UK Employment Law Risks In Cross-Border M&A

The employment law considerations U.S. companies need to think about when acquiring U.K.-based companies or assets

The acquisition of U.K.-based companies or assets will often give rise to employment law considerations that are unfamiliar to U.S. buyers. Our respective approaches to a number of fundamental employment principles differ substantively — for example, the contrast between “at-will” employment in the U.S. and unfair dismissal protection in the U.K. In addition, U.K. employment law brings a variety of concepts to the table that can seem counterintuitive to the U.S. market, such as the automatic transfer of employees on an asset sale.

U.K. employment law has developed in myriad ways and continues to do so. In terms of issues to watch out for, there are now potentially significant employment risks lurking in any due diligence exercise. Holiday pay, equal pay, national minimum wage and employment status are all complex and technical areas, where the failure to spot an issue and seek appropriate protection could lead to a buyer inheriting substantial historic and future liabilities.

Due Diligence Scope

From our experience of working with U.S. law firms on many M&A transactions in the past, an important first step is always to agree a clear due diligence scope and appropriate materiality thresholds at the outset of a new deal. While the big-ticket items mentioned above will find a home in any due diligence report, employment is an area where an incredibly broad range of issues can arise.

Are there particular areas of the business or particular individuals on which the client wants the review to be focused? Is the purchase only viable if the vice president of sales is tied in with a lengthy notice period and robust restrictive covenants? In terms of the materiality of wider risks, how does the buyer define a “show stopper”? Are they only concerned about mass litigation risks or issues where the likely liability could exceed, say, $500,000? Or do they also want to know about, for example, an ongoing dispute over a $10,000 bonus payment?

Agreeing such parameters at an early stage ensures that any review of U.K. employment issues is as focused, commercial and practical as possible, so that the client receives a due diligence report that fully meets its needs.

Post-Closing Objectives

In addition to ensuring that the review of existing HR risks is focused, a clear understanding of the client’s post-closing objectives is also vital. Does the client have a reduction in force planned when the target has joined its wider group? Or is there a harmonization and integration exercise involving changes to terms and conditions, or the introduction of new group employment contracts?

If the client has any future U.K. employment plans under consideration or if the commercial value of the deal is dependent on certain HR changes being implemented post-closing, these intentions should be discussed with U.K. employment counsel as early as possible. The review of employment due diligence can then focus both on the identification of existing risks and the client’s scope to make the changes it wants or needs to make when the deal closes.

U.K. employment law contains a multitude of restrictions on what an employer can do and when, including for example:

• The obligation to give notice of termination of an employment contract — either the minimum notice period set by legislation (which varies depending on length of service), or any longer period, which is prescribed by the contract itself;
• An employee’s right not to be unfairly dismissed after accruing two years’ service — a statutory construct whereby the employer needs to have a potentially fair reason for dismissal and to follow a fair process in order to avoid liability;
• The obligation of an employer to consult collectively for a certain length of time when proposing to dismiss as redundant 20 or more employees at one establishment within 90 days or less;
• The requirement to bargain collectively on certain terms and conditions where the employer recognizes a trade union (or face the risk of costly claims if collective bargaining is bypassed); and
• Restrictions on the employer’s ability to dismiss or change the terms and conditions of employees who joined the target by way of a transfer under “TUPE” — the Transfer of Undertakings (Protection of Employment) Regulations 2006.

There may also be provisions within the employment documents that point to additional benefits offered to the target’s employees above and beyond the statutory levels that apply as a minimum. For example, does the target offer its employees enhanced payments when dismissing by reason of redundancy? If so, is it obliged to do so — i.e. is the right to receive an enhanced redundancy payment a contractual entitlement for the target’s employees, either because of an express provision or because it has become contractual through custom and practice? If it is, the employees will retain that entitlement post-closing and any redundancies may be far more expensive than the buyer was anticipating.

All of these issues have the potential to affect the client’s post-closing HR strategy dramatically.  Early consideration of that strategy within the context of the target’s employment due diligence documents will therefore be important. In some cases, the advice on how much the buyer’s plans will cost and how long they will take to implement can even impact the pricing of the deal as a whole.

Addressing the Risks in Practice

Notwithstanding the wide of range of risks that the target’s U.K. employment practices can present and the various restrictions on what the buyer might be able to do post-closing, it is actually extremely rare for U.K. employment issues to stop the show.

The use of warranty protection within the sale and purchase agreement to flush out compliance issues, and appropriate indemnity protection to cover specific issues, will often give the buyer sufficient comfort in relation to employment risks to go ahead with the deal.

In addition, where the shape of the target’s post-closing U.K. team is important to the buyer, it is often possible to impose requirements on the seller to implement changes before the deal closes, with new service agreements for senior executives and changes to incentive plans often appearing as closing deliverables. Of course, the crucial step in ensuring that appropriate protection and/or closing requirements are put in place to address such matters is to identify the issues in the first place.

And Finally … TUPE

When a collection of U.K.-based assets changes hands, very careful consideration needs to be given to whether the above mentioned TUPE — the U.K.’s automatic transfer legislation — will be triggered. This will almost always be the case where a business (or part of a business) is being sold.

If TUPE applies, this will lead to the transfer, by operation of law, of the employees who are assigned to the target business when the deal closes. In addition, TUPE operates so as to protect those employees’ terms and conditions upon transfer and to give them enhanced protection against dismissal. A clear understanding of what the buyer is inheriting and what terms and conditions it needs to replicate is therefore vital.

When left unfettered by commercial drafting, TUPE transfers all pre-closing liabilities relating to the affected employees from the seller to the buyer. To address this, however, appropriate (and market standard) provisions can be incorporated into the asset sale agreement to ensure that liability is allocated fairly, with each party taking responsibility for their own acts or omissions.

Finally, one thing that can sometimes be missed on an asset sale is the requirement under TUPE for the parties to inform and consult the transferring employees about the sale and its impact on them. This means telling the employees within the target business about the sale before it closes. A failure to do so can lead to a U.K. employment tribunal claim, for which the remedy is up to 13 weeks’ gross pay per employee (i.e. a quarter of the U.K. workforce’s annual salary). Notwithstanding this, commercial confidentiality considerations will often mean that engaging with those employees is simply not possible before the deal has signed.

Advice on the application of TUPE, the need to inform and consult, and the best way in which to achieve this should therefore be incorporated into the deal timetable and the discussions with the other side. For instance, plans for a split signing and closing — with TUPE information and consultation taking place in between — are often agreed very swiftly when the combination of financial risk and commercial confidentiality is taken into account. This is one example of a U.K. employment issue having an impact on the structure of a deal as a whole.

Knowledge and experience of the underlying issues and practical possibilities on both share sales and asset sales is key to ensuring that the U.S. law firm’s ultimate client is fully aware of the risks posed by U.K. employment law. Clear, practical and commercial measures can then be introduced into the negotiations with the other side with a view to protecting the client’s interests and keeping the deal on track.