Intensive labour due diligence promises benefits for M&A

By Ankita Goel De Mallik, Amarchand & Mangaldas & Suresh A Shroff & Co

Acomprehensive due diligence before a private equity investment is an indispensable part of the investment process. For investors, this is an exercise to evaluate the assets and liabilities of the target and either factor these into purchase considerations, or forgo the transaction entirely.

Ankita Goel De Mallik Amarchand & Mangaldas & Suresh A Shroff & Co
Ankita Goel De Mallik
Amarchand & Mangaldas &
Suresh A Shroff & Co

A significant area in any due diligence exercise is the workforce comprising the target. Employment plans can be a major source of liabilities, especially in a merger or takeover, where the target’s liabilities are transferred to the acquirer. Further, an acquirer may not want to take over the employment plans of the target, because the liabilities are unfunded or disproportionate to its actual or projected income, because the plan may not be in consonance with its own employment policies, or because the acquirer may become liable as the successor to the target, for the target’s violations of law in the administration of the plan prior to the transaction.

The findings of a labour due diligence may be used to negotiate with the target to terminate or modify arrangements before the closing of the transaction to limit the acquirer’s liability, or to agree to indemnification provisions in the transaction documents specific to such liabilities. Any changes proposed to employment or benefit plans may require the consent of the affected employees.

The employment policies of the target could also prove important in structuring the investment transaction, as they may determine whether the transaction should be structured as a stock or slump sale i.e. as a going concern, and in a merger the entity that should remain post-merger. If the exposure on account of employment plans is significant, or if the transaction could be a ground for termination of important employee contracts (on account of change of control provisions in employment contracts) or trigger unforeseen payouts on account of termination of contracts, the investor may also want to reevaluate the price offered for the deal.

As a first step, it is important to check if the employment contracts are individually negotiated or standard contracts. Information should be sought from the target on wage levels, fringe benefits (most typically medical care plans including hospitalization coverage, life insurance, short- and long-term disability benefits, maternity benefits, professional development schemes, dependant care coverage, vacation and travel benefits and food providing plans. etc), welfare plans (details of retirement age, pension schemes, provident fund, etc), leave policies, severance pay, etc. It is also important to evaluate policies relating to training, recruitment and performance evaluation, data relating to the ratio of male to female employees, and department-wise distribution. Obtaining details of any ongoing or threatened labour-related disputes or litigation is of course, a standard practice.

Relations between the management and the workers should also be considered through an analysis of details of strikes and other disturbances date-wise; the method of making decisions regarding employees; the role of collective bargaining, etc. A review of provisions of disciplinary proceedings, code of conduct for employees, regulations governing employees and standing orders for the company may also be relevant.

If the acquirer does not want to absorb the entire labour force, there may be a retrenchment of employees in which case, either the target or the acquirer will have to pay compensation under section 25F of the Industrial Disputes Act, 1947 (IDA). Even in the case of ownership or management transfer in an undertaking, whether by agreement or by operation of law, compensation is required to be paid (as if the worker has been retrenched), unless the service of the workman has not been interrupted by such transfers and the terms and conditions of service after such a transfer are not less favourable than before (section 25FF of the IDA). The contract of employment exists between the workman and the target, so the immediate liability is on the target. However, the onus of payment may be shifted in the bargaining terms. The acquirer may also insist that the target transfer some workmen to another establishment owned by it, in which case there is no liability to pay compensation, as per section 25E of the IDA. As a corollary to this process, it may be beneficial to check the employment contracts for non-compete obligations operative post-termination.

It is pertinent to check if the target has entered into lease or leave and licence agreements on behalf of its employees, as (a) the acquirer company may not have a policy of entering into leases to provide accommodation to its employees, in which case it may be unwilling to transfer the leases to its own name, or (b) the leases may require renegotiations with the property owners if there are restrictive clauses on transferability of the lease or restrictions on sub-leasing.

In some cases there may be employee trusts set up by the target, in which case it is important to determine the effect of change in ownership or control or structure of the target company on these trusts. Details of stock options given to employees may be relevant, as they may enable the acquirer to take over or substitute rights in the acquirer’s stock for the rights in the target’s stock being lost in the amalgamation. Thus, the employees will perceive an incentive in the transaction and may be less opposed to it.

Ankita Goel De Mallik is a senior associate at Amarchand & Mangaldas & Suresh A Shroff & Co.


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