Labour Compliance in M&A: The Missing Piece in Due Diligence

In today’s high-stakes mergers and acquisitions (M&A) environment, where valuations often stretch into billions and deal cycles span continents, the legal due diligence process is both indispensable and increasingly sophisticated. Yet, in this meticulous process, labour and employment law compliance continues to be one of the most underestimated areas of legal risk, especially in the Indian context.

While financial tax and regulatory compliance get center-stage scrutiny, employment-related liabilities are often relegated to boilerplate checklists. This is a strategic oversight. Labour law violations can lead to regulatory penalties, operational disruption, valuation hits, reputational damage and prolonged post-deal litigation. In a jurisdiction like India, characterised by overlapping Central and State laws, high union presence and rigorous inspectorate enforcement, labour compliance in M&A is not optional; it is critical risk governance.

The invisible risk: Labour law in M&A transactions

Despite being one of the most regulated aspects of doing business, labour compliance often does not receive proportionate attention in deal documentation or diligence. Why?

Because unlike financial red flags, labour issues tend to be invisible liabilities, not always reflected in the books but fully enforceable under Indian law. These include:

(a) failure to remit provident fund, Employees’ State Insurance (ESI) contributions, or gratuity dues;

(b) improper classification of workers (employee versus contractor);

(c) non-compliance with working hour regulations or wage thresholds;

(d) violations under the Sexual Harassment of Women at Workplace (Prevention, Prohibition and Redressal) Act, 2013 (POSH Act)¹; (e) failure to adopt standing orders; and (f) unresolved disputes or unrecognised unions.

In EPFO v. Hooghly Mills Co. Ltd.², the Supreme Court categorically held that statutory contributions cannot be waived and will override contractual understandings between parties. In M&A, this means that buyers could be held liable for unpaid dues even if not contractually assumed.

Labour law audit: The missing layer in due diligence

A labour law audit is not just a human resources (HR) hygiene check, it is a legal audit with direct implications on valuation, warranties and risk allocation. Key areas typically covered include:

(a) verification of statutory registers and returns under applicable labour laws;

(b) scrutiny of PF/ESI/PT/gratuity/maternity/bonus compliance;

(c) validity of employment contracts and letters of appointment;

(d) engagement terms for contract workers and third-party staffing;

(e) the POSH Act³ compliance [presence of Internal Complaints Committee (ICC), complaints handling and annual reporting];

(f) review of standing orders, HR policies and termination practices; and

(g) pending employee claims or labour litigation.

In Bombay Anand Bhavan Restaurant v. ESI Corpn.⁴, the Supreme Court reaffirmed that even in the transfer of business, employees’ rights remain intact and enforceable against the successor employer.

Gap statements and deal strategy

A well-drafted gap statement, the outcome of a labour audit, provides the acquirer with a tool for:

(a) renegotiating deal value in light of uncovered liabilities;

(b) drafting indemnity clauses for unresolved compliance;

(c) setting up escrow reserves to ring-fence risk; and

(d) requesting pre-closing remediation to improve workforce documentation.

For instance, if the audit reveals non-payment of gratuity for 30 employees , the potential liability may run into lakhs, apart from penal interest and damages. A buyer can demand a specific indemnity clause or escrow cover for this risk.

In EPFO v. Hooghly Mills Co. Ltd.⁵, the Supreme Court underscored that obligations relating to provident fund contributions are statutory in nature and cannot be circumvented merely due to change in management or financial incapacity of the establishment. The Court reiterated that social welfare legislations like the Employees’ Provident Funds and (Miscellaneous Provisions) Act, 1952 (EPF Act)⁶ impose continuing obligations that remain enforceable notwithstanding corporate restructuring. For dealmakers, this judgment acts as a critical reminder that “gap statements” in due diligence must capture not only discovered liabilities but also contingent exposures arising from past non-compliance. Acquirers should incorporate this risk into their deal strategy, whether through purchase price adjustments, indemnities, or escrow arrangements, to prevent post-closing exposure to legacy labour liabilities.

Successor liability in Indian labour jurisprudence

Indian courts have developed a nuanced yet stringent view of successor liability in employment matters.

In Tata Engg. & Locomotive Co. Ltd. v. State of Bihar⁷, the Court stressed that economic liberalisation does not dilute social obligations and that compliance with employee welfare statutes is a constitutional mandate under Articles 39⁸ and 43⁹ of the Constitution of India¹⁰.

Similarly, in Pearlite Liners (P) Ltd. v. Manorama Sirsi¹¹, the Supreme Court ruled that even private settlements with workers prior to acquisition do not bar judicial scrutiny if statutory entitlements are compromised.

Therefore, disclaimers in share purchase agreements (SPAs) are not sufficient in themselves; they must be backed by legal due diligence, disclosures, and where necessary, regulatory filings and remedial action.

Global comparisons: India versus US, UK and EU

Let us examine how India’s labour compliance regime compares with key global M&A markets:

Jurisdiction	Labour due diligence focus	Enforcement characteristics	Key challenges
India	Highly statute-driven; extensive inspections; State-level rules	High; compliance enforced through inspectors, penalties and litigation	Complex and fragmented laws; transition to Labour Codes
United States	Primarily at-will employment; collective bargaining only in unionised sectors	Moderate; risk-based diligence in employment contracts, severance and pensions	Varies by State; less statutory compliance burden
United Kingdom	Transfer of Undertakings (Protection of Employment) (TUPE) regulations make employee transfer compulsory in asset deals	High; regulators actively enforce consultation and transfer obligations	TUPE liabilities automatically pass to the acquirer
European Union (e.g. Germany and France)	Employee rights transfer automatically; works council consultation mandatory	Very high; non-compliance leads to deal delays and fines	Mandatory works council approval can block transactions

Key takeaway: While the EU and UK enforce employee transition through regulation, Indian laws provide similar continuity principles through case law and statutory interpretation, making it imperative for buyers to look beyond contractual representations.

Contract labour: A risky grey zone in Indian M&A

Contract labour remains a grey area in India, and its misuse has led to multiple compliance failures.

The Contract Labour (Regulation and Abolition) Act, 1970¹², prohibits contract labour for core activities in certain industries. Buyers inheriting such engagements may inadvertently step into prohibited structures.

In Air India Statutory Corpn. v. United Labour Union¹³, the Supreme Court laid down the “integration test” to determine whether contract workers are in fact direct employees of the principal employer.

M&A deals involving logistics, facility management or tech firms that rely on contract labour must pay special attention to:

(a) whether the work is of a perennial nature;

(b) whether supervision/control vests with the buyer;

(c) whether contractors are registered under the Contract Labour (Regulation and Abolition) Act, 1970 (CLRA Act); and

(d) whether wages are paid directly by the principal employer.

Failure to comply may result in automatic absorption of contract labour into the buyer’s workforce, without negotiation.

Post-deal compliance and ESG alignment

Modern acquirers, especially private equity (PE) funds and global investors, are increasingly integrating labour compliance into environmental, social and governance (ESG) assessments. A poorly handled workforce integration can trigger ESG score downgrades, shareholder activism or reputational backlash.

In 2022, several Indian listed companies faced Securities and Exchange Board of India (SEBI) scrutiny over undisclosed employee litigations, particularly after acquisitions. Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015¹⁴ now require disclosure of material litigations, including employee disputes, if they have an impact on the company’s financial health or governance.

Labour due diligence is no longer just about liability prevention; it is a strategic ESG imperative.

Emerging trends and Labour Code transition

With the Wages Code, 2019¹⁵, Social Security Code, 2020¹⁶, Occupational Safety, Health and Working Conditions Code, 2020¹⁷ and Industrial Relations Code, 2020¹⁸, India is moving toward a unified labour law regime.

Once implemented, these Codes will:

(a) standardise definitions (e.g. “wages” and “worker”);

(b) centralise registration and compliance portals;

(c) introduce new social security obligations for gig/platform workers; and

(d) make trade union consultation mandatory in large establishments.

For M&A transactions post-Codes enforcement, compliance risk becomes even more central, particularly in pricing negotiations and integration planning.

Conclusion: Labour compliance as a strategic lever in M&A

M&A transactions today are not just about financial synergies, they are about cultural alignment, regulatory resilience and governance integrity. Labour compliance is a vital spoke in that wheel.

Whether you are a buyer seeking to protect your investment, or a seller aiming for a clean exit, labour law due diligence is no longer a soft issue, it is a hard necessity.

Acquirers must integrate labour audits into deal timelines, prepare gap statements, structure indemnities, and anticipate post-closing challenges. Sellers must address compliance pro-actively to strengthen their position and mitigate post-deal risks.

In a country where labour jurisprudence evolves dynamically through both statute and judicial interpretation, the failure to prioritise this function can derail deals and destroy value.