For decades, M&A in India required navigating a labyrinth of 29 fragmented labour laws. Inconsistent definitions and rigid approval norms often created hidden liabilities, turning labour diligence into a purely reactive exercise.
The consolidation of these laws into four new Codes: (i) Wages, (ii) Industrial Relations, (iii) Social Security, and (iv) Occupational Safety, Health and Working Conditions - marks a paradigm shift ("Labour Codes"). While the New Codes promise uniformity and predictability, they introduce new financial realities.
The Labour Codes are a double-edged sword for M&A. The rules under the Labour Codes (which will prescribe procedural aspects, necessary for implementation) have not yet been framed. Therefore, during this flux, the regulatory framework is a (temporary) mix of ‘old’ and ‘new’. While the new framework will reduce the friction of doing business (fewer licenses, centralised registrations, clear obligations and mostly digital compliances), the new regime is also likely to increase the cost of doing business (higher employee benefits, stricter penalties).
Here is how the new regime is likely to impact deal economics and risk allocation.
1. The EBITDA Hit: Redefining "Wages"
Historically, Indian employers minimised statutory costs by structuring compensation with low "basic pay" and high "allowances". This reduced social security contributions, since they were calculated with “basic wages” as the basis of computation.
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The Deal Impact: Valuation Compression: Don't just ask: "Did you pay your dues?", Ask: "How much does our EBITDA drop on account of the increased social security outflow under the new definition of wages?" An expanded wage base increases employer contributions to provident fund and health insurance, as well as direct payments to employees as gratuity and bonus. This directly increases operational costs, compressing EBITDA and, by extension, enterprise value. Price Adjustments: Acquirers may now model these incremental compliance costs into their purchase price. In many cases, this may necessitate a renegotiation of the consideration. |
The Code on Wages will disallow this practice. It introduces a uniform definition of wages, with a proviso which caps exclusions from basic wages at 50% of total remuneration. This means any allowance exceeding this threshold must be added back to "wages" for calculating statutory contributions.
2. "Hidden" Headcount: The Expansion of the Worker Pool
In the previous regime, certain categories of staff, consultants and gig workers were not entitled to statutory benefits. The new Codes have changed the position.
Gig & Platform Workers: Now formally recognised under the Social Security Code, with aggregators mandated to contribute 1-2% of turnover to a social security fund.
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The Deal Impact: Diligence teams must re-examine the target’s ‘employee’ classifications. Misclassification is no longer a grey area - it is a quantified liability. Expect an increase in statutory headcount and associated benefit costs. |
Fixed-Term Employees: Now a statutory class entitled to the same benefits as permanent staff, including gratuity after just one year of service.
3. Restructuring and Retrenchment: Easier Process, Higher Cost
Post-deal integration often involves workforce rationalisation. The new Codes offer a mixed bag for acquirers:
Greater Flexibility: The threshold for seeking government permission for layoffs has been raised from 100 to 300 workers. This allows mid-sized targets to restructure and integrate workforces much faster, removing a major regulatory bottleneck that historically delayed synergy realisation.
Impact on Cash Flow: The cost of letting people go has risen.
Re-Skilling Fund: Employers must now contribute 15 days' wages for every retrenched worker into a new fund.
Immediate Settlement: All dues must be cleared within two days of exit (down from longer traditional timelines).
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The Deal Impact: While execution risk for restructuring may have decreased, the cash cost of integration has likely increased. Buyers must draft robust transfer clauses and ensure sufficient liquidity to meet these tighter settlement deadlines. |
4. Safety and Penalties: From Nominal Fines to Material Risk
Under the old regime, safety compliance was scattered and penalties were often trivial (e.g., ₹1,000 for wrongful retrenchment under the Industrial Disputes Act, 1947), leading to lax enforcement.
The new OSHWC Code unifies these standards and significantly raises the stakes. Penalties for non-compliance have surged - for instance, wrongful retrenchment can now attract fines up to ₹1,00,000. More critically, serious lapses (like failing to conduct health check-ups in hazardous industries) can lead to imprisonment of up to two years and heavy fines.
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The Deal Impact: Safety compliance can no longer be deferred as a "post-closing cleanup" item. The threat of higher fines mandates deep operational audits and site inspections before signing. Indemnity limits may need to be adjusted to reflect this heightened risk profile. |
Key Takeaways
The new Labour Codes transition labour diligence from a legal formality to a financial imperative. The "arbitrage" of ambiguous definitions and low penalties is over. The focus must shift from merely checking for past non-compliance to modelling and addressing future costs.
The Acquirer’s Cheat Sheet:
Re-Model EBITDA: Factor in potentially higher PF and gratuity costs due to the "50% allowance cap".
Verify Classifications: Ensure gig workers, sales staff, and fixed-term employees are accounted for in benefit calculations.
Fund the Exit: Budget for the "Re-skilling Fund" and ensures liquidity for 2-day final settlements during post-deal workforce rationalisation.
Indemnities: Move away from standard language; specific indemnities may be required for wage definition risks and contractor misclassifications.
[The first author is an Executive Partner, second and third authors are Partners, while the fourth author is a Senior Associate in Corporate and M&A practice at Lakshmikumaran & Sridharan Attorneys, New Delhi]
