Distressed M&A: managing employment risk

In the latest of a series of articles concerning distressed M&A, we examine the key employment considerations

17 September 2020

One of the first questions we are often asked by buyers in distressed M&A situations is what is the likely quantum of employee liabilities? It is not uncommon for buyers to want to restructure the workforce post-completion and early engagement on this issue is key.

Transaction structure and its impact on employment

An accelerated but solvent share acquisition will not have any immediate consequence for employees, who will remain employed by the target entity. There may be a requirement for some streamlining or restructuring following acquisition, but a change of ownership of an employer will not have a direct impact on the employment relationship.

However, in a distressed context, particularly where the target business is insolvent, a transaction may well be structured as a purchase of assets. In those circumstances a key consideration for a purchaser will be the possible impact of the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE). TUPE gives rise to a number of difficulties for a purchaser.

Due diligence

In any distressed M&A process information about employees is likely to be limited, especially where a target company's administrators in waiting are running the process or access to employees is restricted. Nevertheless, it is possible that TUPE may operate to transfer employees to a buyer, even if neither seller nor buyer were anticipating that transfer. Further, TUPE operates to transfer employees on their current terms and conditions, even if those terms are uneconomic for the purchaser. Importantly TUPE can also operate to transfer liabilities connected with those employees, such that a buyer can become liable for acts or omissions of the seller.

As a result even limited employment due diligence is very valuable in order to assess the possible costs that might be associated with the transfer of employees and their liabilities. As a minimum, a buyer would want to understand:

  • numbers of employees in the business and the roles undertaken;
  • key terms of employment (for example, place of work, remuneration, notice periods, change of control clauses and enhanced rights or benefits on termination, particularly enhanced pension or redundancy rights);
  • details of any debts owed to the employees, including arrears of wages;
  • details of recent dismissals. A buyer should be particularly wary of any pre-transfer dismissals effected to make the business more attractive to a potential purchaser, as such dismissals may be automatically unfair and therefore become a liability for the buyer; and
  • details of any ongoing or threatened employee litigation.

The usual method of dealing with a transfer of liabilities under TUPE is to seek an indemnity from the seller to cover pre-transfer matters, but in the distressed context that indemnity may not be available (and will not be in the case of a purchase out of administration). Even if a solvent seller can be persuaded to provide cover, its covenant strength may not be strong enough to deliver sufficient comfort. In most circumstances the best solution for a buyer may be to factor in the possible cost consequences for a buyer, either by way of a reduction in purchase price, a time-limited retention from the purchase price or by budgeting for a post-transfer restructure.

Consultation

TUPE triggers an obligation to inform and consult with affected employees before the transfer. A failure to consult carries a financial penalty of up to 13 weeks’ pay per affected employee, and employment tribunals have been very reluctant to accept insolvency pressures or tight transaction timetables as an excuse for a failure in consultation. This issue is particularly relevant for a buyer as such awards are joint and several between transferor and transferee, meaning that a buyer can be liable for a failure in the seller’s consultation. A transfer of any significant number of employees can therefore generate the risk of large awards against a buyer.

Parties to distressed M&A transactions are often reluctant to contemplate consultation before transfer because of a wish to keep the transaction confidential, or otherwise to keep to a compressed timetable. In many circumstances those considerations will outweigh the risks of employment tribunal claims. Nevertheless and where possible, buyers should give careful consideration to the possibility of requiring some form of consultation prior to transfer, as that will go some way towards mitigating the risks of claims.

Impact of insolvency

A purchase of assets from an insolvent seller carries a number of challenges, and a buyer will typically be in weak position in negotiations with insolvency practitioners.

However, the purchase of an insolvent business does have some benefits for a buyer. In particular, a buyer can take advantage of some provisions under TUPE, which are relaxed in an insolvency context and therefore affect the extent of the employment liabilities that it inherits.

A buyer of an insolvent business is not liable for money owed to employees for statutory redundancy payments, arrears of pay and holiday, up to certain statutory limits. Those sums can instead be claimed from the state (via the Redundancy Payments Office). There is also some flexibility in relation to the variation of contractual terms when transferring employees from an insolvent business. That mechanism might allow a buyer to address uneconomic employment terms, particularly if the alternative for employees is redundancy.

What next?

Early planning around employment issues can assist in delivering a successful accelerated sale. If you would like to discuss any of the points in this article please contact James Green or your usual Burges Salmon contact.

Key contact

James Green

James Green Director

  • Employment
  • Financial Services
  • Employment Disputes

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