Labour and employment issues in M&A

August 2023  |  FEATURE | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

August 2023 Issue

Any company engaged in M&A is sure to encounter labour and employment issues on some level. Resolving these issues effectively and efficiently can significantly improve the chances of a successful deal.

Of course, all transactions are different, and the types of employment-related challenges that may arise will depend on the nature of the individual deal as well as the jurisdiction in which it is taking place. But there are some common features from a labour and employment perspective. Failure to adequately examine the existing rights and obligations between the target company and its staff can result in expensive employment claims, administrative fines and other liabilities.

Never skip the diligence

Due diligence is an integral part of any M&A transaction. “Labour and employment is an essential component of due diligence and it is strongly recommended to have labour and employment counsel involved early on to assist in formulating tailored diligence requests,” suggests Daniel J. Doron, a principal at Jackson Lewis. “It should involve identifying ‘surfaced’ exposure and assessing the materiality of the exposure, identifying areas of latent exposure that could become material, and identifying areas that are important for their operational implications.”

There is a financial aspect to due diligence as well, as it may affect deal valuation and shape the course of negotiations between buyer and seller. “Thorough due diligence is critical to understanding the total cost of the transaction,” says Mark Theodore, a partner at Proskauer. “The actual cost of a deal could be 10 or 20 percent greater than the purchase price, once the buyer takes into account legal liabilities, including actual damages, fines, penalties, legal fees – both the company’s and employees’, which the company may be required to pay – and punitive damages. By identifying these liabilities through the diligence process, the buyer may be able to negotiate a reduction in the purchase price or obtain specific indemnity or insurance to cover these hidden costs.”

According to Mr Doron, if representations and warranties insurance (RWI) is to be procured for the transaction, underwriters will expect to see a comprehensive and credible report on labour and employment due diligence “Failure to conduct due diligence may lead to a broad policy exclusion,” he points out. “Even in a non-RWI deal, conducting employment due diligence is a vital element of fulfilling the duty of care owed to shareholders and investors.

“The courts have also spoken on this issue,” he continues. “While the general rule is that, in asset deals, the liabilities may be left behind with the seller, that is not the case for labour and employment liabilities. A key inquiry in saddling an asset purchaser with the labour and employment-related liabilities of the seller is whether the purchaser had notice of the liability. Courts will readily charge the employer with having ‘constructive notice’ under the theory that, in an evolved M&A environment, the purchaser is expected to have conducted labour and employment due diligence, and should not be rewarded for burying its head in the sand.”

Going by the book

When addressing labour and employment issues, acquirers must take into account relevant laws which may dictate the methods they use to approach these subjects.

In the US, for example, topping the list of employment issues in M&A transactions are wage and hour compliance concerns and independent contractor misclassification concerns. “Wage and hour is the area most prone to class or collective action litigation,” says Mr Doron. “Independent contractor misclassification has ramifications ranging from wage and hour exposure, to tax liability, to benefits plan issues and beyond. Further, the use of independent contractors sometimes goes to the core of the target’s business model, such as in a gig economy-based business or in certain healthcare businesses.

“Of course, the most important risks to assess are often specific to a given business. For example, where the target’s business involves the development of vital intellectual property assets, the adequacy of the inventions assignment agreements used by the target is a critical concern,” he adds.

Acquirers should take the opportunity to thoroughly vet their potential new employees. But in the US, the federal Fair Credit Reporting Act (FCRA) establishes rules under which employers generally may obtain and use a background check on a potential employee from a third-party source, and requires employers to take certain steps at three different stages: before requesting a background check, before taking adverse action based on one, and after taking adverse action. In addition to the federal law, many states also have their own background check statutes. Failure to comply with the FCRA or state background check laws can result in costly legal action for acquirers.

In the UK, according to Mark Kaye, a senior associate at Bryan Cave Leighton Paisner LLP, the most significant labour and employment issues in an M&A transaction arise in the context of an asset purchase where there is a transfer pursuant to the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE).

“From a process perspective, the key impact of TUPE applying is that there is an obligation on the seller to inform – and possibly consult with – elected representatives of the affected employees,” he says. “If there is a recognised trade union in place, that body must be engaged. If not, employee representatives must be elected. The buyer must also provide the seller with a ‘measures letter’ setting out any measures that it envisages taking post-closing. This will form part of the information process. Generally, the information and consultation process should last for at least 30 days prior to closing.

“Another key issue arising from the application of TUPE is that the buyer cannot harmonise the contracts of employment of the transferring employees, and any detrimental changes to terms and conditions will be invalid – even if the changes are consensual – if the sole or principal reason for the change is the TUPE transfer. A further challenge is that, in relation to those employees who have two years or more of continuous service, a dismissal will be automatically unfair if the sole or principal reason for the dismissal is the TUPE transfer,” he adds.

Can we get along?

People risks are an increasing concern in the deal process. “A due diligence process will often flush out existing issues which may be detrimental to the business post-closing, as well as flagging up trends which may be of concern,” points out Mr Kaye.  “For example, a significant number of employee grievances may indicate that there are systemic problems within the business which may create cultural issues for the buyer post-closing.”

Integration, retention and cultural challenges mean acquirers must think long and hard about the impact of their transactions on the workforce, and plan accordingly.

“A risk in any M&A scenario is a ‘culture clash’ between the seller and the newly combined organisation,” suggests Mark Theodore, a partner at Proskauer Rose LLP. “Successful integration of the seller’s workforce is critical to retaining key employees. For this reason, the purchaser should work to learn about the seller’s existing company culture and maintain continuity when possible.

“Important aspects of the seller’s company culture and working conditions that the purchaser may consider retaining at least for some period of time include wages, employee benefits, reporting structures, workflow management and vacation scheduling,” he continues. “Most employees find that change is stressful. Any changes to the seller’s company culture should be rolled out in an incremental and thoughtful manner to minimise the impact on employee morale.”

Workers of the world

Given the state of the global economy, individuals and companies alike have experienced widespread economic pressure. Issues around pay, inflation and the ongoing cost of living crisis have contributed to shifting priorities for many employees, which, in turn, has increased the visibility of unions and other employee representative bodies.

As the number of workers interested in union membership grows, and where the possibility of strikes lingers, the role of unions in an M&A process (as well as beyond deal closing), should not be overlooked.

“In heavily unionised businesses, the key issue for a buyer is to ensure that there is proper engagement with the trade union prior to closing in order to reduce the risk of strike action – or other industrial action – post-closing,” says Mr Kaye. “Due diligence in relation to the seller’s relationship with the trade union will be critical in this respect.”

Accordingly, when pursing a deal in which the target employees are members of a union, there are a number of factors for acquirers to consider. “Transaction form becomes a key consideration,” says Mr Doron. “In a stock deal, the union recognition and collective bargaining agreements will transfer as a matter of law. In an asset deal, union recognition is less straightforward but is governed by a set of well-established common law rules. Structuring of the post-closing business is also a key consideration, particularly if the purchaser’s objective is to establish a lawful and defensible ‘double breasted’ operation – a business with both union and non-union workforces.

“It is vital to get a grasp of potential multi-employer plan issues. Does the target contribute to multi-employer pension plans (MEPPs)? Are there current estimates of the withdrawal liability? Will the transaction itself trigger a withdrawal by the seller? Will the liability be assumed by the buyer and, if so, how much? Finally, it is important to ensure that the parties comply with their respective obligations – if any – concerning notice to the union and engaging in ‘effects bargaining’, meaning, bargaining over the impact of the transaction on the employees,” he adds.

According to Mr Theodore, any group that gains a voice in the press can affect a transaction. “Unions have gained a great deal of momentum and visibility coming out of the pandemic as a voice of workers who felt mistreated during the crisis,” he says. “The voice of labour is, at the moment, as loud as it has ever been. That voice can translate into an impact on dealmaking. If the labour unions support a deal, that support could help overcome regulatory hesitancy. If the labour unions are against a particular combination of companies, government approvals, and perhaps even shareholder approvals, could be harder to achieve.”

Though there are limitations to the impact that unions and works councils can have on a transaction, companies must be aware that their influence can still have a bearing in other ways. As Mr Theodore notes, with some exceptions, most European works councils cannot unilaterally block a deal. Equally, unions in the US have no power on their own to block a transaction.

“In certain circumstances, however – particularly where there is a direct relationship between the labour organisation and the employing entity that is the subject of the deal – these entities can utilise their power to slow the regulatory approval process or sow doubt in shareholder minds about the benefits of the deal,” he warns. “The unions may not want to block a transaction but seek some concessions to support it and will apply pressure to achieve their objectives.”

Labour and employment issues will continue to increase pressure on organisations going forward, particularly in industries which have strong, active union representation. However, by prioritising due diligence and preparing to address likely challenges, acquirers can overcome most issues.

© Financier Worldwide

BY

Richard Summerfield