Tag Archives: employee incentives

Employee Rights in Mergers and Acquisitions

An entity to entity merger/acquisition has manifold considerations, movement of employees and their rights being one of the most important aspects. A change in the ownership or management of a company may result in a significant change in the working conditions of employees. Transfer of employees between different locations of the new entity, change in work profiles and execution of fresh or revised employment agreement with the new entity are some of the changes that would arise as a result of a merger or an acquisition. In this post, we have tried to provide a bird’s eye view of the many points and challenges to be conscious of in the process.

Status of the Employee: Workforce in India can be categorised into 2 broad categories of ‘workman’ and ‘non-workman’. There are specific labour statutes which have to be mandatorily complied with in respect of a ‘workman’.

Section 2 (s) of the Industrial Disputes Act, 1947 (“ID Act”) defines ‘workman’ as any person who does any manual, unskilled, skilled, technical, operational, clerical or supervisory work for hire or reward and for the purposes of any proceedings in relation to an industrial dispute, includes any such person who has been dismissed, discharged or retrenched in connection with, or as a consequence of, that dispute, or whose dismissal, discharge or retrenchment has led to that dispute. The section also makes certain exceptions. For example, an employee in a managerial or administrative capacity or a supervisor drawing wages in excess of Rs. 10,000/- is exempt from the definition of workman.

However, as it appears from a plethora of judicial pronouncements in this regard, it is clear that the courts rarely go by a bare reading of Section 2 (s). The courts look into the facts and circumstances of each case while determining whether an employee is a workman or not. As observed by the Delhi High Court in Tata Sons Ltd. v. S. Bandopadhyay [111 (2004) DLT 489], in examining the question of whether an employee is a ‘workman’ or not, what is of importance is the nature of his duties, particularly his primary duties or his basic duties and the dominant purpose of his employment. Further, as held by the Supreme Court in T.P. Srivastava v. National Tobacco Co. of India Ltd. [1991 AIR 2294], duties which require the imaginative and creative mind could not be termed as either manual, skilled, unskilled or clerical in nature and therefore, such a person cannot be termed as a workman. In the case of Delta Jute & Industries Ltd. Staff Association and Ors. v. State of West Bengal and Ors. [2015 (145) FLR105], the High Court of Calcutta held that when a person is performing multifarious functions, the nature of the main function that the employee performs should be taken into account to determine whether the person will fall under the ambit of workman or not.

As a result of these judgements, the courts appear to be creating a distinction between unskilled, skilled and highly skilled employees without actually setting out clear parameters on how and when to classify them as such. Hence, it would be crucial to show that the work performed by an employee is imaginative, creative and highly specialized, in order to claim that such employee does not fall within the ambit of the definition of ‘workman’ under the Act. If an employee falls under the ambit of workman, the old employer as well as the new employer has to ensure that compliance under all applicable labour legislations, including but not limited to those under the Industrial Disputes Act, 1947, Industrial Employment (Standing Orders) Act, 1946, etc. have been met with regard to the employees.

Consent of Employee: As per Section 25FF of the ID Act, where the ownership or management of an undertaking is transferred, whether by agreement or by operation of law, from the employer in relation to that undertaking to a new employer, every workman who has been in continuous service for not less than one year in that undertaking immediately before such transfer shall be entitled to notice and compensation in accordance with the provisions of section 25F, as if the workman had been retrenched. There is a proviso to this section which states that a workman will not be entitled to any notice or compensation if the following conditions are fulfilled:

  • the service of the workman has not been interrupted by such transfer;
  • the terms and conditions of service applicable to the workman after such transfer are not in any way less favorable to the workman than those applicable to him immediately before the transfer; and
  • the new employer is under the terms of such transfer or otherwise, legally liable to pay to the workman, in the event of his retrenchment, compensation on the basis that his service has been continuous and has not been interrupted by the transfer.

However, the Supreme Court in the case of Sunil Kr. Ghosh v. K. Ram Chandran ((2011) 14 SCC 320) has held that, in the event employees are transferred to a new employer, it is mandatory for the old employer to take the consent of the workmen even if there is no change in the terms and conditions of their service and they are transferred on same or more favourable terms. In the event the workmen do not consent to such transfer, they will have to be given retrenchment compensation as per the provisions of the ID Act. This brought through a paradigm shift in the industrial jurisprudence with regard to rights of workman in case of their transfer to new employer. The reasoning given by the Supreme Court for the decision is that a workman cannot be forced to work for anyone against their wish.

Even though the employer-employee relationship for a non-workman is mainly governed by his or her employment agreement, some concepts of the ID Act are extended to non-workman as well. Therefore, even though ID Act is applicable only to workman, it is advisable that certain concepts such as taking consent of the employee in case of transfer to a new entity and other principles of natural justice are followed in case of non-workman as well in order to avoid scrutiny by courts.It has to be noted that the labour statutes and the courts in India are pro-employee and therefore, employers need to be extra cautious while dealing with the rights of the employees.

Notice of Change: As per Section 9A of the ID Act, if there is any change in the working conditions of workman as prescribed in Schedule IV of the ID Act, the workman needs to be given notice at least 21 days in advance of such change.

Continuity of Service: Another important aspect with regard to employees in case of a merger or acquisition if the employees are being transferred is that, they need to be given continuity of service. Their seniority should be taken into account by the new employer and the conditions of service shall not in any way be less favourable than those immediately prior to the transfer. This has to be mentioned clearly in the new employment agreement/ appointment letter entered into with the new entity.

Social Security Obligations: The Supreme Court in the case of McLeod Russel India Limited vs. Regional Provident Fund Commissioner, Jalpaiguri and Others [2014(8)Scale 272] has held that the transferee entity will be liable for any default on part of the transferor entity even if there is an agreement to the contrary stating that the transferor will be liable. This decision of the Supreme Court highlights the importance of a thorough due diligence which has to be conducted by the acquiring entity and clearly ascertain the liabilities of the transferor entity towards provident fund and various other labour laws and obtain indemnification and damages from the transferor companies prior to such acquisition, if required.

The transaction documents entered into between the two entities should clearly provide for transfer of employee benefits, such as provident fund, to the new employer. Please refer to our handbook for details on this aspect, in case of an NCLT driven merger/amalgamation: https://novojurislegal.files.wordpress.com/2018/06/blog_ncltmerger-final-04062018.pdf

Another important aspect in case of a merger or acquisition is with regard to the treatment of leave under statutes such as the various States’ Shops and Establishment Act. Every employee is entitled to certain number of days of leave depending on the length of service in a particular year which can be accumulated and also encashed depending on the state specific Shops and Establishments Act. For example, as per the Karnataka Shops and Establishment Act, 1961, if the employment of the employee is terminated by the employer before such employee has taken the privilege leave which he or she is entitled to or if the employee has applied for leave and have not been granted such leave, or quits his or her employment before he/she has taken the leave, the employer will be liable to pay the employee the wages for leave not taken. Thus, it becomes important for the transferee entity to give due regard to the leave balance of the employees who are being transferred and due regard must be given to the liability that may arise with regard to such leave encashment. Therefore, adequate adjustments may be made to the consideration amount paid to the transferor so that the transferee entity does not incur any additional burden in this regard.

Treatment of ESOPs: ESOPs usually have a vesting period and would be subject to exercise at a price before an acquisition or accelerated vesting in case of an acquisition. This becomes an especially significant point of consideration in case of stock swap structures.

The above-mentioned pointers are few of the many considerations during a merger/acquisition. Depending on the particular structure of a merger/acquisition, the steps for employee transfer/discontinuation needs to be evaluated.

Authors: Mr. Paul Albert and Ms. Sohini Mandal

Advertisements

Ten Frequently Asked Questions on Exercising Employee Stock Options in Private Limited Companies

Employee Stock Option or ESOP is a mechanism through which companies provide options to their employees to purchase equity shares and become stakeholders in the companies, at a pre-determined price, and upon “Exercise”. To read more on the basics of ESOPs please see here.

Over the last couple of years, we have advised many companies on setting up and implementing ESOP and in the process, we have received queries from both employers and employees on exercise of ESOPs, right time for exercising, tax incidences, etc. In this post, we have attempted to put them in the form of answers to Frequently Asked Questions.

  1. Why are ESOPs granted?

Stock options could be granted for various reasons, ranging from motivating employees to contribute to Company’s growth, to incentivizing employees, rewarding for optimal performance, and also attracting talent pool. In most cases of early stage ventures, ESOPs are used effectively as a compensation packaging.

  1. Who can companies grant ESOPs to?

All employees of a company (including employees of parent and subsidiary entities) can be granted ESOPs, other than promoters, independent directors and directors (holding more than 10% of the outstanding equity shareholding in a company, either directly or indirectly). Depending on the structure of the ESOP scheme adopted by a company the board of directors of such company or the trustees of an ESOP trust of such company, have the ability to formulate and identify certain category of employees, like senior management, performance based, etc., who shall be eligible to obtain grants of ESOPs in such companies.

A registered ‘start-up’ (as defined under the Start-up India Action Plan) can further issue stock options to promoters and even directors holding more than 10% of the outstanding equity shareholding.[1]

Consultants/ advisors, however, cannot be granted employee stock options, under the current legal framework.

  1. What does “Exercise” mean?

Exercise is an event through which an employee or ESOP holder actually exercises the right to purchase equity shares of the company, at a pre-determined price (“Exercise Price”), upon completion of vesting of granted ESOPs, or any portion thereof, and upon payment of the Exercise Price. The moment ESOPs are Exercised, the concerned employee becomes a shareholder in the company.

  1. What is “Exercise Price”?

Exercise Price, as explained above, means the purchase price payable by an employee for each equity share that he/she is entitled to get, upon Exercise of vested ESOPs. The Exercise Price could be a fixed number or formula driven, and such number/formula is required to be captured in the ESOP scheme.

  1. What is “Exercise Period” and when can an employee Exercise ESOPs?

The time period within which an employee can Exercise vested ESOPs, is known as “Exercise Period”. Typically, the Exercise Period would be captured in a company’s ESOP scheme, or in stock option agreements executed with employees.

The Exercise Period could be any time, once ESOPs are vested. Some of the instances of how an Exercise Period may be structured, are as follows:-

  • It could be an annual/semi-annual window in a given financial year, within which all employees with vested ESOPs may Exercise (vested ESOPs only);
  • It could be linked with termination/resignation, and any time within the notice period an employee may Exercise vested ESOPs;
  • It could also be at a merger, entity buy over, change of control situation in a company (considering the cash outflow of the Exercise Price by employees at the time of Exercise and tax incidence as discussed in Point No. 6 below).

However, it is recommended that only one of the above-mentioned options are chosen in order to avoid operational confusion. The ESOP scheme of many companies also provide that if vested ESOPs are not Exercised within an immediately next Exercise window, especially in case of termination/resignation, the vested ESOPs shall also lapse.

  1. What are the applicable Tax incidences upon an employee Exercising ESOPs?[2]

In the hands of an employee:

  • At Exercise: The difference between Exercise Price and fair market value of the shares of a company, at the time of Exercise, is taxable as ‘perquisite’ [Ref: Section 17 (2) (vi) of the Income Tax Act, 1961] under the head of ‘Salary’. The exact amount of tax payable would depend upon the relevant tax slab under which an individual employee falls.

The employer/ company has to deduct TDS on the perquisite amount.  For instance, if the Exercise Price per ESOP is INR 10/- and the fair market value of each share in a company, at the time of Exercise, is INR 100/-, the difference amount, i.e. INR 90/- (INR 100/- less INR 10/-) shall be taxable as ‘perquisite’ and TDS shall also have to be done.

  • During Transfer: At the time of transfer (sale/purchase) of shares obtained upon Exercise of ESOPs, the difference between transfer price and acquisition cost is taxable as capital gains and depending upon the tenure of holding of such shares, the capital gains on the concerned employee could be long term or short-term.

It may be noted that the holding period for calculation of capital gains starts from the date of Exercise.

In the hands of companies:

Discount given to an employee, if any, on the fair market value, at the time of Exercise, i.e. the difference between the Exercise Price and the fair market value, is a permissible deductible business expenditure [Ref: Section 37(1) of the Income Tax Act, 1971] in the hands of a company.

  1. What is the process of Exercise?

Depending on the terms and provisions contained in the ESOP scheme of a company, the Exercise process could be the function of an employee holding vested ESOPs, giving notice to the company in this regard, within the Exercise Period. The Exercise Price needs to be paid in full to the company prior to any Exercise. Post such payment, the Company either issues fresh equity shares to the employee (in case of a notional pool) or transfers the shares to the employee (in case of a trust driven pool). Relevant statutory filings and compliances have to be done for issuance or transfer of shares by the company, as the case may be.

  1. What if an employee leaves before Exercising the vested ESOPs?

This is closely linked with the Exercise Period, as discussed in Point No. 5 above. As such, upon termination/resignation, vested ESOPs may be Exercised by an employee, during the relevant notice period, or held on for Exercising during a merger, entity buy over, change of control situation in a company. Many a times, the way vested ESOPs could be Exercised, is also made dependent upon whether such termination or resignation is for a good reason or a bad reason.

Unvested ESOPs, however, under all circumstances, get cancelled, upon a resignation/termination.

  1. Can a company grant loan to its employees for Exercising vested ESOPs?

Rule 16 of the Companies (Share Capital and Debenture) Rules, 2014 allows companies to grant loan to its employees for the Exercise of vested ESOPs. However, such loan has to be granted in compliance with applicable provisions of the same.

  1. Can a company put restrictions on ESOPs / shares granted under ESOP schemes?

ESOPs cannot be transferred, pledged, hypothecated, mortgaged or otherwise encumbered in any manner.  Shares granted to an employee post Exercise may be subjected to transfer restrictions, and other shareholding rights and obligations as may be applicable in the charter documents of any particular company.

In case of Exercise, prior to the occurrence of a merger, entity buy over, change of control like situation, promoters may also evaluate having some control over such ESOP shareholding, such that, if required, ESOP shares can also be sold, seamlessly, of course subject to the same terms and conditions (including price) as available to other shareholders in such a situation.

Authors: Ms Ayushi Singh (Associate) and Ms Sohini Mandal (Junior Partner)

[1] Notification by Ministry of Corporate Affairs, dated 19 July 2016 available at:

http://www.dhc.co.in/uploadedfile/1/2/-1/Companies%20(Share%20Capital%20and%20Debentures)%20Third%20Amendment%20Rules%202016.pdf

[2] We are not tax experts and the contents captured hereinabove is a mere statement of the provisions. Separate tax advice shall be taken in this regard.