Classification: Moderately Material
Negotiation Time: Moderate
Transaction Costs: Intermediate to Expensive
Major Impact: Risk Management
Employees and Employee Benefits
What is This? Transferring employees and their benefit plans from the Seller’s business entity to the Buyer’s is a process that involves quite a few underlying issues that must be worked out between the parties. This covenant lays out how the parties have answered questions such as which employees will be transferred, what benefits they will receive, and who is responsible for employee-related issues that pop up after the Closing.
The Middle Ground: In this covenant, the Seller promises to terminate its employees on the Closing Date so the Buyer can hire some or all of them on its own terms. Next, the Seller agrees to be responsible for all compensation (including benefits) owed to its employees up to the Closing Date, and to pay out that compensation by the Closing Date. The Seller also agrees to remain responsible for all insurance, disability, and workers’ compensation claims that are based on events that occur on or prior to the Closing Date. For those employees of the Seller that the Buyer does hire, the Buyer typically agrees to offer them substantially similar compensation and benefits as previously offered by the Seller or as offered to Buyer’s similarly situated employees. Finally, the Buyer agrees to give the employees it hires from the Seller “service credit” under the Buyer’s health and retirement benefits plans according to their length of service with the Seller.
Purpose: The most important feature of this covenant is the Buyer’s promise to hire the Seller’s employees because it can be used to maintain employee stability and quell any panic that may arise after the acquisition is announced. It is something the Seller can point to in order to assure its employees that the sale of the company does not automatically translate to a loss of their jobs. In other words, it is a wonderful risk management tool. However, the Buyer retains the discretion not to hire employees as it sees fit and the other promises made by the Buyer relate only to the employees it ends up hiring. Thus, the covenant does not guarantee that no employees will be worse off after the sale, but if the Buyer agrees to include it that is a good signal that its intent is to disrupt normal operations of the Business as little as possible.
Buyer Preference: The Buyer wants to retain as much discretion as possible, especially with regard to who it must hire and the level of compensation it must provide. While stability is typically in the Buyer’s best interest, some buyers may use the transition as an opportunity to cut costs by selectively reducing the number of employees, and it is not unreasonable for the Buyer to want to maintain the discretion to do so. Also, if the Seller is subject to the WARN Act (or any state-level corollaries), the Buyer wants to ensure that the Seller takes responsibility for any resulting liabilities.
Seller Preference: The Seller will typically seek a promise from the Buyer to hire all or most of the Seller’s employees at comparable compensation and benefit levels. The desire for the Buyer to hire as many employees as possible is even stronger when the Seller is subject to the WARN Act or a similar state law, since liability under the Act can be minimized or avoided entirely if enough employees are hired by the Buyer. Another tactic for the Seller to avoid WARN Act liability is to explicitly shift that liability to the Buyer in the Agreement, but that will likely take significant negotiation leverage.
Differences in a Stock Sale Transaction Structure: This covenant is not included in a stock sale because the target company remains intact so there is no need to transfer employees to a new entity.
We want The Middle Ground to be an ongoing dialogue for and resource to the lower middle market M&A community. The outline above is generally applicable, but there is always specific case law and nuance around certain industries that can be useful in helping buyers and sellers come together. If you are a lawyer or deal professional, we encourage you to add your perspective below.