Don’t Forget Employment Diligence When Tying Up a Merger

Mergers and acquisitions involve more than business strategy. When companies change ownership or structure, employees’ rights and obligations become crucial considerations. The legal nuances of employment law and their impact on a deal can be critical to a successful or a failed transaction.

Employment diligence is an important step in the deal process and ensuring employee-related liabilities and obligations are identified and addressed is key. Contractual obligations with employees must be honored and considered.

It will be important to strategize how the surviving entities’ workforces should look—who will be laid off, who will continue on, who might be transferred, and under what circumstances. Addressing these questions up front saves time and reduces risk.

Employment Diligence

The employment diligence process involves a detailed review of a company’s workforce, employment contracts, compensation structures, benefits programs, and overall compliance with labor laws. It also helps identify potential liabilities and risks associated with the workforce, which can significantly impact the overall value and success of a transaction.

Employment contracts and agreements. Reviewing existing employment contracts is essential to understand potential ongoing obligations, such as non-compete clauses, severance agreements, retention bonuses, and arbitration provisions (whether such provisions are legally enforceable). Identifying these elements allows for better negotiation of the definitive agreement and separate employment agreements, and helps with advance planning for the post-closing integration.

Compensation and benefits. Analyzing compensation and benefits structures helps ensure they align with the acquiring company’s policies, and can reveal any disparities that could expose you to litigation. This includes examining salary scales, bonus plans, stock options, and other benefits.

Labor laws. Ensuring compliance with local, state, and federal labor laws is crucial. This includes verifying adherence to wage and hour laws, health and safety regulations, anti-discrimination statues, and more. Proper classification of employees versus independent contractors, or exempt employees versus non-exempt employees, for example, is vital to avoid misclassification issues which can result in penalties and back wages.

Standard company policies will also need review, including sexual harassment policy and training obligations, as well as any discrimination or harassment complaints. Non-compliance with existing labor laws can lead to significant legal repercussions, and may require special treatment in the business transaction, such as a special indemnity provision.

An employment attorney can conduct a detailed review of all employment-related documents, including policies and practices and any pending or past litigation involving employment matters. This identification of employment-related liabilities early in the transaction process helps mitigate risks that could otherwise lead to costly disputes or legal challenges post-transaction.

Additionally, a comprehensive understanding of the workforce allows for informed decision-making, enabling better negotiation and integration strategies.

Contractual Obligations

As an initial matter, it’s helpful to identify the key employees as early in the process as possible. These are typically employees critical to the business and are frequently expected to play an important role post-closing, such as transitioning the business to the new owner, ensuring there is continuity in customer contracts, or being the linchpin in the post-closing operations.

Oftentimes, the key employees of a selling entity must sign certain employment agreements with the purchasing entity as a signing or closing condition. Understanding what contractual obligations may be owed to these individuals is often key to drafting new employment agreements.

Many employees, and particularly executives, have change of control provisions in their contracts. These provisions provide for certain benefits to be paid either upon a change of control (single-trigger agreement) or if an adverse employment action occurs within a specific time period of a change of control, such as if the employee is terminated shortly following the closing of the transaction (double-trigger agreement).

If such agreements are in place, the purchaser will need to account for those potential financial liabilities or agree to contract around them after closing.

Employee Transfers

Given the value of employees to an organization, being able to effectively transfer employees post-closing can be key to a successful transaction. Employee transfers should be negotiated and detailed in the definitive agreement where possible to avoid later disputes.

If the purchasing entity is interested in employing the seller’s workforce post-closing, those individuals will need to be provided offer letters notifying them of the change in owner. Those documents outline the employees’ go-forward compensation and benefits, frequently subject to a preservation period following closing as negotiated between the parties, during which time they are guaranteed certain benefits and compensation.

Employee consent may also be required for the transfer. If the workforce is subject to a union or collective bargaining agreement, additional requirements may need to be satisfied.

If there is a risk of employment termination, either because employees aren’t transferring in the transaction or by operation of law, the federal Worker Adjustment and Retraining Notification Act and any state or local corollary will need to be considered.

Finally, if the transaction is occurring overseas, there may be a required works council agreement or other cross-border complexities.

Once the employee transfers have been determined, entities may want to negotiate a minimum percentage of transferring employees as a closing condition, to ensure the employees map into the remaining organization as planned.

Non-Competes

Non-compete agreements are currently under fire in the US, including the FTC’s recent rule restricting such agreements in most circumstances, which was recently enjoined by one court.

The rule doesn’t apply to restrictive covenants entered in connection with business transactions, but entities would be wise to contact an experienced labor lawyer prior to asking employees to execute such a document to ensure it’s legally compliant. Furthermore, in states where noncompetes are void or subject to specific state laws such as notice obligations or compensation minimums, it will be important to be mindful of any such contractual provisions in employee documents.

Given the importance of employees to finalizing a successful transaction, companies contemplating entering into a deal should consult with knowledgeable employment counsel to ensure potential pitfalls are avoided, where possible.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Rebecca Stuart is partner at Sidley Austin and focuses her practice on representing employers in federal and state court litigation.

Write for Us: Author Guidelines