Tuesday, December 16, 2014

International M&A Employment Due Diligence Checklist

By Donald C. Dowling, Jr., White & Case, New York

Thorough due diligence involves a wide range of business and legal issues including antitrust analysis, accounting principles, intellectual property rights, environmental compliance, tax status, and an analysis of pending and potential lawsuits against the seller. One part of any thorough due diligence process is the staffing piece—workplace due diligence into the seller’s labor practices, its employment law compliance and its employee benefits offerings. Due diligence into workforce issues internationally, outside the US is particularly vital, because business acquirers away from employment-at-will in effect inherit the seller’s human resources status quo—whether by vested rights in a stock purchase, by acquired rights in an asset purchase or else by some contractual commitment amounting to some sort of employer substitution. Also, because law in many places shifts pre-closing employment liabilities to the buyer after closing, any prospective buyer of a business needs to study the seller’s global personnel operations and get familiar with the to-be-acquired worldwide workforce.

Using a thorough due diligence checklist helps a prospective business buyer figure out what data to scrutinize and also helps a prospective business seller anticipate what data prospective buyers will expect to see. But conducting due diligence into human resources across borders is tricky, because employment is inherently local, rooted in issues indigenous to each affected country. For example, Hong Kong imposes unique social security and pension compliance requirements, Mexico imposes strict profit-sharing mandates, Brazil imposes an unusual employer-financed unemployment compensation regime, Saudi Arabia imposes unique workforce gender-segregation rules, and South Africa imposes unique diversity plan obligations. An employment due diligence checklist can account for these inherently local workplace and employment law issues only if it gets tailored for all the jurisdictions in play in the present deal.

This international human resources due diligence checklist focuses on staffing issues that tend to arise across various jurisdictions. So this checklist is merely an outline that needs tailoring for each local jurisdiction where a seller in a given deal employs staff:

• Data laws in due diligence. The due diligence process exists to root out noncompliant problems, so the due diligence process itself should never cause its own compliance breach. Many jurisdictions, including the European Union as well as most of the rest of Europe plus Argentina, Canada, Israel, Japan, Korea, Philippines, South Africa, Uruguay and a growing number of others, impose broad data privacy (“data protection”) laws that inevitably have unexpected consequences in the due diligence context. Electronic due diligence data rooms raise exposure under these laws if they offer up to bidders personal information about identifiable seller employees. Bidders cannot shrug this off as the seller’s problem, because liability for breach of data laws can transfer to a buyer at closing, particularly in a stock deal. Compliance steps may require “anonymizing” data room information, entering into “onward transfer agreements” with bidders, entering into cross-border “model contractual clauses” agreements, collecting signed employee consents and taking other steps. Jurisdictions including Argentina, Hong Kong, Japan, Korea and the United Kingdom have issued legal guidance specific to the M&A due diligence context. Follow it.

• Materiality threshold. Prospective business buyers do not care about immaterial aspects of the seller’s staffing operations. International HR due diligence in any merger or acquisition therefore needs to be subject to some materiality threshold. Find out what the threshold is, and then focus HR due diligence only on issues that could exceed it.

• Claims, liabilities and exposure. Is the seller subject to any pending, threatened or potential employment-related grievances, claims, lawsuits, appeals, disciplinary proceedings, workplace inspections or audits, government complaints or investigations, administrative charges, unfair labor practice charges, criminal proceedings or unpaid employee judgments? What about claims disposed of over the last few years, be they settlements or judgments? What is the exposure for the seller’s noncompliance with labor/employment, payroll, safety, and HR data privacy laws? What are the seller’s cash reserves for these claims?

• Corporate employer issues. In each country, identify the seller’s local affiliated corporate entities that employ staff. Learn the relationships among the seller’s operating entities and any “services companies” that employ people.

• Census and organization chart of employees plus contingent staff. Get a census of seller employees (and directors) worldwide, including part-time and contracted-out employees. Include both employees who service the target entity and target-entity employees “seconded” out to service other organizations. Ideally this census should include dates of hire, compensation and job category. Separately, get an organization chart and verify that only the employees who actually serve the target unit—regardless of title or designation—will transfer as part of the deal. Conversely, verify that all essential staff who should transfer will come over as part of the deal. Identify any “shared services” employees who work for both the target unit and non-acquired units. Next, identify the seller’s contingent staff (independent contractors, consultants, agents, secondees, sales representatives, “business partner” staff dedicated to this business and employees working from home or remotely, even overseas).

• Expatriates and immigrants. Collect information on the seller’s expatriate and immigrant populations and programs. Who are the overseas secondees and other posted expatriates? Which corporate entity employs each expatriate? Identify “stealth expatriates” outside the formal expatriate program who are nevertheless working outside their home countries. Check the visa status of non-local-citizen employees worldwide. How might this deal affect these visas?

• Compliance with policies and laws. Identify (and check compliance with) the seller’s own employment policies, written and unwritten. Look at employee handbooks, written work rules, health/safety guidelines. Separately, check whether the seller complies with legally mandated terms and conditions of employment. What special terms and conditions (beyond legal minimums and above market) does the seller extend to employees? The buyer will likely have to replicate these terms after closing.

• Code of conduct. Check compliance with the seller’s internal ethics code of conduct and social responsibility programs, including any commitment to an industry code, any corporate social responsibility program and any so-called “framework” (global union neutrality) agreement. Are these translated into local languages and compliant with overseas language laws? Do the seller’s HR practices comply? Will the seller’s current practices align with the buyer’s practices and comply with the buyer’s policies and codes? Check seller practices regarding government procurement, payment procedures to government officials, and compliance with anti-bribery laws and audit/ accounting rules. Verify that any seller whistleblower hotline complies with Europe’s tough data protection law mandates.

• Supply chain and human rights. Get the seller’s supplier code of conduct, if any, and collect compliance data like social/human rights audits. Collect data on labor practices in the supply chain, particularly as to components and products sourced from poor countries, including construction projects. Consider post-closing obligations on the buyer under California’s Transparency in Supply Chain Act 2010. (Cal. Civil Code §1714.43; Cal. Revenue and Taxation Code §19547.5) Consider post-closing exposure to workplace-context human rights claims. Consider whether the seller’s supply chain practices might, after closing, breach the buyer’s supplier code of conduct, if any. This said, keep human rights issues in perspective. Discount advice (from certain consultants and activists) that the United Nations Guiding Principles on Business and Human Rights and other aspirational declarations somehow impose binding legal obligations relevant to international mergers and acquisitions. For the most part, they do not.

• Compensation and benefits. Using a separate compensation/ benefits checklist, check the seller’s benefits and compensation offerings, including bonus plans. Are they above market? Do they comply with legal minimums? Look into the seller’s compensation philosophy, compensation/benefits “schemes” or plans, severance plans, retirement plans, bonus plans and perquisites (like meals, housing and expatriate benefits). Check sales compensation. Check individual pension promises, special agreements, grandfather clauses, death/disability benefits, cafeteria plans, service awards, profit-sharing and savings plans, tuition and adoption reimbursement plans, employee assistance programs, employee loans and guarantees—even unusual expense reimbursements. Understand the interplay between foreign pension plans and foreign social security in each affected country. Check compliance with local laws that mandate extra payments and benefits (like thirteenth-month pay and profit sharing in Latin America). Get an accounting of any transferring plans and study funding—unfunded, underfunded, and “book reserve” plans can raise huge problems and occasionally even kill deals.

• Equity. Look at seller stock options, stock grants, phantom stock and other equity plans, plus employee ownership programs, officer/director stock ownership, and employee ownership in affiliates and entities doing business with the seller. What will happen to these after closing? If the buyer will not or cannot replicate them, what will it need to do instead?

• Employee insurance coverage. Look at the employment-related insurance the seller provides, like employee life/health/accident insurance, hazardous duty/kidnap insurance, payments to state-mandated insurance funds (workers’ compensation and state social security insurance), expatriate coverage and “key man” policies naming the employer as beneficiary. Consider analogous insurance needs post-closing and, in an asset deal, consider the logistics of getting insurance in place by the closing date.

• Performance management. Study the seller’s performance management system. Focusing on key employees, collect data on job evaluations, performance appraisals and problem employees. Consider integration after closing.

• Labor organization relationships. What labor organizations represent the seller’s workers? Are these independent unions, in-house unions or so-called “white unions”? What about pending employee requests for union recognition or organization? Separately, collect organizational data on the seller’s in-house or company-sponsored labor organizations like local/national works councils, any European Works Council, health/safety committees, staff consultation committees, worker committees, workplace forums, labor/management committees and ombudsmen. How cooperative or contentious are these groups? Collect meeting minutes and records memorializing labor disturbances and days lost to strikes.

• Collective agreements. Look at applicable collective bargaining agreements, “industrial awards,” “social plans” and other agreements with employee representatives—not only union agreements, but also accords with works councils, worker committees, health and safety committees, ombudsmen and the like. Avoid the common mistake of asking only for “collective bargaining agreements”—a phrase usually interpreted as meaning only formal union agreements, excluding informal one off accords and arrangements with works councils. Get expired agreements with terms that still apply. Identify all industry (“sectoral”) collective agreements that bind the seller even as a non-signatory. Does the seller participate in any multiemployer bargaining associations?

• Individual employment agreements. Look at individual employment contracts with employees, including employment agreements labeled “offer letters,” “statement of particulars,” restrictive covenants, non-competes and confidentiality agreements, indemnification agreements, invention and intellectual property agreements, expatriate arrangements, resignation letters and releases. At least check these for key executives and look at form/template agreements for rank and file employees. Be sure to look at contracts with contingent workers—service providers like “temps,” independent contractors, consultants and agents).

• Employee consents. Check individual employee consent forms. Employee consents come in many flavors: In jurisdictions like the UK and Korea, employees may have consented in writing to work overtime. European employees may have consented to employer processing of sensitive personal data. Employees may have acknowledged a code of conduct or work rules in writing. If these consents are electronic, do signatures comply with electronic signature protocols?

• Change-in-control clauses. Check change-in-control, golden parachute, and other transfer-related clauses in employment and agency agreements, including M&A-ratification provisions in any labor union contracts and European Works Council agreements. Of course, dig out every change-in-control clause in every executive employment agreement and find all transferability clauses in independent contractor agreements. These are vital.

• External agreements. Do any external agreements (with third parties) limit staffing flexibility? For example, in a stock purchase, are there acquisition agreements from earlier deals that limit reductions-in-force? Has the seller signed onto any supplier codes of conduct of its customers? Is the seller a government contractor that has taken on staffing-related public procurement obligations? In the United States, for example, a buyer of a government contractor can take on big “affirmative action” obligations after closing, and analogous issues can arise abroad. Separately, look at outsourcing agreements with HR service providers like payroll providers, “temp” agencies, benefits providers and whistleblower hotline providers.

• Payroll and government filings. Check the seller’s payroll processing compliance as to deductions, withholdings, reporting, compliance with mandatory payments to unions and remittances to agencies including government tax, social, unemployment and housing funds. How is payroll issued? Are there any extra deductions (such as for charitable contributions or employee loan repayments)? Does the seller pay mandated benefits like premium-pay vacation, profit sharing and thirteenth-month pay? If the seller employs anyone in countries where it is not registered to do business, how does the seller comply with host-country payroll obligations? Be sure to check “permanent establishment” issues—are there “floating” employees doing business in countries where the seller is unregistered, not paying taxes, and flouting local payroll mandates? This scenario is common.

• Wage/hour compliance. Verify compliance with wage/hour laws, cap-on-hours laws, vacation and holiday mandates, overtime payments, payments during business travel, exempt-status designations, mandatory meal breaks, toilet breaks and rest periods.

• Health and safety; duty of care. Check compliance with health and safety laws, including recordkeeping mandates. Get information on duty of care/safety/evacuation and other protocols such as for hazardous-duty work and occupational health/safety law compliance, particularly for expatriates.

• Discrimination/harassment. Verify compliance with local discrimination/diversity/harassment laws including laws on pay equity, affirmative action, mandatory training and bullying. Verify compliance with the seller’s own discrimination/harassment policies. For example, does the seller impose mandatory retirement in violation of a no-age-discrimination provision in its own code of conduct? (That, unfortunately, is a common problem. Indeed, many international discrimination/harassment policies go well beyond local laws, and many employers violate their own policies.)

• Recent layoffs and divestitures. What layoffs or “collective redundancies” have occurred in the last few years? What divestitures of business units have occurred? Did these comply with applicable laws? What lingering obligations exist in old “social plans”? Any recall rights?

• HRIS. Look into the seller’s employee data-processing and human resources information systems (HRIS). Check how HRIS complies with data protection laws, especially as to cross border data exports. Has the seller made all required notices/communications to employees about HR data processing and collected necessary consents? What so-called “sensitive” staff data does the seller process? Beyond HRIS, verify compliance with data protection laws in the HR context, including as to routine HR data exports overseas, and as to global whistleblower hotlines.

• Powers of attorney. Find out what powers of attorney employees, officers and directors hold. These are particularly critical in Latin America, where there can be different levels of powers, some of which include the power to dispose of company assets. Consider how these powers will need to work after closing.

• Management oversight. What controls does the seller’s headquarters use to monitor local management’s compliance with laws and corporate policies?