Section 197: what a sale of business actually moves

Many sale of business agreements contain a clause along these lines: “The purchaser will offer employment to such of the seller’s employees as it may select, on terms to be determined by the purchaser.” An annexure lists the chosen names. Somewhere in the warranties the seller undertakes to “deal with” everyone who is not on the list.

The clause reads as though the parties are choosing. If the transaction is the transfer of a business as a going concern, they are not. Section 197 of the Labour Relations Act 66 of 1995 has already made the choice, and it made it for every employee in the business.

One · What the section moves

Section 197(2) is short, and each paragraph carries something across to the buyer:

The contracts. The buyer is automatically substituted for the seller in all contracts of employment in existence immediately before the date of transfer.

The rights and obligations. Everything between the seller and each employee continues as if it had always been between the buyer and that employee.

The history. Anything done before the transfer by or in relation to the seller, including a dismissal, an unfair labour practice or an act of unfair discrimination, is treated as having been done by or in relation to the buyer.

The service. The transfer does not interrupt continuity of employment.

The history is the part buyers notice too late. A dismissal dispute the seller’s former employee has referred to the CCMA comes with the business, and so do the start dates that will drive severance pay if anyone is retrenched later.

The buyer has limited room to change terms. Section 197(3)(a) allows it to employ the transferred employees on terms and conditions that are, on the whole, not less favourable than those they had with the seller. That room disappears where any of their conditions are set by a collective agreement (section 197(3)(b)), and collective agreements and arbitration awards that bound the seller in respect of those employees bind the buyer as well (section 197(5)).

Two · When it applies

“Business” includes the whole or a part of any business, trade, undertaking or service. “Transfer” means the transfer of a business by one employer to another as a going concern (section 197(1)). Nothing in either definition requires a sale, and nothing requires the parties to agree that the employees will move.

The Constitutional Court set the approach in NEHAWU v University of Cape Town in 2002. Whether there has been a transfer as a going concern is a question of fact, decided objectively, and the court must look at the substance of the transaction and not its form. The relevant considerations include whether assets, tangible and intangible, pass to the new owner, whether workers and customers move, and whether the same business carries on. No single factor decides the matter, and the absence of an agreement to take over the workforce does not, on its own, take a transaction outside the section. That case was decided on the earlier wording of section 197, but its approach to “going concern” has been followed ever since.

The court has since applied the section well beyond the classic sale. In Aviation Union of South Africa v SAA (2011) it rejected the view that section 197 cannot apply when an outsourcing contract ends and the service moves on to someone else. In City Power v Grinpal Energy Management Services (2015) it found a transfer as a going concern where a municipal entity ended its service agreements with a contractor and took the business over itself.

The definition also explains when the section does not apply. When the shares in a company are sold, the employer does not change: the company that employed the staff on Friday still employs them on Monday. There is no transfer from one employer to another. The labour risk stays inside the company the buyer has bought, which is why it belongs in the due diligence and the warranties.

Three · What the seller and buyer cannot agree on their own

Section 197(2) applies “unless otherwise agreed in terms of subsection (6)”. That agreement must be in writing. On one side sit the seller, the buyer or both of them. On the other side sits the party the employer would have to consult about retrenchments under section 189(1): the person named in a collective agreement, a workplace forum, a registered trade union whose members are affected or, failing those, the affected employees or their nominated representatives. The employer must disclose all the relevant information that party needs to negotiate effectively (section 197(6)(b)).

So the seller and the buyer cannot, between themselves, agree that the employees stay behind. A clause in the sale agreement that says so does not bind the employees, and acting on it is expensive. Section 187(1)(g) makes a dismissal automatically unfair if the reason for it is a transfer, or a reason related to a transfer, under section 197. Compensation for an automatically unfair dismissal can reach 24 months’ remuneration (section 194(3)), double the ceiling for an ordinary unfair dismissal.

That does not mean nobody may be retrenched around a sale. A genuine operational reason, properly consulted on, remains available to either employer. What a court will examine is the real reason for the dismissal, and a retrenchment whose real reason is that the buyer did not want the people is unlikely to survive that examination.

Four · What they must agree

This is where the sale agreement does real work. Section 197(7) requires the seller to agree with the buyer on a valuation, as at the date of transfer, of the transferred employees’ accrued leave pay, the severance pay that would have been payable on a retrenchment, and any other amounts that have accrued but not been paid. The seller must also conclude a written agreement that says which of them is liable for those amounts, on what terms any apportionment is made, and what provision has been made to pay them. The terms of that agreement must be disclosed to each employee who moves to the buyer.

The reasons sit in the next two subsections. For 12 months after the transfer, the seller is jointly and severally liable with the buyer for those amounts if a transferred employee is retrenched, or the employer is liquidated or sequestrated, unless the seller can show that it complied with the section (section 197(8)). And the seller and the buyer are jointly and severally liable for any claim concerning a term or condition of employment that arose before the transfer (section 197(9)). The parties can decide between themselves who finally carries those amounts. They cannot decide that the employees may not claim them.

Two further points for whoever is drafting. If the seller is insolvent, or the sale is part of a compromise or arrangement to avoid winding-up or sequestration for reasons of insolvency, section 197A applies instead of section 197, with different consequences. And the VAT clause does not answer the labour question. Section 11(1)(e) of the Value-Added Tax Act 89 of 1991 zero-rates the sale of an enterprise as a going concern only where, among other things, the buyer is a registered vendor and the parties have agreed in writing that it is sold as a going concern. Section 197 asks its own question on the facts. Calling the sale a going concern for VAT purposes is evidence for the labour question, not the answer to it, and leaving the phrase out will not avoid the section.

Five · Five drafting habits for the sale agreement

Decide early, on the substance, whether the deal is a transfer of a going concern, and record why. If it is a share sale, say so, and carry the employment risk into the warranties instead.

Build the employee schedule from the payroll, not from memory. Start date, current terms, leave balance and any accrued amounts for each person. That schedule is the basis of the section 197(7) valuation.

Write the section 197(7) agreement as its own clause or annexure. The valuation, who pays what, the provision made for payment (a price adjustment, a retention or a guarantee), and the date by which the terms will be disclosed to the employees.

Ask for a disclosed list of pending CCMA referrals, Labour Court matters and grievances. Take a warranty that the list is complete and an indemnity for anything that is not. Those matters move with the business under section 197(2)(c).

If the deal really needs different terms or fewer people, negotiate the section 197(6) agreement before signing. Conclude it with the right consulting party and make the sale conditional on it. Writing the outcome into the sale agreement and hoping is not a plan.

A sale agreement moves the price, the risk and the paperwork between a seller and a buyer. The people who work in the business are moved by the Act, and they arrive with everything they had.

Sources: Labour Relations Act 66 of 1995, sections 187(1)(g), 189(1), 194(1) and (3), 197 and 197A; National Education, Health and Allied Workers Union v University of Cape Town 2003 (3) SA 1 (CC), paragraphs 53, 56 and 58; Aviation Union of South Africa v South African Airways (Pty) Ltd 2012 (1) SA 321 (CC), paragraph 81; City Power (Pty) Ltd v Grinpal Energy Management Services (Pty) Ltd 2015 (6) BCLR 660 (CC), paragraphs 36 and 40; Value-Added Tax Act 89 of 1991, section 11(1)(e). This piece is general information, not advice on a particular transaction.