When Deeper Diligence Found a Hidden Payroll Liability

The situation

Abena had spent six years behind a till at a grocery store, and every spare dollar for the last three of them had gone into a savings account earmarked for one thing: owning a business. She had arrived in Canada from Ghana in her twenties with a business diploma and no local experience, and the grocery job had been a way in, not a destination. Her partner, Gurpreet, worked as a landscaper and had spent enough summers running small crews to know what it took to keep a service business staffed and moving.

Together they found a small residential and commercial cleaning company for sale in Etobicoke, listed at roughly $220,000. The business had a loyal client list, a handful of recurring commercial contracts, and a seller, Lan, who wanted to retire after a decade of running it. The numbers looked solid on the surface: steady revenue, low overhead, no debt on the books. Abena and Gurpreet signed a conditional agreement of purchase and sale and came to Treadstone Law to handle the closing, expecting a straightforward asset purchase.

An asset purchase means the buyer acquires specific assets of the business — equipment, client contracts, goodwill, the business name — rather than buying shares in the company itself. Buyers generally prefer this structure because it lets them pick which liabilities to take on, unlike a share purchase, where the buyer inherits the company as a whole, including debts and legal exposure that may not be obvious on the surface. The plan seemed sound. The diligence review was meant to confirm it.

What the review found

Due diligence is the structured review a buyer's lawyer runs before closing, checking that what the seller has represented about the business actually holds up — contracts, financial records, tax filings, employment arrangements, and anything else that could carry forward as a cost or a risk. Our team requested the standard package: two years of financial statements, the commercial contracts, and the records for anyone who worked in the business.

The cleaning company used six regular workers. All six were paid as independent contractors, invoicing the business monthly, with no source deductions withheld and no T4 slips issued. On paper, that arrangement is common in the cleaning industry and, done properly, it is legitimate. The problem was in how the arrangement actually functioned. Records showed the workers were assigned fixed weekly schedules, used cleaning equipment and supplies the business owned, wore branded uniforms, worked exclusively for this company, and had done so for between two and four years.

Under the tests Canadian courts and the Canada Revenue Agency use to distinguish employees from contractors, those facts point strongly toward employment. Ontario's Employment Standards Act, 2000 protects workers based on the substance of the relationship, not the label the parties put on it — a worker who functions as an employee is entitled to employment standards protections such as vacation pay and notice of termination regardless of what the invoices say. On the tax side, misclassifying employees as contractors means the employer failed to withhold and remit income tax, Canada Pension Plan contributions, and Employment Insurance premiums — an exposure that follows the business, not the individual worker, and that the Canada Revenue Agency can reassess for past periods with penalties and interest added on top.

Our team quantified what that exposure could look like if even a portion of it were reassessed: roughly $18,000 in unremitted source deductions across the six workers for the prior two years, plus an estimated $10,000 in unpaid vacation pay the workers could claim if they were later found to be employees. Together, that put the realistic exposure at approximately $28,000 — over ten percent of the purchase price — sitting on top of a business that had looked, until that point, like a clean deal.

What we did

1. Confirmed the asset purchase structure before anything else. Because the deal was structured as an asset purchase rather than a share purchase, Abena and Gurpreet were not automatically stepping into Lan's corporation and its past tax liabilities. This mattered enormously — a share purchase would have made the misclassification exposure the buyers' problem by default, with no negotiation needed.
2. Flagged the successor employer risk that remained. Even in an asset purchase, a buyer who keeps on the same workers doing the same jobs can be found to have continued the employment relationship for certain purposes under employment standards law, particularly around notice and severance obligations tied to length of service. We explained to Abena and Gurpreet that simply hiring the same six people going forward would not fully insulate them from the workers' accumulated employment standards entitlements.
3. Brought the exposure to the table in writing. Rather than walking away or staying silent, our team prepared a written summary of the misclassification finding for negotiation with Lan's side, including the estimated $28,000 exposure and the reasoning behind it, so the number was not a surprise sprung at closing.
4. Negotiated a price adjustment and a holdback. The parties agreed to reduce the purchase price by $25,000 and place a further $10,000 in escrow with a neutral third party for six months after closing, to be paid to Abena and Gurpreet if any of the six workers filed an employment standards claim or if the Canada Revenue Agency opened a reassessment tied to the pre-closing period.
5. Added a specific indemnity for the misclassification issue. An indemnity is a contractual promise by one party to compensate the other for a defined loss. We drafted a clause obligating Lan to reimburse Abena and Gurpreet, beyond the escrow amount if needed, for any liability arising from the pre-closing classification of the six workers, with a claims window long enough to cover a realistic CRA reassessment period.
6. Advised on going forward correctly. Once Abena and Gurpreet took over, we recommended they treat the same workers as employees from day one if they intended to keep the working arrangement the same — set schedules, employer-owned equipment, exclusivity — rather than perpetuate a contractor label that did not match the reality of the job.

The outcome

The deal closed roughly six weeks later than originally planned, the extra time consumed by the back-and-forth over the price adjustment and the escrow terms. Lan was not pleased to have a decade-old payroll practice examined this closely so close to retirement, and there was real friction before the numbers were agreed. Neither side got everything they wanted. Abena and Gurpreet paid $195,000 instead of $220,000 and had $10,000 tied up in escrow for six months rather than available to invest in the business immediately. Lan accepted a lower net sale price and a lingering claims window rather than the clean exit they had expected.

Three months after closing, no employment standards claim or CRA reassessment had surfaced, and the escrow funds were released to Lan at the end of the holdback period. Abena and Gurpreet had, by then, reclassified all six workers as employees, set up proper payroll remittances, and absorbed the modest added cost of doing so into their pricing. The business itself performed close to what the financial statements had shown. What changed was the price they paid for it, and the certainty they closed with.

This was not a case where the problem simply went away. The exposure was real, both sides paid something to resolve it, and the compromise reflected genuine uncertainty about whether any worker would ever actually bring a claim. That is the nature of a negotiated outcome: it trades a possible large loss for a certain smaller one, on both sides of the table.

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