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How to avoid common pitfalls in employee matters agreements

Mergers and Acquisitions|Talent
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By John Carter and Kelly Karger | April 6, 2021

When details in the employee matters agreement (EMA) are unclear, the buyer and seller can have different interpretations causing problems for both.

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Why are there employee clauses in a sale and purchase agreement?

Employees are a crucial element in most corporate transactions. Employers on both sides of a deal take steps to protect transferring employees, manage employee-related risks arising from the transaction and ensure the transaction value for their respective organizations.

In this blog series, we examine how buyers and sellers may handle employee-related topics via clauses in the sale and purchase agreement (SPA) including:

  • Purposes of the key employee-related clauses in the SPA
  • Common employee-related negotiation terms to agree on
  • Common pitfalls that can come back to bite later
  • Different considerations in asset and share deals, including the use of transition service agreements (TSAs)

In this third blog of our series on employee-related aspects of sale and purchase agreements (SPAs), we look at some of the common pitfalls we see buyers and sellers fall into.

Employee topics that are not covered adequately — or at all — in the employee matters agreement (EMA) or other parts of the SPA quickly raise issues in the post-sign, integration planning phase of a transaction. When details are not clearly stated, buyer and seller teams can have different interpretations of what was intended during negotiations. This may lead to post-close scrambling by HR to ensure there is a common agreement, which can erode team building between the buyer and seller HR teams. In addition, it can give rise to unpleasant surprises, particularly if there are financial implications.

Here we look at some of the common examples seen where the negotiation team leaves the details to after a deal closes to get the deal done, leading to potential financial, legal and reputational problems for both:

  • Incentive programs: If short- and long-term incentive (STI/LTI) programs are mid-cycle at closing, how are the awards determined to reflect underlying performance metrics and who pays for which periods? Agreement will be needed between buyer and seller on both the practical aspects (how performance reviews are carried out) and financial impacts (who pays).
  • Unvested benefits: Programs such as retirement plans may have vesting periods where employer contributions are forfeited when employees leave early. If the transaction means employees must leave the seller’s programs early to move to the buyer’s plans, they may be unfairly penalized if normal vesting rules are applied. If the vesting rules are waived, agreement is needed over whether the buyer or seller pays.
  • Comparability requirements: What compensation and benefit programs are included in determining comparability, or rather are specific programs (such as defined benefit pensions or equity) excluded from the requirement? In many cases these programs are nearly impossible to replicate on a comparable level. We explore this issue in more detail in this article.
  • Compensation programs: Where in the annual cycle is the target company? What commitments have been made for annual reviews, increases and payments? Will any of these come due in the sign-to-close period? How compensation programs are honored will be a key to a deal’s success.
  • Recognition of past service: Certain employee benefits can reflect length of service with the employer such as long-service awards, number of vacation days or termination indemnity payments. Employees may lose out if their past service is not recognized by the buyer after the deal. If past service is recognized by the buyer then there may be an impact on the purchase price, for to reflect the liabilities associated with partially accrued long-service awards.
  • Payments triggered at closing: For benefits such as termination indemnities or severance payments, the deal may legally trigger a payment at closing in some countries. The employees may lose out in this case if the benefit formula means the sum of the benefits from service before and after the deal is lower than if service had been continuous. Agreement may be needed on how to keep employees “whole,” and to the methods that will be used to recognize service and avoid triggering such payments.
  • Recognition of paid time off balances: Will earned but unused vacation days transfer to the buyer? This can be an emotional subject for employees and can impact employee relations if not handled carefully. If accrued balances do transfer, then the buyer will typically seek compensation via the purchase price.
  • Employment litigation: If there are open cases or claims at the time of the deal, then the buyer and seller must agree on how these are resolved and paid.

These are just some examples and show that there are risks to both sides of a transaction if such details are not considered carefully in advance.

For sellers, there are reputational risks if the rights of the transferring employees are not adequately protected. Sellers also need to ensure it is clear what costs they will incur.

For buyers, there are employee relations risks if the employees feel that they are losing out due to the deal. Buyers also need to ensure the purchase price reflects liabilities they may take on in relation to recognition of past service and accrued vacation.

Additionally, when one or more of the parties is publicly traded and the deal is big enough, the SPA may be public for employees and others to see. In most cases you should assume the SPA will be public at some point. To avoid reputational issues or setting unwanted precedents for future deals, all parties should ensure the EMA shows their side was trying to act in the employees’ best interests.

In the next and final blog of this series, we will consider how different deal types — asset or share deals — affect the treatment of employees in transactions and how this can impact the drafting of the employee clauses in the SPA.

Authors

Senior Director, Global M&A

Senior Director, Global Services and Solutions

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