Key Items to Review When Performing Human Resource and Employment Due Diligence

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In the world of cross-border mergers and acquisitions, complex human resource and employment considerations arise during the transaction’s due diligence process. Depending on the transaction’s structure, these issues can be diverse and range in topics from immigration requirements to employee benefit matters to employee representative consultation obligations. 

From the purchaser’s perspective, proper human resource and employment due diligence can help structure a transaction’s terms and limit any unwanted surprises after the deal is signed or closes. Conversely, failure to spot key human resource and employment diligence issues can cause business interruptions and liabilities and negatively impact employee morale.

In this short article, we outline some essential human resource and employment items for cross-border transaction due diligence. This is not intended to be an exhaustive list of due diligence matters and, as with any piece of this kind, should not be relied upon as legal advice.

Employee Consultation Obligations and Collective Bargaining Agreements

In many countries, a target company’s employees may be represented by a union, works council, or other employee representative body and covered by a collective bargaining agreement. 

Closely analyze employee representative arrangements to assess if there are notification or consultation obligations that must occur before the transaction is signed and/or the deal is closed. It may take anywhere from a few weeks to a few months to satisfy the applicable requirement, so it’s important to build sufficient time into the deal timeline to account for the necessary processes. In some cases, employee representatives may also have co-determination rights, which require the applicable employee representative to consent to the transaction before it proceeds. 

Failure to properly observe applicable notification, consultation, or co-determination rights can result in criminal liability. It can also result in litigation and materially delay the transaction’s consummation.

Change in Control and Severance Provisions

To determine whether any meaningful payouts or entitlements will be triggered by the transaction, review key employees’ agreements.

In particular, perform diligence on any agreements containing transaction bonuses, severance provisions, equity acceleration clauses, or so-called “change in control” terms. Assessing this before signing the transaction will help the purchaser determine if new employment agreements should be provided in connection with the transaction (or as a condition of the transaction) to supersede existing entitlements.

If the transaction will trigger such payments or entitlements, this may also result in material tax issues. As a result, tax diligence should also be performed as part of this review.

Pension Schemes

Review employee retirement and pension schemes, and pay particularly close attention to the types of pension plans the target company has in place in any asset purchase transaction or transaction where employees are changing employers outside the US. If the target company participates in or has participated in a defined benefit pension scheme outside the US (as opposed to a defined contribution pension scheme), there may be significant liabilities. In such case, perform robust due diligence before the transaction’s signing to ensure all legal requirements are followed, the transaction agreement adequately protects the purchaser from the target company’s existing liabilities, and the purchaser understands its pension obligations if it moves forward with the transaction. 

Independent Contractor Status

Many companies engage individuals as independent contractors, but treat them like employees in practice. Most countries require a company to reclassify an individual as an employee if the individual is being incorrectly categorized as an independent contractor. If the misclassified individual who provides services to the company is not employed by another entity that is properly treating the individual like an employee (e.g. withholding taxes and remitting social security contributions, accounting for overtime, etc.), liabilities for the company can be significant. This is especially true if the company’s relationship with the individual has gone on for a significant period of time at a high pay rate.

Review a global census of the target company’s independent contractor engagements to assess if independent contractor misclassification might be a material issue. If it is, conduct additional diligence to determine if the purchaser should seek a specific compliance representation with a corresponding indemnity in the transaction agreement.

Immigration Issues

Companies that have multinational workforces often employ individuals with visa requirements or other immigration needs. When a change in ownership of the company or corporate structure that sponsors the applicable employee visa or work permit occurs, the change typically requires a filing or notification with the local immigration authority. Failure to adhere to applicable immigration filing and notification requirements can result in stiff fines, the suspension of the sponsored employee’s ability to work, and the inability to sponsor employees in the future.

Assess whether the transaction triggers a change of corporate ownership or employer that will require updates to any employee’s visa or work permit. If updates are required (including obtaining a new visa or work permit), bake sufficient time and terms into the transaction to account for them (e.g., filings and approvals from the local immigration offices). Such authorizations can take several months depending on the country and type of change. Review any immigration restrictions or waiting times that may also be in place due to COVID-19. 

If the target company is a company with a moderate US headcount, conduct diligence on the target company’s I-9 compliance. Failure to comply can result in material fines and other criminal penalties.  Performing diligence on this issue will also help the purchaser assess whether it should redo target company employee I-9s within the prescribed post-closing time period to mitigate any legacy liability.

Unique State or Local Requirements

Depending on the transaction type and jurisdictions involved, conduct targeted local due diligence. For example, California has several notable state and local laws on employee privacy, restrictive covenants, paid sick leave, vacation payout, and employee classification that do not apply to many other US states.  If the transaction has a material nexus to California, perform diligence into the target company’s compliance with California specific employment laws. Similarly, depending on the nature of the target company’s business and the transaction’s nexus to the EU, performing due diligence on employee staff leasing, GDPR compliance, and pay equity obligations may be worthwhile.

Conclusion

While there are many other important diligence items that should be reviewed as part of standard human resource and employment due diligence on a cross-border transaction, do not overlook the foregoing items. As a best practice, ensure the purchaser’s deal team has a thorough checklist of all due diligence items it wants to cover as part of the transaction’s due diligence process. As due diligence progresses, hone in on key issues based on the information gleaned from the target company’s diligence responses.  Submit supplemental diligence requests to flesh out any material open issues.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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