When businesses change hands through mergers or acquisitions, severance obligations can become a significant issue for both buyers and sellers. Whether you are selling your company or acquiring another, it's essential to understand how severance liabilities are handled and how to manage risk exposure. Contact us by either using the online form or calling us directly at 414-253-8500 for legal assistance with employment and benefit issues in business sales.
Understanding Severance in the Context of M&A
Severance obligations are payments or benefits promised to employees upon termination or in connection with a business transition. These obligations can be outlined in:
-
Employment agreements
-
Severance plans or policies
-
Offer letters
-
Collective bargaining agreements (CBAs)
-
Company handbooks or historical practices
In a business sale, severance liabilities don't vanish - they follow the deal structure and the specific representations and warranties made in the purchase agreement.
Asset Sale vs. Stock Sale: How Severance Is Affected
The structure of the transaction - asset sale or stock sale - plays a major role in determining how severance obligations are handled:
Asset Sale
In an asset sale, the buyer only assumes liabilities explicitly stated in the purchase agreement. This means:
-
The seller typically terminates employees before the closing.
-
The buyer may offer new employment, often on different terms.
-
Severance obligations for employees not rehired often fall on the seller.
However, if the buyer chooses not to hire a substantial portion of the seller's workforce, this can trigger mass layoff concerns, implicating WARN Act obligations (discussed below).
Stock Sale
In a stock sale, the corporate entity remains intact, and so do its employment relationships. This means:
-
Employees continue with the company, now under new ownership.
-
Severance obligations remain the liability of the company - and thus pass to the buyer.
-
Unless negotiated otherwise, the buyer inherits all existing severance liabilities.
Successor Liability: When Buyers Inherit Severance Risk
Even in an asset sale, courts can find that a buyer is a "successor employer" and therefore liable for severance if:
-
The buyer retains a significant portion of the workforce;
-
Operates in the same location;
-
Performs the same business functions;
-
Uses the same equipment or facilities.
This is especially important in unionized environments where successor obligations under CBAs may bind the buyer even when not expressly assumed.
Federal and State WARN Act Requirements
Both federal and state WARN (Worker Adjustment and Retraining Notification) laws may impose notice and severance obligations in the context of a business sale.
Federal WARN Act
-
Applies to businesses with 100 or more full-time employees.
-
Requires 60 days' written notice before a plant closing or mass layoff.
-
Failing to give notice can result in liability for 60 days of back pay and benefits per affected employee.
State Mini-WARN Acts
States like California and New York have their own WARN statutes, often with stricter notice thresholds or severance mandates. These laws may apply even when federal WARN does not.
Buyers and sellers should review deal timelines, termination decisions, and employee count thresholds carefully to avoid inadvertent liability.
Severance Plans and ERISA
If the severance arrangement qualifies as an ERISA-governed severance plan, it brings additional legal considerations:
-
Plan termination requires formal procedures and may need advance notice.
-
Assumption of an ERISA plan can expose the buyer to fiduciary obligations and litigation risk.
-
Even in an asset sale, ongoing employee benefit plans might imply severance promises based on past practice.
It's critical to determine if the severance plan is discretionary or contractual and whether it's a "top hat" plan for key employees or applies company-wide.
Negotiating Severance in the Purchase Agreement
Severance liabilities are often a negotiated item in the purchase agreement, typically handled in the following ways:
1. Express Assumption or Rejection of Liability
The buyer and seller may expressly agree:
-
That severance for pre-closing terminations remains the seller's responsibility, or
-
That the buyer will assume liability, either wholly or partially.
Precision in the language of the representations and warranties, covenants, and indemnities is critical.
2. Purchase Price Adjustments
If the buyer is taking on significant severance liabilities, they may:
-
Reduce the purchase price accordingly, or
-
Require the seller to fund a severance reserve or escrow.
This ensures that the cost of severance does not fall entirely on the buyer post-closing.
3. "No Cut" Agreements or Retention Bonuses
To avoid triggering severance liability:
-
Buyers may offer employment guarantees for a set period post-closing.
-
Alternatively, retention bonuses can be used to incentivize key employees to remain, avoiding costly severance triggers.
Practical Steps for Managing Severance Risk
For Sellers
-
Review all existing employment agreements and severance policies.
-
Identify any implied promises or historical practices.
-
Determine WARN Act applicability based on closing date and termination schedule.
-
Consider implementing waivers or releases if offering severance to reduce litigation risk.
For Buyers
-
Conduct thorough employment-related due diligence:
-
Review severance plans
-
Evaluate potential WARN obligations
-
Understand retention and bonus programs
-
-
Decide whether to:
-
Assume severance obligations
-
Negotiate indemnities
-
Implement new employment terms post-closing
-
-
Request employee census data and current severance liabilities early in the diligence process.
Unionized Workforces and CBAs
When the target company has a unionized workforce, severance obligations may be:
-
Governed by a collective bargaining agreement.
-
Protected by successor employer doctrines, even in asset sales.
-
Enforceable even if the buyer does not explicitly assume the CBA, depending on how operations continue post-sale.
Legal counsel should review any CBA severance provisions to assess the scope of potential liability and plan for negotiations with the union if necessary.
Tax Treatment of Severance Payments
Severance pay is generally treated as ordinary income and subject to:
-
Payroll taxes
-
Income tax withholding
-
Potential golden parachute rules under IRS Code §280G (for certain highly compensated employees in change-in-control scenarios)
To mitigate tax exposure:
-
Consult tax advisors early in the deal.
-
Consider structuring severance as deferred compensation under Internal Revenue Code §409A, with careful compliance to avoid penalties.
Integration Planning and Employee Communications
A major cause of litigation related to severance is poor communication with employees. Both parties should:
-
Clearly define roles in delivering termination notices.
-
Coordinate internal communication strategies.
-
Document all employee interactions and maintain signed acknowledgments for offers, notices, and waivers.
Contact an Attorney for Severance Issues in Business Sales
Severance obligations can have lasting legal and financial impacts long after a business transaction closes. Whether you're a buyer, seller, or investor, working with a knowledgeable attorney can help you navigate the complexities of employment liability and avoid costly missteps.
At Heritage Law Office, we assist clients through every stage of a business sale - from deal structuring and due diligence to severance negotiation and post-closing integration.
Contact us through our online form or call 414-253-8500 to speak with an attorney about your merger, acquisition, or employment-related legal matter.
Frequently Asked Questions (FAQs)
1. What happens to severance agreements when a company is sold?
When a business is sold, severance agreements may either transfer to the buyer or remain with the seller, depending on how the transaction is structured. In a stock sale, the buyer usually inherits all employee obligations, including severance. In an asset sale, only liabilities specifically assumed by the buyer are transferred-unless legal doctrines like successor liability apply.
2. Are severance payments mandatory in a business sale?
Severance is not automatically required unless specified by contract, company policy, or applicable law. However, obligations can arise from employment agreements, union contracts, or even implied company practices. In some cases, federal or state WARN laws may require compensation if proper notice of termination is not given.
3. Can a buyer be held responsible for severance even if it's not in the agreement?
Yes. Buyers can be held liable under successor employer doctrines, especially if they retain much of the seller's workforce, operate in the same location, and maintain business continuity. Courts may impose liability to protect employees, even if the purchase agreement disclaims responsibility.
4. How can companies limit severance liability in a transaction?
Companies can reduce severance liability by clearly negotiating responsibility in the purchase agreement, offering retention bonuses, providing notice under WARN laws, and reviewing existing contracts and policies. Legal and tax professionals should be consulted early in the transaction.
5. Do WARN Act requirements apply to small business transactions?
The federal WARN Act only applies to businesses with 100 or more employees, but several states have "mini-WARN" laws that apply to smaller employers or require more notice. It's essential to review both federal and state laws to determine whether notice or severance payments are required.