Human Resources In M&A Deals – A Critical Analysis

Any form of

restructuring of

business impacts human

resources and hence,

the need to address

concerns related to

human resources…

Human resources and their management

plays a crucial role in the success of any

organization. Thus, an acquirer needs

to pay attention to matters relating to

human resource as there may be financial

implications or operational issues having an impact on

the structure and/or valuation of the deal.

Business restructuring is a necessity for survival and

growth and brings about efficiency and profitability in

today's competitive global economy. Restructuring of

business can take a variety of forms. No matter the form,

there is always an impact on human resources. Hence,

the need for evaluating and addressing concerns relating

thereto is critical for successful implementation of the

transaction.

Share Acquisition

In a share acquisition, the purchaser acquires the entire

legacy of issues and liabilities of a company. Therefore,

due diligence plays a vital role to identify problem areas

to be addressed and resolved in the initial stages of the

deal.

Significant diligence matters include: identifying noncompliances

of statutory obligations that can lead

to potential financial liabilities, labor disputes, and

possible criminal prosecution; classification of nature

and number of the workforce for identification of

potential issues and regulatory requirements, workforce

restructuring, and integration; and examining employee

benefits to ascertain financial obligations. Similarly,

terms of employment are essential where there are

financial implications on change in control or loss of

office. Such conditions are primarily found in senior

management contracts. Where there are trade unions,

there will be collective bargaining agreements requiring

adherence to terms and consultation where such terms

are impacted. Also labor unrest and litigation by or against

an organization by employees or labor authorities are

critical red flags in terms of financial liabilities, criminal

prosecution, and disruption of operations.

Retention of key talent is an important factor in the success

of an M&A. Much of this depends on the manner of talent

alignment and development, incentives, and integration

management. A key aspect for retention is incentive.

Transaction bonus and retention bonus to key senior

management employees are like a double-edged sword for

retention and smooth completion of the transaction and

transition process.

However, in case of separation of key personnel, protection

of the company's proprietary and confidential information

becomes imperative. Given that non-compete provisions

are not enforceable beyond the contractual period unless it

is in connection with the transfer of goodwill, other forms

of safeguards need to be built in to protect the company's

interest, such as return of company assets and proprietary

information, non-disclosure, and non-solicitation

obligations. Such restraints though enforceable beyond

the term of employment must be reasonable and should

not operate indefinitely.

Merger/De-Merger/Business Transfer

Acquisition by way of merger, de-merger, or business

transfer essentially envisages transfer of a business

undertaking resulting in a change of employer. Employees

are transferred to the buyer pursuant to purchase of

the business undertaking. Labor law in India does not

recognize automatic transfer of employees to a third party

unless the conditions of employment contain an express

stipulation of transfer. Typically, contracts of employment

provide for transfer within departments, locations, and

group companies. Transfer to a non-group entity requires

express or implied consent of employees.

Transfer of workmen category employees (i.e., those who

are engaged for any manual, clerical, skilled, un-skilled,

operational, technical, or supervisory work) should be on

no less favorable terms with continuity of service otherwise

they would be entitled to notice and retrenchment

compensation. Hence, a benefit analysis as part of the

diligence becomes critical to satisfy this condition. A holistic

approach should be adopted to ensure that the benefits to

be provided by the buyer are materially not less favorable.

Non-workmen are not subject to such conditions, although

practically such employees are transferred on similar terms

to maintain parity.

Risk of retrenchment compensation claims upon change

in employment conditions following business transfer is

one of the challenges faced in such transactions. Where

change in employment conditions is to the detriment of

the employees, there could be a claim that the transfer of

employment was not on equal terms.

With the employees, the related benefits are also

transferred to the extent possible. Typically provident fund,

gratuity, superannuation, and un-utilized leave balance

are transferred. Analysis of structure of these benefits with

the seller and the buyer aids in determining the process for

transfer. Many organizations establish private funds for

providing PF, Gratuity, and Superannuation benefits. The

accumulations in these funds are typically transferred to a

similarly placed fund of the buyer.

Along with assets, a business carries with it the baggage of

successor liability. The EPF Act and the ESI Act specifically

provide that the acquirer of a business undertaking is jointly

and severally liable with the seller for the past liability.

However, the liability of the buyer is limited to the value

of the assets acquired. Therefore, it is important to obtain

indemnities or adjust the deal value in case due diligence

reveals any default of the seller in PF and ESI contributions.

As a successor, the buyer is also bound by any settlement

agreements with trade unions.

Occasionally, a business restructuring in India is connected

with a global acquisition where the Indian leg either

precedes or coincides with the global acquisition. In such

cases, it may not always be possible to establish payroll

and transfer-accumulated benefits by the closing date.

While the obligation to pay salary and contribute towards

PF is the obligation of the transferee entity, it is possible for

the transferor to make such payment on behalf of and in the

name of the transferee during the transition period.

Asset Sale

In an asset sale, identified business assets are purchased

by the acquirer instead of acquiring a going concern. This

method is often adopted where the undertaking is saddled

with several historical issues. Liabilities are dissected

from the assets purchased. Since there is no transfer of an

undertaking, the acquirer can cherry pick the employees

it may choose to offer employment to. Unlike a business

transfer, there is no requirement to ensure favorable terms

of employment to the workmen. Nonetheless, in order

to induce employees to join the acquirer, the terms of

employment are equal or more beneficial and past service

is contractually agreed to be recognized for the purposes

of retiral benefits. Ordinarily, workmen-category employees

are to be paid retrenchment compensation when termination

occurs without cause. However, voluntary resignation by a

workman falls outside the purview of retrenchment. The

challenges faced in such transactions is the uncertainty of

employees joining the employer; claim of coercion; demand

for retrenchment compensation; and attempts to thwart the

sale by unionized employees.

Where the purchaser does not intend hiring the employees,

the seller would need to either terminate or re-deploy the

employees. Process for termination for workmen category

may include seeking a prior approval from the authorities in

case of a manufacturing unit where 100 or more workmen

are engaged. In a non-manufacturing unit, there is only

an intimation requirement. Other requirements include

compliance with the last in, first out principle unless

justifiable reasons for deviation can be demonstrated, and

the right of first refusal to the retrenched workman in case

the employer intends to hire in future in the same position.

Ancillary Matters

Integration and Harmonization: The success of a merger

and acquisition depends on how well an organization

deals with issues relating to integration. Key matters

which the HR of an organization should know are the

identified employees to be hired, the terms of employment,

compensation and benefits, roles and designations,

reporting lines, nature of liabilities, and labor compliances.

Timing of harmonization is critical to eliminate claims of

retrenchment compensation.

Employee Communication: Communication plays a very

critical role at the time of business restructuring. Keeping

employees informed on a need-to-know basis about the

deal and the reasons at each stage of development helps

in mitigating unnecessary rumors, unrest, and retaining

talent.

Downsizing: Plans of downsizing should be swiftly

implemented so that it does not become a hindrance in the

process. The method adopted for downsizing is another

critical aspect for consideration.

Reporting Requirements: Depending on the structure,

a business restructuring results in change in ownership

management and headcount which needs to be reported to

the statutory authorities under the EPF, ESI, Shops Act, and

Factories Act.

Disclaimer – The views expressed in this article are the personal views of the author and are purely informative in nature.