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It is basic that any company making an acquisition should conduct due diligence concerning the target company’s business operations and potential liabilities, including human resources and labor and employment matters. The objective of this process is to ascertain whether there are material risks that could adversely affect the value of the transaction and, if so, whether the risks are such that the company should take mitigating measures to allow the transaction to go forward.

Historically, except for some limited exceptions (multi-employer pension plan withdrawal liability and the duty to assume a labor agreement being the most notable examples), labor and employment matters typically do not present a sufficient degree of risk or potential liability to fall into the “deal killer” category or to require implementing mitigation strategies, such as reductions in purchase price, escrow holdbacks, or shifting the cost of rep and warranty insurance. But things are changing, and there are a number of emerging labor and employment risks that have the potential to materially affect the value of a proposed transaction.

In this article, we identity some of these emerging risk factors, which should be the subject of due diligence and may also need to be addressed via mitigation strategies.

Before getting to the list, here is a reminder about the basics of labor and employment due diligence in any transaction.  Typically, there are five broad areas of inquiry:

  1. Labor and employment costs;
  2. Demographics, organizational structure and operations of the target’s workforce;
  3. Employee benefits information;
  4. Compliance with and potential liabilities related to:
    • Federal, state and local employment laws and regulations;
    • Contract and employment documents;
    • Legal duties and requirements arising out of the employment relationship; and
  5. Labor union matters.

The emerging developments fit into the fourth category above and involve actual or threatened liabilities. They are topics that should be addressed in diligence and carefully assessed by qualified counsel regarding the degree of risk and likelihood of liability.

#MeToo and Sexual Harassment Claims

While the law on this topic has been around for some time, since 2017, allegations of historical and recent sexual harassment have received high profile attention. Beyond the highly public examples involving prominent individuals, such behavior occurs in a variety of workplaces.

For example, the EEOC’s statistics show an increase in the number of charges claiming sex discrimination from 2017 to 2018, with 74% of all charges including this allegation. And according to the EEOC, a sizable number of those charges specifically involve sexual and workplace harassment.

These claims carry financial risk, and, while compensatory and punitive damages under federal law are generally capped at $300,000 (not including back pay, front pay, and attorney’ fees), there is also exposure under parallel state and municipal laws, under tort theories of recovery such as assault, battery, and defamation, and for claims against officers and directors for failing to provide for appropriate policies and practices regarding such matter.

In fact, there are numerous published reports of high profile examples of seemingly intentional coverups by executives and secret settlements, which should be a concern of any purchaser acquiring such a company. And perhaps even more significant is the potential reputational risk that also can adversely impact both the target company and the purchaser.

Wage and Hour Collective and Class Actions

Wage and hour claims may not carry as much publicity or reputational risk, but they carry a higher possible financial impact. Looking at just Texas statistics, new filings in such cases continue to increase year over year and are nearly triple the number of such cases a decade ago. Damages can be substantial, with the potential for three years of back pay plus liquidated damages. For example, in 2017 and 2018, there were reported settlements ranging from nearly $10 million to $50 million.

A particular M&A challenge concerning wage and hour matters is that there are a variety of ways a target company can be exposed to liability: misclassification of employees as independent contractors, misclassification of employees requiring payment of overtime, failure to pay minimum wage, and improper compensable time practices such as off the clock work (which is common in some industries), improper rounding, and failure to pay for preliminary and postliminary work. Additionally, a number of courts have ruled that successors can be liable for such claims, despite attempted disclaimers and exclusions in purchase documents, which places a premium on purchase price reductions, indemnity, or holdbacks. Given the significant risk involved, it is essential that these topics be addressed both in the diligence phase and the post-acquisition phase of any transaction.

Unique State Law Claims

Unique and potentially consequential state labor and employment laws are passing with increasing frequency. Certain jurisdictions, most notably California and New York, have extensive workplace laws that cover hiring practices, worker retention, pay practices, information that can be disclosed about employees, and workplace safety, as well as their own mini-WARN Acts. As with the other emerging topics, these unique state laws also must be considered in any due diligence assessment.

It is important that the above risks be included on the list of diligence topics and carefully analyzed in any prospective transaction in order to determine the level of potential liability, to determine possible mitigation strategies, and to identify matters that may need attention post-closing.

Art Carter and Arrissa K. Meyer are attorneys with Littler Mendelson’s Dallas office and A. John Harper, III is an attorney with Littler Mendelson’s Houston office. They have extensive experience advising employers on all aspects of labor and employment law, including advising purchasers and sellers regarding the labor and employment issues involved in business transactions.