October 17, 2017

Human Resources In M&A Deals – A Critical Analysis

- Pooja Ramchandani, Partner [ Shardul Amarchand Mangaldas ]

Pooja Ramchandani

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.

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