Labor Issues a Costly Concern During Acquisitions

When a company is considering a merger or weighing the idea of an acquisition, it is crucial to assess the impact on operations and, specifically, on labor and employment issues.

Deal attorneys and bankers focus on the underlying value analysis and purchase documents, which clearly are important.

However, liability for labor and employment issues can be created by acts or omissions and rarely is avoided solely by virtue of indemnification clauses or seller warranties in deal documents.

Put simply, our legal system operates in large part to protect the “little guy,” which in the employment context, means the employee, not the company. This means that, despite the iron-clad separation of entities from a financial perspective, if operations continue following deal closure, an acquiring entity may be held liable for workplace obligations agreed to by the seller-predecessor or for acts or omissions creating liability prior to the close of the purchase. 

The Employee’s Right

How can this be, you ask? Remember the little guy. If they felt like they were wronged before the deal closed, they will chase both companies (especially if the selling entity was in financial distress). From a legal standpoint if, from our employee’s perspective, nothing changed after the deal closed — same physical office, same managers, same processes — it is possible the buyer may be found liable for the wrongdoings of the predecessor entity.

The idea is that a company should not be able to escape liability to its employees solely by changing its corporate name and closing a deal. Someone needs to make sure the little guy’s wrongs are righted.  The way the courts often do it is by extending that liability to the “new” entity. The question is, how does “NewCo” avoid this? Ensure labor and employment are key components of due diligence, including the following:

Wage and hour. If you are the seller, conduct internal policy and practice audits on wage and hour issues as part of due diligence. These audits can reveal existing procedural violations that could mushroom into “bet the company” class actions if not cured (or expressly carved out of the purchase price!). Some examples of such issues are pay stub compliance, meal/rest break issues, and employee or contractor misclassification. One of the most frequently overlooked areas of exposure is unpaid vacation or paid time off for employees of the selling entity — all of whom would technically be terminated (and thus owed these monies) in an asset purchase. Even if the buyer hires every one of them.

Employment agreements. Know your obligations to employees, no matter the role. High-level executives who are key to the transition often have change in control or severance provisions in employment agreements that trigger significant payouts in an asset deal. If the buyer wants to retain these folks, the terms of new employment should be agreed-upon before closing. The buyer also should be conscious of any restrictive covenants — if key personnel are departing as part of the deal, make sure you are protecting your assets by limiting their ability to go across the street and start a competing concern. Even in California, noncompetition arrangements are available for limited purposes in the context of a purchase or sale of a business.

Turnover/hiring practices. Prepare yourself for WARN Act obligations, which require extended notice/payout periods, even if employees are not going to miss a day of work because they are being hired by NewCo. Diligence should include a discussion of which entity will be handling WARN and COBRA notices. And once NewCo takes over, to help avoid the type of pass-through liability described above in the context of an asset deal, it should follow standard hiring practices for each of the “old” employees. Assess them like any other new hire, and ensure all paperwork is completed to establish the new business relationship.

Labor union issues. Make sure you know about the seller’s union agreements or activity. Ask whether there have been organizing drives or union activity.  If there is any organized labor, ask to see all collective bargaining agreements and review all grievances. The CBAs may contain clauses obligating the buyer to assume the terms contained therein and the seller to expressly disclose the potential of a deal. If you are not planning to transition the organized operations to NewCo post-close, you may be responsible for posting a bond to cover the withdrawal liability for the multi-employer pension plan into which the seller previously contributed. This can be hundreds of thousands (or even millions) of dollars, and it is held in escrow for five years.

Immigration. Understand your employee base. Does the selling entity have employees for whom it has sponsored work visas? If so, there needs to be an assessment of transferability and a discussion regarding that process. Does the deal involve international payments or taxes or transfers of operations that will necessitate analysis of non-U.S. issues?

Any company considering a merger or acquisition is acutely focused on the potential effect on its balance sheet from a pure numbers standpoint. It is axiomatic that a business’s largest asset (or liability) can be its workforce. Remember that effectively transitioning operations requires careful planning and educated decision-making as to how, or if, NewCo will be adopting the prior workforce and the policies and practices that applied to it. In order to make responsible decisions regarding the value of any prospective transaction, and the risks associated with it, both sides should look beyond the balance sheet to the people on the ground.

As these issues highlight, diligence regarding matters of potential exposure stemming from the labor and employment function is crucial when assessing the true net impact of a potential deal on your company’s bottom line. The little guys can have a huge impact; don’t overlook that in your focus on the paperwork.