Mergers and acquisitions (M&A) remain a critical part of corporate growth strategy, even among smaller, privately held companies. While acquirers usually devote significant resources to financial, tax and operational diligence, many deals fall apart due to unanticipated employment‐related liabilities. Employment law due diligence is not simply a box to check—it is an essential process that identifies hidden risks, informs valuation, and shapes integration strategies. For buyers in asset or stock transactions, the workforce and its associated obligations can either enhance the value of the acquisition or quickly turn it into a liability.

Deal Structure: Asset Purchases vs. Stock Purchases

The starting point for employment law diligence is understanding the type of transaction. Whether the deal is structured as a purchase of equity or as an acquisition of assets has a dramatic impact on which employees transfer, which liabilities carry over and the extent of legal flexibility for the buyer.

Stock Purchases and Mergers: Automatic Transfer of Employees

In a stock purchase or merger, the buyer acquires the target entity in its entirety. The underlying legal entity remains intact, which means that employees continue to be employed by the same company, just under new ownership. As a result, employment relationships generally transfer automatically without the need for new offer letters or acceptance processes. All existing liabilities—including past wage-and-hour violations, discrimination claims, pension obligations, and other compliance issues—remain with the acquired entity and are effectively assumed by the buyer. This continuity streamlines the transition but places a premium on thorough diligence. The buyer needs to know exactly what obligations it is inheriting.

An equity purchase also means that existing contracts and licenses usually remain intact. Benefit plans, collective bargaining agreements, and restrictive covenants stay in place unless renegotiated. Therefore, buyers must review the target’s employee handbooks, employment agreements, severance policies, bonus plans, retirement plans, and any outstanding litigation. Without proper due diligence, a buyer could assume liabilities far beyond those contemplated in the purchase price.

Asset Purchases: Selectivity and Successor Liability Risks

In an asset purchase, the buyer acquires selected assets while the target continues as a separate legal entity, even if it later dissolves. The buyer may choose which employees to hire and which liabilities to assume. This flexibility is attractive when a buyer wants to cherry-pick talent and leave behind unwanted obligations. Employees who are offered positions typically must sign new employment agreements; those not hired remain the seller’s responsibility. Benefit plans generally stay with the seller unless the buyer expressly agrees to assume them.

However, buyers must recognize that asset transactions do not insulate them from all employment liabilities. Federal common law imposes successor liability in certain circumstances. Courts or government agencies may hold a buyer liable if it had notice of potential claims and substantially continued the seller’s business operations. Language in purchase agreements about “non-assumption” of liabilities may protect the buyer contractually, but it will not override statutory successor liability. Buyers should conduct robust diligence and, where appropriate, negotiate indemnification and escrow provisions to mitigate these risks.

Core Components of Employment Law Due Diligence

Employment law due diligence is broader than reviewing a target’s headcount and payroll. It requires a systematic evaluation of regulatory compliance, contractual obligations, workforce composition, and cultural compatibility. The following topics should be covered regardless of deal structure.

1. Reviewing Existing Employment Agreements and Policies

Individual contracts and offer letters. Review all employment agreements, offer letters, and severance arrangements. Buyers need to identify terms that may require renegotiation, such as compensation, equity, bonuses, restrictive covenants, change-of-control clauses, and termination rights. States vary considerably in their enforcement of non-compete and non-solicitation provisions. For example, California effectively prohibits most post-employment restrictive covenants, while other states enforce them under specific conditions. Buyers should confirm that existing agreements comply with applicable laws and decide whether to issue new agreements upon closing.

Handbooks and policies. Analyze the target’s employee handbook, HR policies, and procedures for compliance with federal and state laws. Pay particular attention to hot-button items such as anti-harassment policies, equal employment opportunity statements, family and medical leave practices, background check procedures, and arbitration agreements. Ensuring that policies are up to date will reduce the risk of class actions or agency investigations.

Bonus and incentive plans. Determine whether bonuses are discretionary or non-discretionary. Non-discretionary bonuses must be included in the regular rate when calculating overtime for non-exempt employees; failure to do so exposes the employer to significant liability. The due diligence team should request documentation of all incentive programs and verify compliance with the Fair Labor Standards Act (FLSA) and state wage laws.

2. Wage and Hour Compliance and Worker Classification

Misclassification of workers is one of the most common and expensive employment issues uncovered during diligence. Buyers should examine whether employees are properly classified as exempt or non-exempt under the FLSA and equivalent state statutes. Exemption status requires meeting both salary thresholds and duties tests; misclassified employees may be owed overtime and other damages. The purchaser should also review the target’s policies on overtime, meal and rest breaks, off-the-clock work, and timekeeping practices. Errors in these areas can result in agency audits and class or collective actions.

Independent contractors present another classification risk. Federal and state governments use various tests to determine whether a worker is truly an independent contractor. Misclassifying employees as contractors can result in liability for unpaid wages, taxes, benefits, unemployment, and workers’ compensation insurance. Due diligence should include an analysis of each contractor’s role, the degree of control the company exerts, and whether the worker provides services to other clients. Buyers may decide to reclassify certain contractors upon closing to mitigate future exposure.

3. Union and Collective Bargaining Agreement Issues

Buyers must identify whether the target company has a unionized workforce and whether any collective bargaining agreements contain successor clauses. The National Labor Relations Board (NLRB) applies a “successor employer” doctrine when a buyer continues the seller’s business and retains a majority of its employees. Even in an asset sale, if a majority of the buyer’s new workforce previously worked for the unionized seller, the buyer may be required to recognize and bargain with the union.

Union contracts often include provisions requiring the agreement to bind any successor or assign, limiting the buyer’s ability to change wages, benefits, or policies. Buyers should evaluate the terms of these agreements, including grievance procedures, seniority systems, job guarantees, layoff rules, and arbitration clauses. They should also determine when the collective bargaining agreement expires and whether there are pending grievances or arbitrations.

4. WARN Act and Mini-WARN Requirements

The federal Worker Adjustment and Retraining Notification (WARN) Act requires employers with 100 or more employees to provide 60 days’ advance written notice of a plant closing or mass layoff affecting at least 50 employees at a single site of employment. When a business is sold, the WARN Act applies notice obligations based on the timing of a plant closing or mass layoff. Generally, if the layoff occurs before or on the closing date, the seller is responsible for providing notice; if it occurs after the acquisition, the buyer must comply.

At least 20 states have their own mini-WARN laws with lower employee thresholds or longer notice periods. Buyers must analyze the workforce composition and planned workforce reductions to determine whether federal or state notice requirements apply.

5. Benefits, Pension, and ERISA Liabilities

Employee benefit plans can represent significant liabilities in an acquisition. Buyers need to review all benefit programs, including medical, dental, life insurance, disability, retirement, and other fringe benefits.

401(k) and other defined contribution plans should be reviewed for compliance and outstanding obligations. Defined benefit pension plans—though relatively rare these days—can impose substantial liabilities if underfunded. Health and welfare plans must meet ACA, COBRA, and other compliance obligations. Executive compensation arrangements should be checked for change-of-control provisions that could trigger severance or accelerated vesting.

6. Immigration and Form I-9 Compliance

If the target employs foreign nationals or sponsors work visas, immigration issues become critical. Stock buyers should review all Form I-9s for current employees to ensure they are complete and accurate. Asset purchasers typically must obtain new I-9 documentation from employees they intend to hire from the seller.

For employees on certain visas, transactions may require amended petitions or new filings depending on whether the employing entity changes.

7. OSHA and Workplace Safety

Under OSHA, employers must provide a workplace free from recognized hazards. Especially in potentially hazardous workplaces, buyers should request safety logs, review citations, and evaluate the target’s safety policies. Corrective actions may need to be implemented before or shortly after closing.

State Law Variations and Local Considerations

U.S. employment laws vary widely. Buyers should consider mini-WARN laws, non-compete enforceability, pay equity and salary history rules, paid leave mandates, and state marijuana laws, among others, when integrating a workforce. Acquiring companies without experience as employers in the target jurisdiction are especially at risk without additional scrutiny. In multi-state transactions, these variations can significantly complicate post-closing compliance.

Post-Closing Integration: Preparing for Day One and Beyond

Employment law due diligence is a critical aspect of any M&A transaction. By understanding the differences between asset and stock purchases, scrutinizing employment contracts and policies, assessing compliance, and planning for post-closing integration, buyers can better protect their investment and promote a smooth transition.

Even the most thorough diligence cannot eliminate all risks. Integration planning should begin well before closing and address onboarding, compensation alignment, communication, cultural integration, and retention of key personnel. Post-closing compliance monitoring is also crucial for addressing any issues identified during diligence.

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