Employment Law Due Diligence in M&A: What Buyers & Sellers Need to Know

M&A transactions typically involve a significant amount of due diligence by the parties.  Before consummating a transaction, the buyer needs to ensure that it knows exactly what it is buying—including the nature and extent of the seller’s potential liabilities under federal, state, and local employment laws and the corresponding litigation risk.  The seller also needs to ensure that the representations and warranties that it makes in the transaction agreement are accurate in all material respects.

By adopting a deliberate approach to M&A due diligence, buyers and sellers are able to identify employment law risks and negotiate remedial measures to close the deal.  Sellers that fail to take such a deliberate approach may find themselves in breach of the representations and warranties made in the transaction documents.  For their part, buyers may find themselves “on the hook” for significant employment liabilities.

What follows is a summary of the most significant employment law issues that the parties will encounter when performing due diligence in connection with an M&A transaction involving a privately held company.

The Due Diligence Process

To gain a deeper understanding of the seller’s compliance with federal, state, and local employment laws, M&A attorneys need to review carefully documents related to the seller’s employment practices.  A non-exhaustive list of the documents to be reviewed in due diligence typically will include the following:

  • Organizational charts
  • Employee census
  • Employee handbooks
  • Job descriptions
  • Form I9s
  • A summary of previous, threatened, or pending employment claims
  • A summary of previous, threatened, or pending investigations or proceedings by any federal or state governmental agency into the seller’s compliance with law, particularly wage and hour laws and non-discrimination law
  • A summary of any previous, threatened, or pending labor activity, including work stoppages, slowdowns, and picketing
  • Employment agreements
  • Independent contractor / consulting agreements
  • Retention bonus agreements for key employees
  • Summary of employee benefits
  • Copies of any pension, profit sharing, deferred compensation, and retirement plans
  • Restrictive covenant agreements
  • Documents evidencing the appropriateness of seller’s classification of workers as employees vs. independent contractors
  • Documents evidencing the appropriateness of seller’s classification of employees as “exempt” or “non-exempt” under federal and state wage and hour laws

M&A counsel also needs to investigate the nature and extent of any employment litigation involving the seller.  Due diligence may include a review of the following documents:

  • Copies of pre-suit settlement demand letters
  • Copies of complaints and other pleadings filed in any pending civil action
  • Copies of settlement agreements with former employees
  • Copies of any injunctions, judgments, or court orders involving the seller
  • Files for any claims submitted to the seller’s EPL insurance carrier
  • A summary of any matters pending in mediation or arbitration

Disclosure Schedules

Once due diligence is complete, the seller and their counsel will prepare comprehensive disclosure schedules.  The disclosure schedules will list any exceptions to the representations and warranties that the seller is making in the transaction agreement.  For example, the seller may represent and warrant to the buyer that there are no threatened or pending employment claims other than those claims listed on the employment matters schedule.

Key issues to consider when drafting, reviewing, and negotiating employment-related disclosures include the following:

  • Do the disclosures accurately reflect the representations and warranties made in the transaction agreement? Are they consistent with statements previously made by the seller?
  • Have all contracts listed in the disclosure schedule been thoroughly reviewed?
  • Will any of the contracts listed in the disclosure schedule be impacted by a “change in control?” For example, will the “change in control” transaction trigger payment of incentive compensation or severance pay?
  • If employment litigation is listed, what is the potential exposure to the buyer?
  • Should the buyer request indemnification for any employment-related liabilities disclosed as part of the due diligence process?

Next Steps

For over 25 years, Duffy & Sweeney has advised and counseled clients in connection with M&A transactions involving private companies.  Allow our team of experienced practitioners to guide you through all stages of the transaction, from the initial letter of intent to the closing. Contact Jean Harrington to learn more.

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