Global investors with aggressive expansion plans often invest in cross-border acquisitions that fit in with their strategic ambitions. Among the array of strategic, financial and people-related issues faced by investing companies, one of the major pain areas is labor and employment laws in India governing employee rights. Labor laws contain restrictions on transfer of employees, redeployment, redesigning employee roles and responsibilities, recalibrating headcount numbers and employee costs.
Most of the employment practices in India are built on the foundation of pro-labor and outdated employment and labor laws. While the intent during their initiation was to protect labor discrimination, the failure to amend them according to the nation’s changing economic and business environment has resulted in multiple hurdles for employers. However, recent years have witnessed attempts to alter a few clauses and relax a few restrictions with a view toward promoting business investments.
A strong diligence on the above matters is key to identifying the depth of impact that each would have on the deal scenario. While some could be identified through verification of available documentation, others might be situational and require a detailed understanding of existing and past operational practices. For instance, circumstances causing labor strikes and lockouts will not have any supporting documentation. Similarly, long pending employee-related litigations could have a history of citations which have not been resolved. Such observations could have material financial and strategic impact on a deal and also provide a view of the existing operational discrepancies. This allows buyers to align themselves strategically and plan for a successful integration or to decide whether to abandon the investment altogether, given the possible negative synergies.
Indian labor laws and the current labor situation are two areas of concern for buyers in cross-border transactions – e.g., acquisitions of Indian operations and multinational companies setup operations in India. Apart from the long list of regulatory approvals, the existing labor environment is of key concern to foreign investors looking for absolute clarity.
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Employee trade unions
Many manufacturing setups in India have employee trade unions. These can basically be of two types – internally registered unions with no affiliation to external bodies or unions affiliated to politically proclaimed national union bodies. While the preamble of both is to protect labor rights and interests, in the case of the latter, involvement of external stakeholders in decision-making during collective bargaining adds additional complexities.
Though history is replete with examples of hostile environments created by unions, significant changes have been undertaken with the inflow of a skilled workforce and professionally trained HR personnel.
During M&A scenarios, the key focal point is to understand the union structure, its history of formation, past issues/ concerns and associated repercussions. In addition, it’s important to understand existing operational practices and how they might need to be altered to cater to the go- forward business strategy.
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Collective Bargaining Agreements (CBA)
In India, CBAs or “Long Term Settlements,” are usually signed for three years. Like every CBA, it lists out the details of an organization’s expectations from its labor workforce, compensation, benefits and related additions or alterations. However, there are instances where the CBAs are delayed due to differences between management and unions. This delay usually leads to operational disruptions which affect productivity, employee engagement and on-going disputes.
In such scenarios, the buyer needs to understand the seller’s reasons for such delays and whether these delays can be overcome prior to deal closure. However, the buyer does have the authority to influence the seller on compensation and benefits, as the impact of these decisions will have a cascading financial effect on the future operations of the buyer. The best practice here is to provide Representations and Warranties Insurance in the purchase agreement.
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Employee litigations
Given the pro-labor nature of the Indian labor laws and the everlasting judicial battles, employee-related litigations are the key areas of concern during M&A. Employee- related litigations may include disciplinary actions, undue termination from services and violation of code of conduct. Judgements toward such cases are usually issued by the Indian Labor Court, which tends to involve an unpredictable amount of time. These types of litigation decisions usually revolve around employee reinstatement and compensation, which may have an unprecedented financial impact.
Therefore, during M&A scenarios, the status of litigations – both past and present – need to be thoroughly verified. While these are critical areas of concern, they are definitely not deal breakers. The immediate resolution that buyers may adopt to protect themselves is to provide for Representations and Warranties Insurance in the purchase agreement, and require the seller to deal with them as and when the judgement comes in. However, in instances requiring reinstatement of a considerable number of the workforce – who may be redundant for the buyer’s future operations – identification of such observations during the due diligence process will help in substantiating the go- forward decision of the deal.
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Contractual workforce
In India, it is a common practice to deploy a third party or contractual workforce in operational areas which are secondary or unskilled in nature. This provides employers the flexibility to conduct such operations without the responsibility of fulfilling regulatory requirements.
The provisions of employing such workforces are clearly laid out under the Contract Labor Regulation & Abolition Act. The act provides for statutorily identified operational activities where a contractual workforce can be deployed, with the onus on the employer to ensure that their regulatory benefits are being provided for by the respective contract manpower provider. However, due to lack of awareness, many organizations tend to be non-compliant. Apart from the financial impact of penalties arising from such non-compliance, the other major concern is the possibility of a judgement reinstating such contractual workforce as permanent employees. Therefore, during M&A due diligence activity, it becomes imperative to understand the contract labor structure and their regulatory compliance. It is also important to review the status of compliance on benefits being provided by the contractor, as implications of any non-compliance would fall directly on the principal employer.
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Statutory benefits and social security system (Fig 8)
Provident Fund and Employee State Insurance (ESI) are defined contributions to social security schemes that provide post-retirement benefits and health and welfare benefits, respectively, to employees. Both employers and employees contribute to these funds as per statutorily regulated rates. It is the responsibility of the employer to file monthly returns by a specified date. Any non-compliance attracts penalties, and continuous non-compliance may result in drastic legal implications. During M&A scenarios, associated documentation needs to be verified to ensure the seller complies. Reasons for irregularities in such payments need to be understood and should be described in the purchase considerations.
With respect to statutory bonuses, employees within a certain salary threshold are required to be paid at statutorily regulated rates. Employers are also required to file returns with associated bodies. While the act provides the range for minimum and maximum bonuses to be paid, the rate of bonus is derived based on the organization’s financial performance. Non-compliance to such regulations may attract penalties with associated legal implications even amounting to imprisonment. In M&A scenarios, it is imperative to verify the rate of bonus payouts in alignment to the organization’s performance, and issues of irregularities need to be accounted for in the purchase agreement, ensuring all future implications of such irregularities will be the seller’s responsibility.
Gratuity is a benefit to be paid at the time of an employee’s retirement, provided that the employee has completed continuous service of five years, irrespective of the nature of employment. However, as per the Gratuity Act and the Indian Generally Accepted Accounting Practices (GAAP), employers are required to actuarily value their gratuity annually through a certified actuary, and provide for this in the accounting books. In M&A scenarios, the buyer must validate the valuation to ensure that it has not been undervalued, as this may lead to future financial implications. The mitigation strategy here would be to re- evaluate the gratuity and make the necessary adjustments to the purchase considerations.