Post-Merger Integration: Employment and HR – marrying up the terms
The impact of failed M&A is not simply limited to the costs. Buyers will also need to consider the scope for reputational damage and the impact it will have on its brand. Like a divorce, the unwinding of the merger can be very complex, costly and emotionally draining. In some cases, walking away may not be an easy option.
Professor Scott Moeller, Director of the M&A Research Centre at The Business School, explored how unconscious bias affects deal success in his white paper that you can access along with more information on our dedicated Headroom page.
Professor Scott highlights in this White Paper that bias of excessive optimism and overconfidence could play a part in the decision making process, ‘with close to 50% of all deals failing – and the urban myth that it is even much worse than that – one reason for over 25,000 M&A deals being announced every year is that the board and CEO believe that ‘this time it will be different’’.
Bharti Moore, Senior Associate in RWK Goodman’s Corporate team comments “the success of a deal cannot be left to chance, care needs to be taken when dealing with personnel issues. The legal and operational changes arising from a post-merger may cause uncertainty and unrest for some staff. It is vital for the buyer’s board and management team to navigate integration matters in a clear and effective way, to mitigate legal risks and crucially to help deliver the operational success of the integration. The impact of failed M&A is not simply limited to the costs. Like a divorce, the unwinding of the merger can be very complex, costly and emotionally draining. In some cases, walking away may not be an easy option.”
In the latest instalment of our Headroom series on M&A deals, we look at the challenges faced for buyers and employers on the buy side, and point out some common pitfalls and overlooked opportunities around employment contracts that will help smooth an often bumpy transition.
What are the biggest risks to buyers when it comes to taking on employees of the target company?
- Acquiring employee liabilities
The biggest risk for a buyer in acquiring the seller’s workforce is taking on the liabilities arising from their contracts of employment. This may be in the form of overly generous terms and conditions in excess of usual market rates or liabilities arising from a seller’s failure to comply with its contractual and legal obligations. A failure to comply with health and safety duties, minimum wage laws or holiday pay calculations, for example, can create substantial exposure.
During the transaction process, specialist and detailed due diligence is essential to ensure that the buyer understands what it is acquiring. Although, suitable protections can be drafted into the transactional documents to protect the buyer, the integration team should get involved at this stage to start planning and looking ahead to explore how to minimise the legal and operational risks.
- Changing terms and conditions / harmonisation
A common challenge for a buyer is the limitations on its ability to change employee terms and conditions post completion. On a share purchase, the usual rules around varying contracts apply. However, on an asset purchase, the Transfer of Undertakings (Protection of Employment) Regulations (TUPE) provide significant protection to transferring staff against changes to their terms and conditions. Post-transfer harmonisation of terms is unlawful which can lead to a “two-tier” workforce.
- Key personnel and Restrictive covenants
The loss of key personnel, who are critical to future business successes can pose a risk to buyers.
On an asset purchase, where TUPE applies, if an employee objects to the transfer of their employment to the buyer, their employment ends immediately, by operation of law, on the transfer date. There is no statutory novation of their employment contract and so no contractual relationship arises with the buyer. This may have the effect of nullifying any restrictive covenants, as the buyer has no way of enforcing them and the seller will no longer have any legitimate interest to protect.
Even where staff do transfer, restrictive covenants in employment contracts can be problematic for the buyer. Depending on the particular circumstances, restrictive covenants in transferring employees' contracts may not protect the buyer’s interests because the covenants will be interpreted by reference to the seller and its business. It is therefore not uncommon for buyers to try to agree new restrictive covenants with transferring employees; however, such changes are likely to be void under TUPE.
Consideration should be given by the buyer to explore ways to overcome this.
What practical steps should buyers take to align employment terms?
On a share purchase, where a buyer is not restricted by TUPE, they may wish to harmonise terms and conditions with existing staff of the target company, to align with the buyer’s wider group. This is common practice for contractual benefits, such as healthcare cover, as it can reduce the administrative burden and overheads. Aligning core terms such as pay, bonuses and share schemes requires more care and careful planning to avoid the risk of breaching the contract and giving rise to constructive unfair dismissal claims. The buyer should consult with staff with a view to obtaining their agreement to the changes. If that is not possible and there are strong business reasons for the changes, it may be possible to dismiss and re-engage staff on new contracts, however, that can be high risk and will not be conducive to employee engagement and retention.
On an asset purchase, the effect of TUPE is that changes made to terms and conditions, where the sole or principal reason is the business transfer, are void and unenforceable.
Where a buyer wishes to harmonise terms (that is, bring the transferred employees' terms in line with its existing staff), the transfer will be the reason for the changes and they will be void.
Where a buyer changes terms because of the transfer but there are some extenuating circumstances unrelated to the transfer, the transfer may not be the sole or principal reason for the change but it will depend on the circumstances. Mere passage of time since the transfer will not be sufficient to break the connection with the transfer, but might make the link with the transfer less obvious to the employees which could reduce some of the risk.
A buyer wishing to make changes will therefore need to rely on one of the exemptions under TUPE for them to be enforceable.
If a buyer can’t rely on one of the exemptions, if only beneficial changes are made to terms and conditions, on a practical level they are unlikely to be challenged by staff (although technically they would still be void). If some of the changes are detrimental, the buyer could seek agreement from the employees that the beneficial changes are subject to ongoing acceptance of any detrimental changes; however, buyers should be aware that if challenged the changes are likely to be deemed void.
James Sage, Partner in RWK Goodman’s Employment team comments “a further option is to consider dismissing the employee, re-engaging them on the new terms and entering into a settlement agreement to compromise the automatic unfair dismissal claim arising from the dismissal. However, there will be a cost to this. It is also worth noting that whilst a settlement agreement can be used to settle any claims arising out of a TUPE transfer, it cannot be used to effect a consensual variation in the terms of the contract that would otherwise be void under TUPE”.
It is often assumed that employees will move forward with a sense of adaptability and compliance, but discontent around employment contracts has the power to derail even the largest and most stable employers. This integration process requires carefully planning and managing.