Key Takeaways

• With future legal attacks on workplace diversity, equity and inclusion (DE&I) efforts likely, private equity and strategic acquirers should engage in legal due diligence review of acquisition targets’ employment practices to ensure that those practices are compliant with current laws.
• Due diligence in the mergers and acquisitions (M&A) context should include specialist review of DE&I communications, initiatives, mission statements, policies, programs and resource groups as well as contractual DE&I obligations.
• Risk factors identified in the course of due diligence review of targets’ DE&I programs can be addressed through representations and warranties, specific indemnities, pre-closing covenants, and post-closing integration efforts.

The U.S. Supreme Court’s decision in Students for Fair Admissions, Inc. v. President and Fellows of Harvard Coll., No. 20-1199, 600 U.S. – (U.S. June 29, 2023) has opened the door to future legal challenges against DE&I efforts in the private sector. Just as private employers should take the opportunity to review their DE&I programs to ensure compliance with current law, private equity funds and strategic acquirers should conduct a legal due diligence review of targets’ DE&I programs to assess and address any risks of noncompliance.

Potential acquirers of companies with a material number of U.S. employees should request that any target DE&I employment policies be provided for review, and they should work with employment law specialists to assess potential risk. In addition to DE&I policies, counsel should review DE&I communications and mission statements, as well as related initiatives, programs and resource groups.  If necessary, counsel can assist with the design and implementation of an alternative approach to DE&I that meets the client’s objectives in a way that is compliant with law.

As we have previously discussed on July 5, 2023, DE&I hiring or promotion policies that rely on the use of group preferences or quotas based on protected categories (including race or ethnicity, among others) are already prohibited by federal law. However, the spotlight on such policies generated by the Supreme Court’s ruling makes it more likely that policies that are either noncompliant or susceptible to attack but may have escaped scrutiny in the past will be the subject of claims by private litigants.

Employment counsel should also review any provisions in the target’s material commercial contracts that purport to bind the target to its counterparties’ DE&I policies. Commercial contracts include customer and supplier contracts, distributor agreements, and licenses. There is financial as well as legal risk if a target is contractually required to engage in employment practices that are not compliant with law, particularly if the contract purports to bind the target’s affiliates (which, after the closing of an acquisition, would include the buyer).

Finally, the legal due diligence review should also consider any pending or historical litigation involving the target that contains DE&I claims. Factors to consider are the number of cases, the dollar amount of damages, and any equitable relief (such as an injunction) or other outstanding obligations under a settlement agreement.

The legal due diligence process enables a buyer to use the information uncovered to identify potential liabilities or risks and negotiate contractual protections.

As a starting point, a buyer can request that sellers provide representations and warranties about their DE&I program, including compliance with laws, in the purchase agreement. A breach of a representation would then give rise to a claim for indemnification, in accordance with the terms of the purchase agreement. Representations and warranties are used for protection against unknown liabilities.

A buyer that is already aware of a risk factor relating to the target’s DE&I program and does not want to assume any potential liability can seek a specific indemnity from the sellers. In that case, the purchase agreement would specifically provide that the sellers agree to reimburse the buyer for any costs or expenses incurred in connection with the particular practice or risk factor identified, including the costs of defending against any third-party claims.

In addition, in the case of a known risk, the buyer may want the sellers to correct the issue prior to closing. In that case, the purchase agreement would contain a pre-closing covenant of the sellers to take the required action and possibly a closing condition allowing the buyer to back out of the deal if the corrective actions are not taken.

Alternatively, the buyer may be willing to address any identified issues on a post-closing basis as part of the merger integration efforts or deployment of best practices. In relation to any DE&I risk factors, decision-makers with respect to hiring, promotions and compensation, as well as DE&I committees and personnel, may need to be retrained on how to properly address DE&I in accordance with the law.

While the effects of the Supreme Court’s ruling on the corporate world remain unclear, acquirers should guard against foreseeable risks to the extent possible and watch closely as further legal cases refine the conclusions of the Supreme Court.  

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