Conducting due diligence in connection with an acquisition involves, among other things, the identification of material risks. Historically, acquirers have not focused too heavily on employment practices as these risks have more often than not been considered either too individualized, esoteric and anecdotal, of too low value, or too remote. Times have changed. The rise of wage-hour collective and class action claims in the last dozen or so years has elevated risks posed by the methods companies use to pay their workers to a level where a serious review of a target’s labor and employment practices, including pay practices, has become a requirement to avoid unknown risks. But in order to understand how to avoid these risks, the acquirer needs to know where to look first, and then protect itself in the definitive documentation.
To be sure, the risks associated with wage hour claims can be difficult to spot. Some industries have a greater propensity for violations, sometimes it is the pay practices of the target that causes the greatest concern, and sometimes it is just the nature of the workforce that lends itself to issues. For example, the retail and hospitality industries in particular have been hit hard, with areas of concern often focusing on whether salaried managers must be paid overtime, whether hourly-paid employees worked off the clock, and, in the hospitality industry specifically, whether and to what extent the byzantine tip credit and tip pooling rules have been satisfied for servers, bartenders, and hosts. Companies that employ a large number of technology workers — which is virtually every sophisticated company now — often face claims that IT employees or service technicians should be paid hourly wages with overtime rather than salaries. Also, healthcare companies have been flagged for issues, from automatic deduction claims to recently enacted overtime requirements.
These risks are by no means limited to companies with high numbers of employees. Those who provide services as contractors — a growing phenomenon in the new gig economy — are increasingly viewed as employees entitled to wage-hour protections even though many of them are “1099 employees” aka independent contractors. Companies that do not employ workers themselves, but rather work with agencies or other companies which in turn employ workers, are increasingly alleged to be — and are being held liable as — “joint employers” with those employing entities. This phenomenon can even extend liability for wage-hour practices to parents for the acts of their subsidiaries, to franchisors for the acts of their franchisees, or even to owners for the acts of their companies. So what does an acquirer do?
Expand Due Diligence
The most effective method to minimize wage-hour risks when acquiring a company is to expand the historical due diligence process to include:
1. Reviewing employee classifications, including exemptions, incentive compensation structures and large groups of independent contractors on the company’s premises and/or doing work in the name of the target company.
2. Analyzing how a target company tracks and records time for employees within employee classifications that pose high risk to liability.
3. Reviewing target company records for information regarding affiliates and outsourcing companies that are frequent targets for wage-hour issues (e.g. call centers). 4. Reviewing state specific laws that are target rich environments (e.g. California) and consulting local counsel where employee concentrations are. A telltale sign that potential issues exist or target is contending with is copies of budgets and spends for outside labor and employment counsel, and copies of audit letters to determine reserves on balance sheets for potential claims.
However, while identifying the risk is important, the next step is quantifying the risk and structuring the transaction and negotiating appropriate protections specific to these unique matters.
Structuring the Deal and Terms
It is a common misconception that structuring a transaction as an asset purchase rather than an equity or stock purchase will have the effect of completely eliminating exposure and liability related to labor and employment risks. Just like some successor liability claims stand when meeting certain circumstances in other fields like tax or Erisa, so may a court impose liability upon the acquirer for past wage and hour violations of the target, even if all labor and employment liabilities are explicitly excluded within the asset purchase agreement.
Standard work arounds include, like other potential claims, cash escrow set asides or seller note financing deductions to cover potential, actual or settled claims through the statute of limitations period, or adjusting the purchase price for the target company based on the assessment of risk / reward. Another option would be to include an indemnification provision within the purchase or merger agreement to require the target company to bear or share the burden of potential wage claims in the future, which could take the form of equity give ups or other valuable deductions, including cooperation from former management.
But other more nuanced work arounds include retain strong audit and termination rights, and defining “losses” to include fines for noncompliance levied by enforcement bodies and the costs to bring a target into compliance, and/or excepting these claims and costs from the baskets and caps normally inserted into acquisitions. There may also be some pre-closing steps the target can take to further wall off liabilities post-closing, which may include separating assets and the business from employees and service providers entirely through a drop-down or restructuring. While each situation is unique, in today’s environment, such risks should not be underestimated and it is incumbent upon acquirers, large and small, to pay close attention.
Robert Winner is a corporate partner in the Chicago office of Seyfarth Shaw LLP, and is a member of the firm’s mergers & acquisitions practice group. Noah Finkel is a labor & employment partner in the Chicago office of Seyfarth Shaw LLP, and is a co-chair of the firm’s Wage & Hour Litigation practice group.