What Happens to Employees When You Buy a Business in an Asset Sale?

Does an asset purchase agreement include employees?

Not as purchased assets. An asset purchase agreement transfers things the seller owns. Employment relationships are between the seller's entity and each worker, and in an asset sale that entity stays with the seller. So the agreement typically says the seller will terminate all employees effective at closing, and the buyer may (or must) offer employment to some or all of them.

What the agreement does include is a set of employee clauses: a list of employees with their pay, start date and accrued time off; the buyer's hiring commitment, if any; who pays final wages, bonuses and accrued vacation; which benefit plans stay with the seller; and representations that wages, overtime and payroll taxes have been paid correctly. Read those clauses as carefully as the price terms.

A stock purchase is different. There the buyer acquires the company itself, so employees stay employed by the same employer, with their existing terms, accrued obligations and history.

Does the buyer have to keep the seller’s employees?

Generally no. Unless the agreement requires it, an asset buyer can choose whom to hire and on what terms, subject to anti-discrimination laws, any union obligations and any commitments it makes in the agreement. Sellers sometimes negotiate a promise that the buyer will offer jobs to all or most staff on comparable pay, both out of loyalty and to limit their own severance and notice exposure.

In practice, small business buyers usually want the staff, because the team often carries the customer relationships and know-how. The usual approach is to interview key people before closing, make written offers conditional on closing, and make the retention of named key employees a closing condition if the business depends on them.

Who pays final wages and accrued vacation?

When the seller ends employment, state final pay laws apply to the seller. Many states set short deadlines for the final paycheck, and some treat accrued vacation as earned wages. In California, for example, Labor Code section 227.3 requires earned, unused vacation to be paid at the final rate of pay whenever employment ends, so the seller normally pays it out at closing.

Some deals instead have the buyer assume accrued vacation and honor it, with a matching reduction in the price. That can be good for morale, but check whether your state allows it and get the employee's agreement in writing where required. Whatever the approach, the agreement should state it, attach the accrual figures, and include a seller indemnity for wage claims relating to the period before closing.

Can a buyer inherit the seller’s wage and employment liabilities?

Usually the excluded liabilities clause leaves past employment claims with the seller. But federal courts sometimes apply successor liability to labor and employment claims. In Teed v. Thomas & Betts Power Solutions, 711 F.3d 763 (7th Cir. 2013), the court held an asset buyer liable for the seller's unpaid overtime claims under the Fair Labor Standards Act, even though the purchase agreement said the buyer was not assuming them. Key factors were that the buyer knew of the pending lawsuit and continued the same business with the same workforce.

The lesson for buyers is that a disclaimer is not enough. Ask for a list of pending and threatened employment claims, check whether staff are correctly classified as exempt or as contractors, and back the seller's wage indemnity with an escrow or a setoff right against any seller note.

Does the WARN Act apply when you buy a business?

The federal WARN Act requires employers with 100 or more employees to give 60 days' notice before a plant closing or mass layoff. It has a specific sale-of-business rule. Under 29 U.S.C. section 2101(b)(1), anyone employed by the seller on the effective date of the sale is considered an employee of the buyer immediately afterwards, so a sale on its own does not trigger notice when the buyer keeps the workforce.

The Department of Labor regulation at 20 C.F.R. section 639.4(c) splits responsibility: the seller must give notice for any closing or layoff up to and including the effective date of the sale, and the buyer is responsible for those after it. Most very small businesses fall below the 100-employee threshold, but several states have their own mini-WARN laws with lower thresholds, so check your state if the deal involves layoffs.

What happens to health insurance and COBRA?

Benefit plans normally stay with the seller in an asset deal, and employees join the buyer's plans, if any, after closing. Coverage gaps between the two are a common source of complaints, so time the switch carefully.

For employees who lose coverage, the COBRA regulations for business reorganizations, at 26 C.F.R. section 54.4980B-9, put the obligation on the seller's group as long as it keeps any group health plan after the sale. If the seller drops all its plans, the obligation can pass to the buyer's plan when the buyer is a successor employer that continues the business without interruption or substantial change. Small sellers often wind up their plan at closing, so buyers should address COBRA in the agreement rather than assume it is the seller's problem. Very small employers may be covered by state continuation laws instead of federal COBRA.

What paperwork does the buyer need: I-9s and payroll?

For immigration paperwork, USCIS gives a buyer that takes on a seller's employees two options. It can treat them as new hires and complete a new Form I-9 for each, or treat them as continuing in employment and keep the seller's existing forms. If it keeps the old forms, it takes on responsibility for any errors in them. Many buyers in small asset deals choose new I-9s for everyone, applied consistently to avoid discrimination concerns.

If the buyer is enrolled in E-Verify, it should also check how its enrollment applies to acquired staff before closing. Whatever route is chosen, complete the forms on time: Section 1 by the first day of work for the buyer and Section 2 within three business days, using the closing date as the start date.

For payroll taxes, Rev. Proc. 2004-53 sets out a standard procedure, where the seller issues Forms W-2 for wages it paid and the buyer for wages after closing, and an alternate procedure, where the buyer can issue a single W-2 covering the full year. The agreement or a closing side letter should say which is being used. The buyer will also need new Forms W-4 and its own payroll accounts and workers' compensation coverage in place for day one.

What about contractors, key staff and employee non-competes?

Independent contractors are a separate question. Their contracts are with the seller's entity, so they transfer only if the buyer takes an assignment of the contract, which may need the contractor's consent. Check whether any "contractors" are really employees in disguise: misclassification claims for unpaid overtime and payroll taxes are a common hidden liability, and the seller's representations should cover them.

For key staff, many buyers offer retention bonuses paid in installments over the first year, sometimes funded partly by the seller through a price reduction. The purchase agreement can make signed offer letters from named people a condition of closing, so the buyer does not pay full price for a business whose top salesperson leaves the day after.

Employee non-competes and confidentiality agreements signed with the seller do not automatically protect the buyer. Whether the buyer can enforce them depends on whether they were validly assigned and on state law, and some states, including California, treat most employee non-competes as void. Buyers usually ask hired staff to sign new confidentiality and invention assignment agreements with the buying entity, and they should check what the old agreements say before relying on them.

What should buyers check in the employee clauses?

Before you sign, compare the employee terms in the purchase agreement with this list. The Business Purchase analyzer flags which liabilities stay with the seller and what the indemnity is worth in dollars and dates, which helps you test the wage protections.

• A complete employee census attached, with pay rates, classification, start dates and accrued time off.
• A clear statement that the seller terminates employment at closing and pays all final wages and required accruals.
• Any hiring commitment you make is limited and specific.
• Seller representations that wages, overtime, payroll taxes and benefit contributions are current and that workers are correctly classified.
• A seller indemnity for pre-closing employment claims, backed by escrow or setoff.
• Key employee retention as a closing condition where the business depends on named people.
• Allocation of WARN, COBRA and payroll reporting responsibilities.