Legal Due Diligence in M&A: Key Considerations for Employment Relationships

The mergers and acquisitions (M&A) process is complex and requires a thorough legal due diligence review. One of the critical areas to assess is the employment relationships within the target company. Failure to conduct a comprehensive labor law analysis can result in unforeseen obligations and financial risks post-transaction.

During legal due diligence, it is essential to examine employee contracts, including standard and individualized agreements, as well as other employment-related contracts such as non-compete agreements, confidentiality commitments, and bonus schemes.

Key aspects to assess in employment contracts include:

• Salary structure and compensation terms
• Severance packages and other benefits
• Termination conditions
• Employment of foreign workers and related legal implications

A common issue in M&A transactions is the misrepresentation of non-compete agreements. A frequent mistake is the failure to define proper compensation for the non-compete period, which, under Lithuanian labor law, must be at least 40% of the employee’s average salary. Improperly drafted non-compete agreements can be deemed invalid, potentially leaving the acquiring company without protection if key employees exit post-transaction.

Confidentiality agreements must also be carefully assessed. This includes verifying whether employees clearly understand which data is classified as confidential, the duration of confidentiality obligations, the employer’s role in data protection, and applicable penalties for breaches.

It is crucial to check for any outstanding payments related to salaries, vacation pay, overtime, or other employee benefits.

Executive and managerial contracts may contain significant severance clauses, commonly referred to as golden parachutes, which entitle executives to substantial payouts in case of a company acquisition. In some cases, these payouts can equal a full year’s salary, making them a major financial burden if overlooked during due diligence.

European case law consistently reinforces that all employer obligations to employees remain in force, even if they were not properly settled before the transaction. Thus, failing to identify unpaid wages or other liabilities, or omitting legal safeguards in the acquisition agreement (e.g., penalties for undisclosed financial obligations), can result in substantial financial losses for the buyer.

If the target company has active trade unions or collective bargaining agreements, it is crucial to evaluate their terms and commitments, as these obligations will remain in effect post-acquisition.

Collective agreements may include additional employee benefits such as:

• Higher salaries
• Extended vacation entitlements
• Extra bonuses or social security benefits
• Restrictions on modifying working conditions, working hours, or organizational structure

Such provisions can increase operational costs or complicate business restructuring efforts following the acquisition.

Due diligence should include an assessment of all ongoing labor disputes, including cases related to:

• Unlawful dismissals
• Discrimination or workplace harassment claims
• Wage disputes
• Other labor law violations

Additionally, it is advisable to evaluate potential disputes, such as pending employee complaints filed with labor authorities. Repeated conflicts may indicate poor HR management practices and expose the buyer to further legal risks.

Employment law due diligence is a crucial component of M&A transactions. A meticulous review of employment contracts, agreements, and collective bargaining conditions can help identify potential risks and ensure a smooth transaction process. In practice, some sellers intentionally or unintentionally conceal employment-related information, making it essential to include legal safeguards in the acquisition agreement, such as warranties and liability clauses.