Works Agreements as potential Stumbling Blocks in an M&A Deal

published on 23 September 2024 | reading time approx. 6 minutes

If there exists at least one works council in the target of an M&A deal, the labour law regime of the target is significantly influenced by works agreements. Due to their collective nature, ineffective or void works agreements (Betriebsvereinbarungen) can have significant economic or operational consequences. If the transaction is structured as an asset deal, the transfer of undertaking (Betriebsübergang) regularly associated with an asset deal can lead to complex questions regarding the applicability of works agreements in the acquired business after the transfer of undertaking and make it more challenging to standardise working conditions. It is, therefore, essential to identify potential problems in connection with the target's works agreements early as part of an employment and labour law due diligence.

Formal errors in works agreements

When reviewing works agreements, the focus of the employment and labour law due diligence will be on the content regulations of the works agreements. However, the formal aspects of a works agreement should not be overlooked. Formal errors in works agreements can lead to a works agreement's ineffectiveness or even voidness. Void works agreements can have considerable financial consequences, e.g., if the void works agreement is intended to replace another financially less favourable works agreement.

Even comparatively simple errors may have severe consequences. For example, data rooms often contain works agreements that are not signed by both parties, the employer and the works council. The written form applies to works agreements. Therefore, both parties to the works agreement must have actually signed the works agreement ("wet ink"). It is also permissible to conclude works agreements in electronic form. However, it must be checked here whether the digital signatures have also been provided with a qualified electronic signature and whether the parties to the agreement have signed the same document electronically.

In addition, it should be checked whether the parties were correctly represented when signing. If the works agreement has been signed by members of the works council other than the works council chairperson, the reason for this should be clarified.

There are also sources of error regarding proper representation on the employer's side. A typical example is a works agreement signed by only one managing director who is not authorised to represent the company alone.

If at the target, a central works council (Gesamtbetriebsrat) exists and/or the target forms part of a group of companies with a group works council (Konzernbetriebsrat), the question may arise as to whether the works agreement was concluded with the competent works council. The works agreement is null and void if the incompetent works council is involved. In practice, the situation is frequently encountered where the parties to the works agreement have assumed that the general works council is incorrectly competent for a particular matter. Central works agreements are often concluded purely for practical reasons. The reasons are apparent: The employer wants to avoid negotiations with several local works councils. However, this approach overlooks the fact that pure considerations of expediency are not sufficient to justify the competence of the central works council. The central works council is only responsible for matters affecting the entire company or several companies and cannot be regulated by the local works councils within their operations. Overall, the labour courts are reluctant to accept the competence of a central works council. Even if the local works council has delegated its responsibility to the central works council, the effectiveness of the delegation should be examined. In the event of an ineffective delegation, the central works council has acted as the incompetent body. A comparable situation also arises with the competence of a group works council. Consequently, the competence of the group works council in the matter of a group works agreement should also be critically reviewed.

Challenges with the content regulations of works agreements

A fundamental examination point in the employment and labour law due diligence process is the content regulations of works agreements. The focus here is on works agreements with a high financial impact (variable remuneration, company pension scheme) or works agreements that have an operational impact. These include, for example, works agreements on shift systems. In the case of works agreements providing financial benefits to employees, provisions that exclude certain groups of employees from the benefits are particularly problematic as the exclusion may be discriminatory.

A typical case is remuneration regulations that violate the prohibition of discrimination against part-time employees, as they exclude part-time employees from remuneration benefits, e.g. anniversary bonuses. The acquirer may face considerable financial losses if the part-time employees claim the benefits previously withheld from them.

Another aspect to be reviewed is whether the works agreement does not violate the so-called collective bargaining proviso (Tarifvorbehalt). In principle, works agreements may not contain provisions on pay and other working conditions that are regulated or are usually regulated by collective bargaining agreements. It is often overlooked that the collective bargaining proviso also applies to employers who are not bound by collective bargaining agreements. It can also be challenging to determine whether a provision in a works agreement is a provision usually regulated by collective bargaining agreements. For certain social matters, regulated in Section 87 of the Works Constitution Act (Betriebsverfassungsgesetz), a less strict collective bargaining agreement proviso applies. In this case, a works agreement may not regulate a matter that is already regulated by a collective bargaining agreement applicable to the operation.

A violation of the collective bargaining proviso results in the invalidity of the regulation. The invalidity of the regulation can lead to unpleasant loopholes in the company's employment and labour law regime.

Fate of works agreements in the event of a transfer of undertaking

An acquisition through an asset deal regularly triggers a transfer of undertaking. In this case, particular attention must be paid to examining the consequences of the transfer of business for the applicability of the sellers' works agreements after the transfer of undertaking.

If the acquired operation or part of the operation is continued by the acquirer as a separate operation, the existing local works agreements generally continue to apply. However, something else may apply if the acquirer has central or group works agreements on the same subject matter in place and the acquirer's works agreement was not concluded by way of delegation, e.g. to the general works council. If these conditions are met, the central or group works agreement generally supersedes the local works agreement. Whether a supersession takes place must be determined by interpretation. In some cases, it is in the interests of the acquirer if newly acquired operations do not fall within the scope of an existing central works agreement. This may be the case, for example, with a central works agreement on company pension schemes. A central works agreement can also be designed from the outset in such a way that newly acquired operations do not fall within its scope.

If the acquired operation or part of the operation is integrated into an existing operation of the acquirer, the seller's works agreements become part of the employment relationship, and the regulations of the transformed works agreement continue to apply. The situation is different if the acquirer has a works agreement (local works agreement, general or group works agreement) on the same subject matter in place. In this case, the acquirer's works agreement applies. If the works agreement is transformed into the content of the employment relationship, the employer is prevented from deviating from the transformed provisions to the detriment of the employee by means of contractual agreements for one year beginning at the time of the transfer of the business. This can make it difficult to standardise working conditions after the asset deal.

What options are there for adapting works agreements in the context of an M&A deal?

Suppose problems or the need for adjustment are identified during due diligence. In that case, the question arises as to whether the seller can still correct these issues before the closing or whether the acquirer bears the burden of adjustment after the closing. It becomes problematic if the works agreement is concluded with the wrong works council, as there will generally not be enough time to renegotiate the works agreement before the transaction is completed. The same applies will likely apply to problems with the content of works agreements, e.g. in the case of discriminatory regulations in the works agreement. Risks can be considered in the purchase price or through appropriate provisions in the purchase agreement. Suppose a works agreement is not legally objectionable but makes the target company less attractive to the acquirer. In that case, the seller can make the company more "saleable". By mutual agreement with the works council, the seller may make an adjustment to the works agreement that will only take effect shortly before the closing. The labour courts generally consider this approach to be permissible. However, care must be taken to ensure the adjustment is not abusive. The principles of protection of legitimate expectations and proportionality must also be observed.

After the closing, it is the acquirer's turn to make adjustments. The acquirer can then conclude a superseding works agreement with the relevant works council, as the more recent works agreement replaces the older works agreement. The principle of favourability does not apply here, so a deterioration of working conditions is also possible, provided that the works council cooperates. Even regulations transformed into the employment relationship can be replaced by a works agreement before the end of one year, as the prohibition of change does not apply in this case. However, there is an exception for the adjustment or replacement of pension schemes. The replacement of a pension scheme or adjustments to a pension scheme are only possible within a very narrow legal framework.

In addition, the acquirer should take a look at its own "works agreement landscape" before concluding the purchase agreement. As already mentioned, the appropriate drafting of a central or group works agreement can ensure that the new employees joining the company in the course of a transfer of undertaking do not, for example, participate in generous anniversary payments regulated in a central works agreement. Finally, the desired replacement of (transformed) works agreements of the seller's business can also be made possible by an integration of the operation into the acquirer's operation. In this respect, the fate of works agreements should always be kept in mind when structuring a deal.

Conclusion

Due to the financial obligations created by works agreements alone, particular attention should be paid to works agreements in the context of a due diligence under labour law. This applies all the more if the company is to be acquired through an asset deal. It is also essential for the acquirer to consider the effects of a transfer of undertaking on the applicability of its labour agreements. Ideally, the acquirer should define an ideal works agreement landscape that is considered when structuring the transaction. If these points are considered, works agreements can be prevented from becoming stumbling blocks in an M&A deal.