The assessment in Merger and acquisition (M&A) transactions focuses on helping sell a company, part of a business, or group of companies for the highest possible value. The due diligence process plays a key role in confirming the proposed price aligns with the actual conditions of the target company.
Often in this process, the labor and employment analysis, or the delivery of this information by the target, can be underestimated or overlooked, despite the potential legal and financial consequences that it can bring.
Key labor issues often found in M&A due diligences in Costa Rica:
- Working shifts that exceed the daily limits established in the Political Constitution and the Labor Code.
- Implementation of on-call regime without a proper Policy to regulate it.
- Misclassification of job positions as ¨exempt¨ employees.
- Improper use of fixed term or professional services contracts.
- Incorrect vacation accrual and payment.
- Differences in salary or shifts within equal positions.
- Failure to accurately report and pay the social security charges.
Recommendations for a proper evaluation:
It is recommended to draft a labor checklist requesting the necessary information and documentation for an adequate assessment, which should include at least the employee headcount and organizational chart, payment slips and reporting to the social security fund, samples of employment contracts, all current existing policies, detail of shifts, list of employee benefits, overtime and time off payment, among other key aspects.
Likewise, the analysis of the employment conditions of the target company should also consider if the transaction will imply the transfer of existing employees, and if so, what will be the mechanism to do so. In an employer substitution, the replaced employer is jointly liable with the new employer for the obligations arising from the contracts or from the law, for a term of up to six months from the substitution date, and after that term, the liability will subsist only for the new employer. If there is any change in employment conditions from one company to the other, the substitution cannot be carried out unilaterally, it will require the agreement of the employees. The lowest risk mechanism will be the termination and re-hire of the employees, for which it is necessary to evaluate if any of the impacted employees are under any of the special protections offered by law, as this would impede their termination.
Economic risks and liabilities:
Liabilities can entail not only the payment of labor rights to employees but could also imply the imposition of fines for violation of labor regulations, as per article 398 of the Labor Code, and can cause delays or even reconsideration of the merge or acquisition. These fines can go from 1 to 23 base salaries, approximately US $925.00 to $21,275.00, amount that will be determined as per a judge’s discretion, considering factors such as the seriousness of the offense, the number of workers directly or potentially affected, the damages caused, among others.
It is also relevant to consider that, in employee’s pension, there is no statute of limitation for claiming the incorrect reporting and payment of social security charges; therefore, any unpaid amounts must be covered entirely by the employer (over 37% of the employee’s monthly salary), including interests and fines, which can end up being very costly, depending on the number of employees and their salaries.
These breaches can also have an impact in the purchase price. For example, on one occasion, the General Manager of the target company was paid part of the monthly salary through payroll, and part was paid as a contractor, and thus it was not reported to the social security fund for over the 25 years in which he had held such position. The contingency before the social security fund was so high that the offer was reduced in half a million dollars. In another case, the incorrect reporting and payment of the ordinary salary and salary in kind represented a one-million-dollar omission to the social security fund, which along with other situations, caused the sale to be cancelled.
In conclusion, overlooking labor and employment aspects during an M&A transaction in Costa Rica can lead to serious legal, financial, and even reputational consequences. All M&A due diligences ideally should have a specialized labor & employment team to assess on these key matters. A thorough labor due diligence should not be a secondary step; it is a critical factor that can determine a large part of the success or failure of a deal.
