Managing labour law issues in cross-border M&As

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Priyanka Gupta of Majmudar & Co outlines the key employment concerns that companies could face following a merger

A change in the ownership or control of a company can have implications for its employees. However, employment related issues are often not adequately dealt with by either the transferor or the transferee.

This can create difficulties for the transferee – especially when the merger or acquisition is cross-border in nature.

The transfer of control could lead to new policies being implemented that in turn could lead to changes in the terms of employment. This could bring to light several issues with the original employment contract that could create problems for the new owner of the company.

Priyanka Gupta
Priyanka Gupta

Checking the fine print

The due diligence carried out on Indian companies as part of a merger or a financing transaction at times reveals that Indian employment laws may have not been fully complied with. For instance licences and permissions may not have been obtained, records and reports may be haphazard and employee benefits and stamp duties on employment related agreements may not have been paid. Such non-compliance may result in significant fines and other penalties for the company and in turn for the prospective purchaser company.

Thus, as a first step, the purchaser entity must carry out a comprehensive due diligence to ensure that the Indian target company or the seller is compliant with Indian employment laws.

While doing so, the purchaser must check if the Indian company has executed employment agreements with all its employees. If so, the fine print needs to be analysed to check the terms of agreement relating to change of control, termination, benefits payable, intellectual property assignment, confidentiality, non-compete, non-solicit, etc. For example, Indian law will not validate employment contracts with “at will” termination provisions and all kinds of non-compete provisions may not be enforceable.

In many cases, the original employment agreement ends up being a one-page offer letter that does not clarify the terms and conditions of employment, or in some cases, a loosely drafted employment agreement without intellectual property, trade secret, confidentiality protection or ownership provisions that comply with Indian law.

As such, what is discovered as part of a due diligence exercise is crucial. It will help the purchaser decide whether to absorb the Indian company’s employees on the same terms and conditions or to execute fresh agreements with them. Further, such issues can result in significant concerns when the agreements have to be enforced against the employees.

Understanding links

Another important issue is the seller company may be using consultants, contract labour and third party contractors. In such cases it is necessary to distinguish between an employer-employee relationship and a principal-independent contractor relationship to determine the purchaser’s liabilities and obligations.

It is vital to identify this segment of the workforce at the time of transfer to the new entity as there is a chance that the employees may raise regularization and permanency claims, even if there are agreements recording that they will not be regarded as the seller company’s employees. This could happen if the company has been exercising substantial direct supervision and control over these workers’ activities and if they provide the necessary work-related tools to the workers.

Trimming the wage bill

Moreover, if the purchaser does not wish to absorb all employees and some have to be terminated, the company will have to comply with the statutory termination requirements, which include severance compensation. Details of these severance payment obligations are provided in the Industrial Disputes Act, 1947, a central legislaton, and the Shops and Establishments Act, 1948, which is a state specific employment law. However these acts do not cover managerial employees. If contract labour has been used, the company needs to have complied with the registration requirements and the Contract Labour (Regulation and Abolition) Act, 1970.

Managing moves

If the key employees of the Indian company do not wish to be employed by the purchaser, the purchaser must assess the risk involved in the employee resigning. As the employee may have had access to the company’s critical business information, processes, trade secrets, etc., it is possible that such information could be misused. To avoid this, the purchaser together with the Indian company, can enforce confidentiality obligations on the departing employee, if the employment agreement provides for it.

However, as regards the non-compete obligations – several judgments have held that a non-compete provision operating beyond the term of the contract is void and unenforceable under section 27 of the Indian Contract Act, 1872. Therefore, a company may not be able to restrain a departing employee from joining a competitor.

If a foreign purchaser wants to send one of its employees into India to work with the company, the employment relationship will have to be structured carefully to avoid Indian income tax law issues with respect to creation of an Indian permanent establishment.

Further, while drafting employment policies for the Indian entity that draw on the basis of the purchaser’s global employment policy, care must be taken to ensure that it is compliant with Indian employment laws.

Safeguards

To get past labour-related issues in case of change of ownership, some purchasers have resorted to terminating the employment of all employees with the seller company before rehiring them under fresh agreements. Additionally, to avoid getting involved in litigation with the seller’s employees the deal between the parties could include indemnification provisions to cover such circumstances.

It is imperative that employment law issues be given due attention at the initial stage of the deal. Waiting to resolve them at a later date and as and when they arise would be unwise.

Last but not least, a strong human resources management policy should be implemented and employment law compliance ensured promptly upon closing of the deal.

Priyanka Gupta is an associate at the Mumbai office of Majmudar & Co, International Lawyers.