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Avoiding Costly Mistakes: Understanding Employee Risks in Dental Practice Transactions

By March 19, 2024March 25th, 2024Employment Law

What happens to the employees of small businesses when they are purchased or sold? In a recent Ontario Court of Appeal case, Manthadi v ASCO Manufacturing (“Manthadi“), important precedents were set regarding employee rights and obligations during business transitions. What should have been a simple asset sale morphed into a wrongful dismissal lawsuit. Since many dental practice transitions are conducted as asset sales, the Manthadi case offers some important lessons for dentists, buyers and sellers alike.

A Going Concern

Employee transition issues often depend on how the buyer plans to operate the business. If a buyer intends to step in and operate with a business as usual approachusing largely the same terms and minimal changes, they will often agree to continue to employ some, if not all, of the seller’s existing team to minimize costs and maximize efficiencies. This is referred to as purchasing a going concern. The risks of taking on employees as part of a going concern transaction depend on multiple factors, including:

  • the structure of the transaction (i.e., an asset sale, a share sale, a combination, etc.)
  • whether the seller had previously implemented written employment contracts which are legally valid and enforceable
  • whether the buyer wants to (re)hire team members indefinitely or on fixed terms (i.e., for defined periods, based on need)

The Manthadi Case

Background

In 1981, the plaintiff, Sandra Manthadi, started working as a blaze welder for 63732 Ontario Limited (“637”), a Toronto-based manufacturer. In November of 2017, 637 sold all its assets/equipment, including its trade name (ASCO Manufacturing), to another company, 2603420 Ontario Inc. (“ASCO”). Prior to closing, 637 presented Manthadi with a “Settlement and Release Agreement”. The agreement offered her a lump sum payment equivalent to 8 weeks gross pay in exchange for a release against 637 for all employment-related claims. Manthadi accepted and signed the Settlement and Release Agreement. After the deal closed, ASCO extended job offers to many of 637’s former employees. However, the Brampton-based company did not tell the employees it planned to move its purchased equipment out of Toronto. Manthadi accepted the offer of continued employment with ASCO, albeit under very vague circumstances:

  1.  She was not asked to submit a resume.
  2. The new management did not interview her.
  3. She did not receive a written contract to review and sign.

After only about a month, Manthadi was notified of a shutdown in operations and was placed on temporary lay-off shortly thereafter. She later received an ROE, which cited a termination of her employment due to a “shortage of work/end contract or season.” As Manthadi believed that ASCO’s offer of employment had been indefinite, she claimed wrongful dismissal. ASCO argued that her job was temporary from the start and only meant to last until it had finished moving its purchased assets to a new facility.

Issues

The main issues in Manthadi relevant to dentist practice buyers and sellers are:

  1. Validity of Releases: Will a release signed by the employee and the seller also help protect the new employer?
  2. Nature of Employment: Was ASCO’s offer of employment temporary or indefinite?
  3. Recognition of Prior Service: Could the plaintiff’s prior years of service with 637 be considered in assessing reasonable notice of termination?
  4. Going concern Transactions: Was ASCO’s purchase of 637’s assets a purchase of a going concern or merely a purchase of certain assets?

The Decision

  1. The Court found that the release Manthadi signed before closing favoured 637 and did not prevent Manthadi from bringing a claim against ASCO, despite ASCO’s argument that it had “stepped into” 637’s place as its agent as a result of the purchase and sale transaction.
  2. Regarding the term length of the employment offer, the Court decided that Manthadi’s employment with ASCO was indefinite and not fixed, as ASCO had failed to properly communicate that they intended to hire her to do a specific task for a limited period.
  3. Regarding prior years of service, the common law permitted the Court to consider prior service with 637 in determining damages for lack of reasonable notice of termination.
  4. Finally, the Court found that the sale of 637’s assets was a going concern transaction. Although it was ASCO’s responsibility to clearly and unequivocally inform the employees that their employment would be for a limited purpose and time, it failed to do so.

In the end, ASCO was held liable for nearly forty thousand dollars in damages caused by wrongful termination.

Why Does This Matter?

Practice owners and prospective owners should take note of this case for several reasons.

Validity of Releases

Manthadi showcases that unless it is expressly negotiated and agreed upon by the parties involved, buyers in asset sales cannot rely on releases favouring sellers when it comes to employee-related risks or obligations. The Court’s reasons included:

  • Although 637 was obligated to fulfil certain conditions per its asset purchase agreement (such as firing its staff and agreeing to pay the buyer for any pre-closing employee liabilities), obtaining releases from terminated employees was not required in the purchase agreement. The releases were instead an extra measure that 637 took to protect itself. If ASCO had wanted the benefit of such releases, the Court found that it could have negotiated accordingly.
  • The Court pointed out that the ‘privity of contract’ concept prevailed. Although by no means new or groundbreaking, ‘privity of contract’ is the principle that only those who are directly parties to an agreement (or those who are named beneficiaries in an agreement) can benefit from its terms. ASCO had no reasonable expectation that 637’s release would protect it since it was not named in the release. By signing, Manthadi had agreed to release the seller from any claims arising from her dismissal at that time but not future claims that could arise with the buyer post-closing.

Clarity in Employment Agreements

Manthadi also reminds us how important it is for dental practice employees to be presented with written contracts that clearly set expectations, whether by the seller pre-closing or by the buyer after the sale. ASCO would have significantly benefited from presenting a written offer of employment to the plaintiff that clearly stated the offer was for a temporary position.

Much of the Court’s discussion in Manthadi centred around whether the plaintiff’s post-sale employment with ASCO was definite or indefinite. This mattered because while employment contracts of ‘indefinite duration’ (i.e., with no set end date) carry obligations to provide reasonable notice of termination (or pay in lieu of notice), such obligations generally do not apply to fixed-term employment contracts (as explained in Ontario Regulation 288/01). At the end of a fixed-term employment contract, the protections of the ESA and the common law do not apply.

Without a written agreement, the employer bears the burden of proving that an employee was hired on a fixed term. Using unequivocal and explicit language, the employer must establish “unambiguously” that a fixed term was the intention. ASCO’s lack of communication made this impossible.

Consideration of Prior Service

Manthadi clarifies the applicable law where employees seek to include their prior years of service with a predecessor employer when seeking wrongful dismissal damages against a successor employer.

Under the common law, when an employee has been employed by a purchaser of a business after having been employed ‘for some time’ by the seller, and that employee is wrongfully dismissed, at least some recognition will be given to the employee’s service with the previous employer.

In Manthadi, the Court found that it could – and did – consider the plaintiff’s prior years of service with 637 when assessing appropriate notice (or pay in lieu thereof) owed by ASCO, resulting in a much higher amount owed by ASCO.

Going Concern Transaction

Manthadi also provides guidance on the legal test to see if a purchase and sale in Ontario constitutes a going concern transaction or a mere asset transfer.

To recap, going concern transactions involve a change of ownership where the buyer intends to continue operating the business as usual. By contrast, a mere sale of assets would spell a clear break in employment, and prior service would not be considered a relevant factor.

In determining that Ms. Manthadi’s employment with ASCO was within a going concern transaction, the Court reviewed many factors and noted the following:

  • Ms. Manthadi’s post-closing hourly wage and working hours were the same as they were pre-closing.
  • There was no evidence that 637 disrupted or ceased its operations before the sale.
  • Nothing was communicated to the plaintiff by the purchasers, leading her to believe that she would continue doing the same work while being paid the same rate.

This distinction between a going concern transaction and a mere asset sale holds significant implications for anyone entering negotiations to purchase a dental practice.

Bottom Line

Manthadi serves as a warning to dentists contemplating or negotiating practice purchases. This is because, in most dental practice transitionsexcept simple chart sales or simple asset purchases where the buyer does not plan to buy a turn-key operation, the goal is to continue operating the practice, in which case the purchaser will be expected to acquire a going concern. As a result, dental practice purchasers should prepare to onboard some or all of a seller’s existing team members and consider their prior years of service. The case highlights the importance of negotiating clear pre-and-post-closing employment terms between buyers and sellers and, once again, brings the crucial role of proper written employment agreements to the forefront.

If you are considering acquiring a practice or need help navigating the employment implications of an acquisition, DMC is your one-stop shop for information and advice tailored to dentists. We are happy to offer guidance on any employment law questions you may have. Send me an email or call our team at 416-443-9280.

The Content of this post is provided for informational purposes only. It is not intended to be legal, financial, tax, or other professional advice of any kind. You are advised to contact DMC (or other counsel) to seek specific legal advice concerning your individual situation.

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