Buyers beware: labour must be key focus in takeovers

By Xiong Xiaorong and Xie Yan, Tiantai Law Firm
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Companies seeking to complete a business transformation or strategic development such as expansion, industrial chain upgrading or diversification, for example, may do so through a share acquisition. This, however, can expose them to risks caused by improper handling of labour relations.

LABOUR DUE DILIGENCE

Xiong Xiaorong Tiantai Law Firm
Xiong Xiaorong
Associate
Tiantai Law Firm

It is essential that buyers carry out due diligence prior to any share acquisition, which usually includes an investigation of the target company’s shareholding structure, corporate governance, financial and assets conditions, major creditors’ rights and debts, connected transactions, labour and personnel, taxation, and litigation and arbitration status.

The legal entity status of the target company is sustained after the purchase, and the acquirer, after joining as a new shareholder, will continue to enjoy the rights and perform the obligations of the target company.

However, it could face a litany of potential risks such as unpaid wages, bonuses, overtime pay and annual leave pay, or have to pay any social insurance or housing provident fund that has not been paid in full.

When conducting labour and employment due diligence on target companies, buyers should focus not only on the proportion of labour contracts signed by in-service employees, the percentage of employees with paid social insurance and the duration of labour contracts, but also employees’ age and length of service, the time of signing the labour contract, wage structure, wage payment, various welfare benefits (such as equity and cash incentives), the contribution base of social insurance and housing provident fund, enterprise annuity, non-competition restrictions, and potential occupational diseases.

COMPLETENESS OF T&CS

Xie Yan Tiantai Law Firm
Xie Yan
Associate
Tiantai Law Firm

After completing the acquisition, buyers often reform the target companies in line with their strategic development plans. As the employer’s legal entity status does not change through the acquisition, the original labour contracts will continue to be performed. Based on comprehensive factors such as employing autonomy and labour costs, acquirers should give due consideration to any termination of labour, economic compensation, signing second labour contracts, open-ended labour contracts and other issues. Buyers need to attach special importance to the clarification and completeness of the labour terms involved in the share acquisition agreement.

If buyers decide not to accept or fully accept all employees of a target company based on their assessment of its post-acquisition business needs, they might consider requiring the seller to make any job cuts before the acquisition.

If acquirers decide to fully accept all employees, they may set out clauses on bearing possible employment risks in the share acquisition agreement, specifying that any economic compensation and indemnity arising from salary arrears and underpayment of social insurance before the delivery date shall be borne by the original shareholders, or requiring the transferor to first eliminate relevant risks before finalising the transaction.

EXECUTIVE RELATIONS

After completing the share acquisition, the new owners will also adjust the board and senior managers, who often serve as the bridge of trust between the employees and the company. If directors and senior management are replaced en masse, it may lead to a trust crisis among employees of the target company.

Buyers should therefore carefully consider the timing of their reforms and try to avoid large-scale personnel changes soon after completing the takeover. Instead, they should focus on stabilising the core management team and ensuring the posts and compensation of personnel, properly communicate with and guide employees, and understand the internal situation of the target company through multiple channels, then formulate appropriate personnel adjustment plans based on the specific situation, implementing changes one step at a time.

EMPLOYEE RELATIONS

Buyers often streamline, abolish or reorganise internal functional departments after a takeover, which may involve adjusting the positions and salaries of a large number of employees, or even mass layoffs, which can easily give rise to multiple labour disputes or even mass disturbances in serious cases. Therefore, matters related to labour contracts should only be changed after a consensus is reached.

Even if workplaces, posts or salaries remain unadjusted, in order to avoid hidden risks, it is still recommended that acquirers should clearly define the rights and obligations, posts, salaries and other related matters with employees.

When streamlining, abolishing or reorganising any internal functional departments, many companies would terminate employees on the grounds that “the objective circumstances on which their labour contracts are concluded have undergone major changes, making their continued performance impossible, and the employers and employees have failed to reach any agreement on the changes to the labour contracts after negotiation”, quoting article 40 of the Labour Contract Law.

However, judicial authorities are stricter in determining “major changes in the objective circumstances”.

Generally speaking, they should refer to the occurrence of force majeure or objective circumstances that make it impossible to fulfil all or part of the terms of a labour contract. However, for subjectively controllable layoffs, they are deemed internal structural adjustments actively initiated by companies to adapt to market changes, but not to be determined as “major changes in the objective circumstances”. Therefore, caution is advised in invoking the article which may or may not apply to the situation of share acquisition and the operating conditions of the target company.

As regions differ in the level of their economic development and employment conditions, when it comes to implementation of the labour law there is also variation in employment policies and judgment standards. Buyers need to focus on the local policies relevant to the target company’s place of incorporation and, if necessary, submit consultation letters to the local human resources and social security bureaus so as to formulate more favourable plans.

Furthermore, in the interest of avoiding increased acquisition costs due to labour risks and difficulties in promoting follow-up reforms, or any mass disturbances after the acquisition, buyers should give their full attention to the handling of labour relations during a takeover, and adopt relatively flexible and prudent measures during and after the acquisition.

Xiong Xiaorong and Xie Yan are associate at Tiantai Law Firm

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