Employment considerations when acquiring a business: the buyer’s perspective

When acquiring a business by way of share purchase, or when buying assets of a business subject to the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE), a buyer will want to review the target’s employment practices. We consider 10 common employment issues that arise around acquisitions.

1. Are employment contracts legally compliant?

Section 1 of the Employment Rights Act 1996 sets out what, as a minimum, needs to go in the contract of employment such as the employee’s normal working hours, pay and notice provisions. Since April 2020, contracts of employment must also identify:

• whether there is a probationary period,
• particular benefits to which an employee is entitled,
• whether there is any compulsory/ voluntary training, and
• any other paid leave entitlements.

Contracts also need to be provided to employees and workers from day one of employment.

The April 2020 changes catch a lot of targets out. Whilst the contracts may be satisfactory pre-April 2020, they are no longer compliant and targets often have a number of employees hired post April 2020 on non-compliant contracts.

2. Are the terms appropriate – for example covenants?

The second question on contracts of employment is whether the terms are appropriate. Whilst this question could apply to many aspects of the terms, take as an example whether there are suitable restrictive covenants in place for key employees. As a starting point, a restrictive covenant will be unenforceable (as a restraint of trade) unless it goes no further than is reasonable to protect the legitimate commercial interests of the target. Beware of lengthy or poorly worded non-compete clauses which may be unenforceable.

Conversely, it is not uncommon to see senior employees in roles with close client contact to have short notice periods and no restrictive covenants, presenting a risk that immediately following the purchase of the business, they resign and look to set up in competition.

A simple exercise is to consider the following: ‘does this contract do enough to protect the business?’ and ‘does this contract go too far, such that we wouldn’t be able to rely upon it?’.

It is common for key employees to be tied down to new terms and conditions as part of the transaction process.

Where TUPE applies, extreme care is needed in effecting changes because the starting point of the legislation is that changes to terms and conditions are void if relating to the transfer itself. Often, new terms can be put in place, but careful legal advice is essential.

Also, be aware that restrictive covenants may not be effective to the wider business of the buyer and/ or its group following an acquisition, which may be another reason to consider new terms.

3. Directors – are they office holders or employees?

A common issue that arises when purchasing a target relates to the employment status of directors, especially those who intend to stay on following the transaction. Some selling director/ shareholders will categorise themselves as employees, pay themselves via PAYE and have appropriate contracts in place. Others will try to argue that they are actually office holders and, on that basis, pay themselves a very small salary (often below the national minimum wage) and have no written contract in place.

If a director is paid less than the national minimum wage, that liability will be the buyer’s concern post acquisition, in those circumstances it would be appropriate to ask the seller to make up the arrears between actual pay and national minimum wage for the period of the underpayment and/ or indemnify as part of the share or business purchase agreement.

If directors are staying on and do not already have ‘service agreements’ (terminology for senior employment contracts), it would be sensible to make it a condition of the sale that they enter into service agreements. Equally, if selling directors have service agreements but the terms do not sufficiently protect the business then it would be sensible to require them to enter into new service agreements as part of the sale.

Where director shareholders of the target will be leavers, in addition to an indemnity in the sale agreement, it is common to have a simple settlement agreement with nominal consideration to address any risk (however unlikely) of any statutory employment tribunal claims being issued after termination.

In a transaction to which TUPE applies, another option is to ensure that a leaver signs a formal objection to transferring employment, which provides good protection for a buyer transferee.

4. The handbook/ policies – is it contractual? Is it out of date?

Some companies like to use a handbook, others like to have loose-leaf policies. The first thing to check is whether the handbook and/ or particular policies are contractual. If so, when considering varying any policy terms, a formal variation exercise may be required. If the policies are discretionary or non-contractual, a formal variation is unlikely to be necessary.

By way of example, if the target operates a contractual enhanced redundancy policy entitling employees to very generous redundancy packages and you envisage making redundancies immediately following the sale, you may consider factoring those costs into any purchase price.

You might also want to look at when policies were last reviewed. Stagnant policies have recently come under fire when defending discrimination claims (in particular) so it is important to understand when policies were last reviewed and whether it would be appropriate to undertake an update following the purchase.

Be mindful that on a TUPE transaction, rather than share purchase, employees have protection against a variation of contract.

5. Does the target provide enhanced terms and benefits?

Companies will often find other ways than salary to incentivise employees. It could be generous annual leave entitlements, bonus schemes, company sick pay, private healthcare, etc.

As part of due diligence, you may look to calculate the cost of these entitlements to consider whether they are viable long term and also consider whether employees are contractually entitled to the benefits to understand how any desired changes might best be implemented.

6. How does the Target calculate holiday pay?

Despite high-profile case law confirming that regular overtime/ commission/ bonuses should be included in holiday pay calculations and the reference period for calculating holiday pay moving from 12 weeks to 52, many companies continue to calculate holiday pay based on basic salary/ contracted hours only.

This presents a potential risk that some/ all staff claim arrears of pay from periods of annual leave going as far back as two years. A buyer may look to reduce/ remove that risk by insisting upon an indemnity in the purchase agreement.

7. Do employees work more than 48 hours per week and how does the target monitor that?

There can be numerous working time issues which arise on an acquisition, but queries around the 48-hour working week are common. Employees are legally entitled to work no more than 48-hours per week, on average, unless they opt out. To opt out they must do so in writing. Companies must also keep accurate records of hours worked by employees.

When purchasing a business, you should ask the seller to confirm:

• whether employees work more than 48-hours per week,
• if so, whether they hold valid opt-outs, and
• what steps they take to monitor working hours.

It is, technically, a criminal offence for a company to breach the 48-hour working hour rules so it’s important that you do not inherit those liabilities.

8. Is the target involved with any ongoing or intimated employment litigation?

Whilst less common, there is a chance that the Target is actively involved in litigation with a current/ ex-employee or that litigation has been intimated by an employee/ ex-employee.

If that’s the case, it would be sensible to get as much information as possible to understand whether: (a) the target is able to successfully defend the litigation, and (b) what the potential cost of defending any claim plus potential compensation award would be. The same also applies for any intimated claim.

One course of action in those circumstances is to ask the sellers to indemnify you for any losses that occur in connection with the litigation. Whilst this protects you from a financial point of view, it may not protect you from any reputational damage caused by the litigation.

9. Does the target use workers or self-employed consultants?

Following a number of high-profile cases, there is increased scrutiny on the use of workers and self-employed consultants. This, as well as recent IR35 legislation, means it is important to accurately determine employment status and ensure, if there is employment or worker status, appropriate tax is deducted, and rights and protections are afforded to individuals.

You should ask to see written contracts between the target and individuals but should also be asking pertinent (but non-exhaustive) questions such as the regularity of contracts, the level of control exercised over contractors and the right of any individual to provide a substitute to perform services to the company.

If concerns arise as to correct classification of the contractor for employment and tax purposes, again an indemnity may be considered from the sellers, and you may wish to consider indemnity protection in the purchase agreement.

10. Does the company have significant recent leavers and is there a pattern?

Finally, it is good practice to ask the seller to provide a schedule of all employees who have left the company within the last say six to twelve months with an explanation as to why they left. If the selling company has had a series of resignations in a particular department or for a particular reason, this could suggest that there is a negative culture which needs to be dealt with. It could also signal a possible enhanced litigation risk.

To discuss any of the issues raised in this article, contact a member of our team here, or one of the authors listed below.