Employee or contractor? The cost of getting it wrong

When buying a company, knowing the difference between employees and contractors can save big money and headaches, says Toronto business lawyer Anton Katz.

“If the buyer doesn’t do his homework, he could be faced with substantial sticker shock down the road,” says Katz, principal of Anton M. Katz Barrister and Solicitor.

“For a company with 10 or 15 long-term employees, it could cost a purchaser hundreds of thousands of dollars if he doesn’t do his homework,” he tells AdvocateDaily.com.

When a business is sold, the buyer becomes the “successor employer” and inherits all of the obligations to the employees, says Katz.

“Let’s say you have an employee who’s been with the company for 30 years. Then, a year after you buy the company, things aren’t working out with the employee,” he says. “You would be on the hook for 31 years of service — the one year that he worked for you and the 30 he worked for the previous employer.”

If that worker had been an independent contractor rather than an employee, there would be no such obligation, says Katz.

In the example of the business with 10 to 15 long-term employees, the distinction between the two becomes an expensive one, he says.

“If those employees are making an average of $50,000 a year and are entitled to two years of termination pay, with 10 employees, that’s $1 million.”

Katz says it’s common for buyers to insist that the vendor terminate the employment of long-term employees as a condition of sale. The new employer can then rehire them.

“In that case, the employee has the best of both worlds because they’re getting termination pay for their years with their former employer and they’re getting an
employment contract with the new one,” he says.

“And the advantage for the new employer is that the clock resets to zero.”

Katz says there is a hybrid option available for such business deals, where the vendor doesn’t terminate the employment of any workers but agrees to indemnify the purchaser in the event of a termination after the deal is closed.

In the case of the 30-year employee, explains Katz, “The purchaser says, ‘Hey Mr. Vendor, this is just not working out. I’m not happy with the employee and I want to terminate his employment. I’m going to pay severance on the full 31 years, but you need to indemnify me — or pay me back — for the 30 years of service that are attributable to you.’”

He says the purchaser should also “satisfy himself that the people the vendor says are independent contractors really are. There are various tests that the courts have articulated over the years and once those have been applied, the buyer won’t have sticker shock down the road.”

Katz cautions that just because a seller says a worker is a contractor doesn’t make it so. He says it’s better to do one’s homework. The Canada Revenue Agency has set out a number of guidelines for determining the difference.