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Due diligence and warranty support for transactions (employment law aspects)

EM Law are experts in helping clients buy, sell and invest in businesses. Part of the process in such transactions involves information gathering, review and reporting (known as due diligence) and warranty support with much of this activity centred around employee issues.

The due diligence process

Assuming that the buyer has some control over the due diligence process, and is not purely dependent on information that the seller is prepared to provide, the buyer’s advisers will usually prepare a request specifying the information about the business that the buyer would like to look at.

Following the review of the information that has been provided, there is usually opportunity for the buyer’s advisers to make follow up enquiries, for example about information that has not been provided, or further details of matters referred to in the information provided. Once the seller has provided the additional information, or declined to do so, the adviser will report to the buyer on the relevant matters. The extent of the report obviously depends on the scope of the review that has been agreed at the outset.

If the transaction proceeds following the due diligence exercise, the information gathered in the exercise itself will have an effect on the rest of the transaction. Due diligence may reveal potential liabilities that were previously hidden. Identifying those liabilities gives the buyer in an asset sale an opportunity to negotiate an indemnity against such liabilities. By convention, indemnities are not usually given in a share sale, so protection will usually be obtained through an appropriate adjustment to the purchase price.

In both share and asset sales, warranties are used to give another layer of protection. Liabilities that are not disclosed as a result of the warranties may give rise to a claim for damages in respect of losses suffered by the buyer (subject to any agreed threshold for claims). Disclosures against the warranties (combined with the due diligence) should therefore allow the buyer to make an informed appraisal of the value of the business.

Issues arising on a due diligence exercise

The key issues that a due diligence request is likely to focus on, and the reasons behind each request, are outlined below.

Employee list

The buyer is likely to request a full list of the employees and apprentices. Arguably, when The Transfer of Undertakings (Protection of Employment) Regulations 2006 (“TUPE”) applies, it will also want details of any workers.

A list of consultants, contractors and agency workers

The buyer will want a full list of any consultants, contractors or agency workers providing regular services to the target, with details of the terms on which such services are provided, including copies of consultancy agreements.

In a share sale, the target company will remain bound by the terms of any consultancy or other arrangements. It is therefore important for the buyer to be aware of what agreements have been entered into and on what terms, so that it can take these into account when determining the cost of running the business going forward and the cost of terminating any such arrangements.

Key employees

The buyer will want individual profiles of key management and copies of employment contracts with directors and any other key employees, possibly those earning in excess of a specified amount. The relevant salary level will obviously depend on salary levels within the business as a whole and what is viewed as material within the context of the overall deal.

The aim of this request is to obtain the service contracts of (generally) senior managers, to assess in more detail the cost of employing those individuals, the types of benefit with which they are provided, their notice periods and any other unusual or onerous benefits in the contract of employment.

Standard terms and handbooks

The buyer will want to see copies of standard terms of employment, and staff handbooks applicable to employees. The information provided should include details of annual working days and hours, overtime rates, holiday entitlements, salary review dates, change of control provisions, health and safety rules, disciplinary and grievance procedures, maternity and other parental leave policies, equal opportunity policies, whistleblowing policies, information technology policies, sickness policies and details of any code of ethics, business conduct policy or similar guidelines published for the attention of its employees or its customers or clients.

Benefits

The buyer will need details of all contractual and discretionary benefits provided to employees and how they are funded, including information about flexible benefits plans, bonus arrangements, life assurance, private health insurance and profit sharing schemes. This will allow the buyer to assess the cost of providing the benefits and identify any funding deficiencies.

Holiday pay

Where employees are entitled to variable remuneration, such as bonuses and commission, or regularly receive overtime payments, the buyer will want to assess the risk of claims for underpaid holiday arising out of any failure to include such payments in the calculation of statutory holiday pay.

Employee share incentive arrangements

For either a share purchase or an asset purchase, the buyer will want to know about employee share incentive arrangements in which the target’s employees or directors participate or are entitled to participate. The buyer will also want to know about any employee benefit trusts or similar arrangements under which the target’s employees or directors may benefit in any form.

Pensions

The buyer will ask about “historic” pensions promises which may have been made by the transferor within a specified time period and in respect of which it may be liable following a transfer.

Redundancy and severance arrangements

The buyer will require details of any redundancy or severance policy, procedure, practice, right or arrangements (whether or not contractual) or which have been applied in a specified period and the estimated cost of any contemplated redundancies. In addition, the buyer will generally want details of any planned redundancy programme. If there are any such plans the parties will need to agree who will bear the costs of that exercise.

Absent employees

The buyer will want details of any employee who has been or is expected to be absent from work for more than a specified period, say three months, in the last 12 months (whether on secondment, or as a result of sickness or maternity leave or otherwise) who has or may have a statutory or contractual right to return to work.

This information should give the buyer a clear profile of the workforce it will be taking on, whether or not they are currently working in the business. This is important both to ensure that on completion the buyer does not take on employees that it is not expecting and to highlight legal issues that may need to be addressed in the asset purchase agreement. For example, employees with extensive sickness absences could indicate the possibility of a personal injury claim arising at some point in the future.

Recent terminations of key staff

The buyer will want details of key directors and employees who have left the target during a specified period before completion. This information will be most relevant where the buyer will be relying on existing management to run the business post-completion. If several key staff have departed within a fairly short time, this may raise questions about the ability of existing management to run the business successfully. Those issues would then usually be addressed by the buyer through further discussions with management.

Recent disciplinary action and terminations

The buyer will want to see details of all employees dismissed within a specified period, and any potential constructive dismissals.

This request should highlight whether there are likely to be tribunal proceedings that have not yet been lodged arising from dismissals. Again, appropriate provision should be made in the sale and purchase agreement or through the purchase price.

Claims

The buyer will need details of any existing or threatened proceedings by any former or current employee or trade union or employee representative, including details of any outstanding employment tribunal claims.

This request gives an indication of claims that have actually been lodged or threatened by employees or former employees or trade unions. This supplements the information on recent terminations. Taken together, this information should enable the buyer to form a reasonably accurate assessment of the possible liabilities stemming from employment litigation and allow it to deal with them through warranties, indemnities or an adjustment in the purchase price.

Accidents

The buyer is likely to want details of any accidents within a specified period (typically three years, to tie in with the limitation period for personal injury claims), including information about whether proceedings have been brought or threatened in respect of such accidents and details of any other accidents or injuries in respect of which proceedings are outstanding.

Again, the enquiry helps the buyer form a complete picture of likely employment liabilities in the target. When combined with information about absent employees, the buyer will be put on notice of possible or actual personal injury claims and can then agree how best to deal with those.

Immigration checks

The buyer will need to know which employees have limited leave to remain in the UK and that the seller carried out right to work checks in respect of its employees.

On a share purchase, the buyer will inherit any statutory excuse against civil and criminal liabilities which the seller obtained by carrying out compliant right to work checks on its employees. However, the buyer will also inherit any historic liabilities if the seller has been employing workers illegally in the UK. Therefore, it is advisable for the buyer to carry out new right to work checks as soon as possible post acquisition.

Where a buyer inherits employees as a result of a TUPE transfer it will not inherit the civil or criminal liability of the seller for employing such employees illegally pre-transfer. However, it will not inherit the benefit of any ongoing statutory excuse obtained by the transferor in respect of the employment of those employees either. To obtain a statutory excuse, the buyer must therefore conduct its own right to work checks on the transferring employees and has a 60 day grace period from the date of the transfer within which to do so.

Sponsorship of migrants

In addition to the immigration checks referred to above the buyer will need to know whether the seller holds, or has held, a sponsor licence and whether any employees are currently sponsored under Tier 2 or Tier 5 of the immigration points based system.

For any questions you may have concerning due diligence or warranty support on employment matters contact Helen Monson or Imogen Finnegan.

Due Diligence Lawyers EM Law Helen Monson     Due Diligence Lawyers EM Law Imogen Finnegan

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