right.

You should never assume that the seller has acted compliantly with respect to employee wages and entitlements, and this should form part of your due diligence in the sale. This includes everything from employee classification levels, rostering practices, and record-keeping requirements.

5. Understand what happens with any existing enterprise agreements

Lastly, you should know whether the seller has an enterprise agreement in place that applies to any of its employees. As with the above, you should not assume that the seller has applied the enterprise agreement correctly, but once you have determined it properly has application, this may have far reaching consequences during the transfer.

In general, an enterprise agreement will transfer with employees to the purchaser, however will not apply to any new employees who commence work after the transfer has occurred. This means that it is possible (and indeed very common) for some employees to be covered by an enterprise agreement and some performing the sale role to be covered by a modern award.

The Fair Work Commission has the power to make orders with respect to either limiting the scope of an enterprise agreement to not apply to transferring employees, or expanding it so that it applies to all employees of the business.

Transfers of business can be complex, and there are numerous considerations and options available to you when it comes to employee entitlements. If you require assistance with legal due diligence during a sale of business, contact NRA Legal for a confidential discussion on 1800 572 679.

By Calum Woods and Lindsay Carroll, NRA Legal