M&As shackled by labour laws

After the general elections in April-May, India is sensing a revival of industrial growth. The investment environment, especially the foreign strategic mergers and acquisition space, also seems to be upbeat. In this buoyant market, a recent Supreme Court judgment may stir the hornets’ nest for strategic acquisitions in India.

Since Independence, labour jurisprudence in India has somehow always been pro-labour.

A close study of the judgments passed seems to suggest that the pro-socialist judges, the most prominent of them being VR Krishna Iyer, have been staunch guardians of labour rights.

Furthering this pro-socialist approach, the Supreme Court in a recent judgment has stated that both the transferee and transferor of an establishment are jointly and severally liable for

damages imposed by the authorities for not contributing the statutory payments toward labour dues, prior to the date of transfer of the establishment.

This, in effect means that, in case of a business transfer or asset purchase (either in whole or part) of an establishment, which has labour-related social security dues pending, the seller and the purchaser are jointly or severally liable to pay not only the pending dues but also damages if any imposed by the government authorities.

The law is clear that the liability of dues is jointly on the transferor and transferee in case of transfer of an establishment.

Clear position

However, there was a difference of opinion amongst various high courts in India regarding the position on payment of damages.

But now with the apex court's affirmation on this point, the legal position has for the time being become clear.

Some facts may throw more light on the latest legal position. An Indian entity which owned a tea-estate (transferor), had defaulted in making contributions under the social security contribution legislation, namely the employees’ provident fund laws.

On account of the non-payment, notices were issued for imposition of damages. The transferor asked for waiver of damages but the request was rejected on the predication that the transferor was not in any financial difficulties and there were no rehabilitation proceedings pending before the financial reconstruction authorities.

Meanwhile, the tea estate was sold to another Indian company (transferee) who in turn paid the pending labour dues but not the damages sought to be imposed by the authorities.

Further, the contract recording the transfer of the tea estate clearly mentioned that the liability for payment of any damages on account of non-payment of labour dues would solely lie with the transferor.

On this pretext -- and on the grounds that since the transferor had defaulted in paying the labour dues it was only the transferor who should be made liable to pay damages -- the transferee challenged the order for it to pay damages.

Non-payment of social security contributions is a reality in many Indian companies. This reality is a big concern in today’s M&A market when strategic acquisitions and asset purchases, especially by multinational companies, have become frequent.

Diligence works

In light of this, it becomes imperative for acquirers to not only do detailed diligence on unpaid social security dues but also take adequate measures to ensure that they are adequately protected from damages/penalties (if any) imposed by the authorities. Merely stating in the definitive agreements that any damages would be the responsibility of the transferor/seller, does not ring fence the acquirer/transferee.

Specific indemnities from the transferor and holdbacks by the acquirer on the purchase price may be a few effective ways of protecting the acquirer in such situations.

Acquirers of Indian businesses or assets have to be very diligent and careful to safeguard themselves from shelling out huge sums as damages for intentional breaches of the law by erstwhile owners.

The writers are with J Sagar Associates