Summary: India’s consolidation of 29 central labour laws into four Labour Codes marks a landmark transformation of the country’s regulatory landscape, with far-reaching implications for M&A transactions. The introduction of Labour Codes is not just a compliance issue, but one that actively impacts deal making. While the Labour Codes promise a more streamlined compliance framework in the long term, the current transitional phase — where central rules remain unfinalised and most states are yet to implement the Labour Codes — introduces significant near-term complexity for dealmakers. In this blog, we aim to highlight some of these considerations, including on valuation impact, penalty enhancements and heightened due diligence requirements. This blog also serves as a summary of ongoing considerations for transactions in light of the new Labour Codes.
India’s labour laws have undergone a historic transformation with the implementation of four Labour Codes — the Code on Wages, 2019 (“Wages Code”), the Industrial Relations Code, 2020, the Occupational Safety, Health and Working Conditions Code, 2020 (“OSH Code”), and the Code on Social Security, 2020 (“SS Code”, and together “the Codes”) — consolidating 29 central labour laws into a unified system. However, the central government has not finalised rules, and most states have not implemented them.
For M&A transactions, this shift presents a nuanced landscape. While the legacy laws were complex, they were well-tested; in contrast, the Codes bring near-term navigational complexities until established practices solidify, alongside broader structural changes reshaping deal dynamics. The Codes present both strategic opportunities and heightened compliance requirements for dealmakers.
Transfer-Related Provisions
The Codes, like previous labour legislations, do not contain express provisions for automatic transfer of employees in M&A transactions. Consequently, employee transfers are handled substantially as under the erstwhile laws. For instance, in transactions involving transfer of workers (akin to ‘workmen’ under erstwhile law), the new employer must grant continuity of services to workers who have been in continuous service for at least a year and offer no less favourable employment terms. Workers who refuse the transfer will be deemed to have been terminated.
Considerations for ongoing transactions
The Codes pose challenges for transactions currently in progress. The following sections outline key considerations:
Valuation
The redefined wage structure, which caps exclusions (such as PF, HRA, conveyance allowance, overtime, commission) at 50% of total remuneration, necessitates a comprehensive analysis to evaluate the computation methodology for key social security benefits like PF, ESI, gratuity, and leave encashment. Gratuity and leave encashment now carry enhanced liabilities, given that these must be calculated on the new wage definition. Leave encashment must also be computed annually as well as at the end of service, linked to fixed remuneration in both cases. This redefined wage structure could materially impact target company valuation, particularly for worker-centric businesses, potentially triggering price adjustments. The tax implications resulting from changes adopted pursuant to the Codes and any consequent valuation changes also need to be reviewed. Additionally, the costs attributable to gratuity-related insurance obligations and associated premium expenditure warrant careful assessment. Accordingly, a fresh valuation exercise may be warranted for transactions pending closing.
Indemnities and closing
Enhanced penalties under the Codes substantially increase risk exposure, with fines reaching up to INR 10,00,000. Failure to obtain registration under the OSH Code also debars an establishment from employing workers, posing significant business continuity risks. Buyers should accordingly negotiate higher indemnity caps for labour-related claims, lower baskets/ thresholds, separate sub-caps for high-risk areas, and extended warranty survival periods (bearing in mind the extended transitional period). Indemnities will cover past non-compliance, while future compliance costs must be factored into buyer’s valuation assessment. Buyers should also seek standstill and post-closing covenants providing for mutual cooperation to address enhanced compliance requirements. Parties should review closing conditions and timelines to ensure compliance and workability with Codes.
The modified definition of ‘employer’ now deems the managing director or manager to be an ‘employer’, where they have substantial control over establishment affairs. Parties must factor this expanded definition into transaction documents, particularly where liability may pass to buyers and incoming directors, and include robust risk allocation and ring-fencing provisions to address past liability.
Material Adverse Effect (MAE) and Force Majeure
Parties should thoroughly review force majeure and MAE clauses to assess whether the introduction of the Codes (and resultant additional compliance costs or valuation impact) triggers an MAE or constitutes a force majeure event that could lead to termination or other consequences affecting pricing and deal terms. Parties should carefully reallocate risk for any changes in law occurring between signing and closing.
Additional Considerations for M&A Transactions
Key Due Diligence Considerations
The new regime introduces a single registration/ licensing system under the SS Code and the OSH Code, streamlining multiple permit requirements under earlier laws. However, commercial establishments may now require dual registration under the Codes and under local shops and establishment acts. Migrating to a single registration system will pose implementation challenges that parties must address in transaction documents, depending on the deal stage. In business transfer deals that have already been signed, parties should consider post-transaction seller support for such migration, with appropriate risk allocation for interim non-compliance. For future deals, while the unified system will enhance due diligence efficiency, the consequences of non-registration necessitate that corrective actions be structured as a condition precedent rather than routine post-closing remediation.
Contract Labour Considerations and Additional Obligations on Principal Employer
Buyers must now verify all contractor licences. Engaging contract labour through unlicensed contractors attracts penalties for the principal employer. Additionally, the prohibition on engaging contract labour in “core activities” may necessitate significant operational restructuring if discovered during due diligence, potentially impacting transaction timelines and business operations. Given the heightened scrutiny on the categories of personnel engaged by a business, it is increasingly risky to adopt aggressive positions on the classification of workers, contract workers, consultants, and gig workers. Buyers must carefully evaluate these matters during due diligence to identify and rectify non-compliance prior to closing.
Warranties, Indemnities, and Pre-Closing Actions
Enhanced penalties under the Codes substantially increase risk exposure. Although the Codes generally decriminalise minor offences, serious infractions such as failure to deposit employees’ statutory contributions attract imprisonment. Given this enhanced exposure, parties must address labour-related non-compliance prior to closing and factor the time and cost of corrective actions (for instance, regarding contract labour arrangements, building necessary capital infrastructure, and employee payouts) into deal documents.
Post-Acquisition Structuring
The threshold for seeking prior government permission for retrenchment in a factory, mine or plantation has increased from 100 to 300 workers, providing greater post-acquisition restructuring flexibility. However, buyers’ monetary liability may increase due to new contributions to a ‘worker re-skilling fund’ and higher end-of-service benefits for retrenched workers — amounts that parties should calculate pre-closing. Employers must now settle all amounts due to terminated employees within business days, prompting sellers to prepare information and finances ahead of closing. In business/ asset transfers involving employee transfers, buyers and sellers are now jointly liable for ensuring all social security benefits (not just PF payments) have been paid – therefore any non-compliance would need to be corrected by closing or immediately thereafter. Fixed-term employment is now expressly recognised, enabling buyers to structure transitional employment arrangements while maintaining parity with permanent employees. Any change in ownership, management, or registration must be electronically intimated to the registering officer within 30 days. Working hour norms under the Codes may diverge from state-specific shops and establishment laws. This divergence, coupled with mandatory leave encashment requirements, warrants careful post-acquisition consideration, particularly for the services sector and manufacturing businesses. Employers are required to issue appointment letters to all workers; where the target has not issued these, buyers must implement an appointment letter programme immediately post closing.
Conclusion
The transition to the Codes represents both a challenge and an opportunity for M&A practitioners. While the current transitional phase — with legacy laws coexisting alongside incoming Codes — demands heightened vigilance across due diligence, valuation, and documentation, the long-term benefits of a streamlined regulatory framework are significant. As implementation timelines crystallise and state-level rules take shape, parties should closely monitor the development of rules and schemes under each Code, as these will provide crucial details impacting transaction costs and timelines. Dealmakers who proactively engage with these evolving requirements will be best positioned to structure compliant and commercially optimal transactions.