Industrious Conversations: Closing the Loophole changes from a corporate transactions lens

Jennie Mansfield:

Hello, and welcome to Ashurst Legal Outlook. This is the fourth episode in our Industrious Conversations series, bringing you insights into industrial relations developments in Australia from our leading Employment team at Ashurst. My name is Jennie Mansfield, and I am a partner in the Employment team. Today, we will be discussing a different perspective on the Closing the Loopholes changes that our team has been dissecting in our Industrious Conversations podcast series, that is, the impact of the changes on corporate transactions. I am joined in this discussion by my colleague, Jon Lovell, who is also a partner in our Employment team.

Jon Lovell:

Hello everyone. Jennie, it's great to join you for a discussion around the impact of the Closing the Loopholes changes on corporate transactions. We are seeing a really significant level of deal activity across a number of sectors in the Australian economy at the moment, but at the same time, we are seeing really significant changes to our workplace relations environment. In fact, the most significant changes that we have seen in decades.

Where we propose to start today's discussion is around some of the commercial impacts of those changes, and right at the top of that list is what the changes mean for the labour models or arrangements that many Australian businesses may have in place. Those labour models and arrangements typically centre around flexibility, how labour is delivered, and often will involve a mix of directly employed full-time and casual employees, labour hire and contractors. And the Closing the Loopholes changes present some challenges, and really important commercial considerations for each of those groups.
Jennie, I might start by unpacking the labour hire arrangement changes. When we think about labour hire, we all think about a conventional labour hire, which is a quite simple arrangement. Conventional labour hire is where an employer has directly employed employees in the business, and then the employer supplements that labour by engaging a labour hire provider. The new regime has a very real potential to impact the costs associated with that type of arrangement and the flexibility. The key challenge with the labour hire arrangements regime under Closing the Loopholes is that it is much broader than that. In fact, by design, it picks up any in-house or intra-group arrangements where you have labour working across the group performing similar work but under different terms and conditions of employment. Those differences in terms and conditions of employment can be part of a clear business strategy, but quite often are a product of history, and in fact might be a result of past acquisitions where differences in terms and conditions haven't been addressed or harmonised over time and remain in place now.

Our colleagues, in a separate episode in this podcast series, have unpacked in some detail those labour hire arrangements changes. When it comes to corporate transactions, we think they do create some pretty significant, and potentially material, commercial considerations. From the perspective of a vendor, it is really important to understand those parts of the business, whether using conventional labour hire or in-house labour hire or secondment arrangements. What is the potential impact of a labour hire arrangement order? What is the prospect of a union or employees obtaining such orders? And what information could a vendor give potential buyers around the strategy in place for effectively managing or containing labour rates?

On the flip side, buyers need to be very mindful of the potential flow through impacts to labour costs, should there be a change in labour rates as a result of labour hire arrangement orders, and make a clear-eyed assessment. Jennie, it's not just labour hire that is presenting challenges to the labour model or mix of Australian businesses. There are also some important changes which relate to casual employees and independent contractors. Maybe you have some perspectives on that?

Jennie Mansfield:

Yes. Thanks, Jon. I think there are real parallels in the way that these labour models have changed, in terms of the statutory definitions. You will remember that we have had a couple of years of relaxation where we have been able to rely on High Court authority to the effect that a written contract capturing all the terms of the casual employment contract, or all the terms of the contractor agreement, were substantially determinative of the nature of those two types of relationships. The Closing the Loopholes amendments to the definition of 'employee' and to the definition of 'casual employee' take us back to the pre-High Court position where there is a higher level of uncertainty, which is quite hard to diligence in a corporate transaction to give the buyer security about what the labour cost model is going to look like going forward.

Our colleagues, Scarlet Reid and Talia Firth discussed casuals in the last episode in this podcast series, and noted that the statutory definition of casual employee has been amended to address the practical reality of the employment relationship. That includes post-contractual conduct, and it is all designed to look at whether the employee had a reasonable expectation of ongoing work, as opposed to just checking that the contract has the type of words and the definition of casual that would let you proceed on the basis that it was genuinely casual employment. There is a bit of a save in the legislation. We haven't gone back to the bad old days where potentially all casuals with a regular and systematic pattern of work might be found to be ongoing employees with a huge backlog of entitlements and no offset for the casual loading they had been receiving. Closing the Loopholes does recognise that you could offset that casual loading, but it is an area of some uncertainty, and much harder to diligence when you have to look into practical reality, rather than reviewing contractors.

The second area is contracting, as you mentioned Jon, and a very similar approach where you can't rely on the concept that the contract is king. You need to look into the nature of the relationship between the contracting parties to see if the person is genuinely an employee within the new statutory definition or an independent contractor with no access to employee-like entitlements. So again, when it comes to due diligence, there is a lot more work to do in trying to assess the practical reality behind the relationship, the level of control, and how the contract operates in reality. There is also a level of uncertainty for the buyer around whether the existing contracting arrangements will be upheld and if they can continue in their current form as the basis for their ongoing labour cost assumption.

Jon Lovell:

Jennie, I think that is absolutely right, and one of the practical challenges we face in due diligence in any business is how you can possibly come to an assessment about the practical reality of a relationship based on usually limited information and a desktop review. Our experience in seeking to effectively work through these issues is to really focus instead on the systems and processes and governance that a target business might have in place to grapple with these issues. We can then ask directed questions, not only "what are your template independent contractor or casual terms and conditions of employment?", or "how many such persons are working in the business?", but focus instead, in a more expansive way, "what are your systems and processes for grappling with these issues?", and try to make a qualitative assessment of the level of maturity in the target business when it comes to these issues.

If you see little regard to the effect of these changes, a business as usual approach, that may well be a red flag. In contrast, if you see a sophisticated business that understands the import of these changes and has a very clear strategy in place for where it uses casual or contractor labour, and has thought about it carefully, that might give a buyer a greater deal of comfort. On the flip side, when acting for vendors, it is about getting out ahead of those issues. That is, getting very clear about the systems, processes and governance in place around these issues. The old approach of simply putting the template contracts, and the number of casual employees and contractors, in the data room just isn't going to pass muster.

Jennie Mansfield:

It's an interesting point, Jon, and a great parallel to the big issue in due diligence of payroll compliance. Ten years ago, I would not have been asked to diligence payroll compliance in a corporate transaction. Generally, there would be a general compliance with laws warranty. Maybe in a particular deal you would ask for a warranty about compliance with workplace relations laws in a very general sense, and we would leave it at that, unless there was a known problem. With the significant shift in regulatory scrutiny of compliance, payroll compliance has really become the top issue for employment due diligence, in terms of materiality, and we are very frequently conducting a sampling exercise to support warranty and indemnity (W&I) insurance. Alternatively, we are working with our colleagues in our own Ashurst Risk Advisory or an external audit firm to pull together a more comprehensive due diligence of compliance with awards and enterprise agreements to detect whether there is any issue. What has your experience been, Jon?

Jon Lovell:

The parallel with your experience is a great deal of attention and focus, particularly where the deal is subject to W&I insurance, it is placed on compliance. The practical reality of course, in the context of a transaction, is what does a payroll compliance review require? It typically requires, a lot of detailed and sensitive information about employees and labour rates and terms and conditions. In a competitive process, there can be real practical issues associated with a vendor being willing to share information of that nature, and there can also be really significant time constraints.

Certainly, as you say Jennie, it can be practical to undertake some targeted sampling, but again, our focus really has to come back to systems, processes and governance. What's the first question we ask of most vendors? Have you done your own payroll compliance review in the last 12, 24, 36 months? What did that compliance review look like? What is the methodology and assumptions that you have used? What has been fed into that process? If any issues, were they questions of interpretation or outright issues of non-compliance? What has been the response and remediation of any identified issues? That can be a very effective way to get to the nub of these issues very quickly, including in time-constrained or competitive transactions.

Jennie Mansfield:

I agree with that, Jon. It's a really interesting parallel to what you were suggesting about labour hire arrangements. Counter-intuitively, I find that if I get an answer that there has been a problem and it has been rectified, I am much more satisfied with that than if I get an answer to a request for information that says "we have fully complied", or "there have been no issues" or an eerie silence about which award applies. I think that is the situation in diligence where you start to red-flag payroll compliance.

Often, you are right, we can't get a diligence done to a satisfactory level before we sign the deal, and there is not really an opportunity to deal with it by way of an immediate adjustment to the purchase price. We have been working on complex situations where there can be, for example, a holdback in the deal price and a reconciliation at a later point after a more fulsome audit and a series of payments to employees. There is still always going to be the unknown about what the regulator is going to do about the detected non-compliance, and how that should be dealt with, and whether penalties need to be factored in. So it is a really tricky area for parties to wrangle with, particularly now that the consequences are higher. Jon, what is the change in that area?

Jon Lovell:

Bringing it back to the Closing the Loopholes changes, it is fair to say as you have reflected, Jennie, that this has been an increased area of focus in transactions over the last five, six or seven years. The Closing the Loopholes changes, in a nutshell, raised two issues. First, they attach much greater financial penalties to issues of non-compliance. Penalties will be able to be attached and calculated as a multiple of the scale of underpayments, and there is a new regime that elevates, or allows for even greater penalties to be implemented, where there are serious contraventions. That raises a really critical point when it comes to issues that have been identified through the course of a transaction, including a diligence process of the kind we have already been discussing.

Under the old regime, there was a form of serious contraventions with increased penalties, but a very high bar to establish serious contraventions, actual knowledge, or essentially complete recklessness as to the circumstances giving rise to the contravention or non-compliance. Now that the threshold has been lowered, it is about knowledge or the existence of systematic issues that can give rise to serious contraventions and, by extension, serious penalties. It is really important whether it is in the context of in-transaction due diligence or implementing the transaction post-completion. If compliance issues are identified, and the owners of the business have knowledge of those issues, it is essential that there is a clear program and strategy in place for remedying the non-compliance.

Now, our experience with regulators has been a bit mixed, but what I can confidently say is, in the context of acquisitions where a buyer has come in and identified issues and worked efficiently to set things right, then the Fair Work Ombudsman and other regulators are far more likely to be disposed to a lower level compliance outcome, and possibly even an informal outcome. The opposite is that issues are identified, lots of things are happening in relation to the acquisition or bedding down of the new business. Then they are deprioritised and some time passes. During this process, you miss the opportunity to have taken a proactive approach to remediate the issues. Importantly, even if the issues arose as a result of the previous owners conduct, the conduct is assumed, if you like, by the new owners. Having done diligence and identified the issues, there is a risk of serious contraventions because there is knowledge of those systematic issues and they have not been adequately addressed. So, it is really important in the context of a transaction where non-compliance has been identified to think about the commercial mechanisms which might be available, such as holdbacks and adjustments to purchase price that Jennie, as you have referred to, it is critical to have a clear program or strategy in place for remedying non-compliance within a reasonable period following completion.

Jennie Mansfield:

That is absolutely right, and the flip side of that is doing assurance to make sure that the go-forward position on payroll is correct and that the mistakes that needed to be remediated have been rectified within the systems. So, there is quite a lot of work to do in that busy post-completion environment that you described, Jon.

What about the other changes to Closing the Loopholes that we need to tackle in due diligence? I suppose there are some other changes like to fixed-term contracts and pay transparency that can be worth calling out to make sure a buyer does not perpetuate sins of the past.

Jon Lovell:

Jennie, there are absolutely some other issues that we commonly see arise. I might speak briefly to fixed-term contracts, and then turn back to you for a discussion around pay secrecy. The fixed-term contract regime under Closing the Loopholes has now been in force for some time. We are coming up to 12 months since civil penalties have been attached to any non-compliance with those provisions. I think it is safe to say that not all businesses will necessarily have clear frameworks in place for properly managing this issue, and that there might be different, and more expansive, views about the circumstances in which exceptions apply. Our experience from the perspective of a prospective buyer is that there is a need to look very carefully again, not just down in the detail of particular fixed term arrangements, but also at what types of processes or frameworks the target business has in place to properly engage and deal with this issue. In circumstances where it has not been fully thought through, are there issues on the other side of completion where there will be challenges with further extending a fixed term contract and what challenges might that pose to the business, particularly in circumstances where you might have key or senior personnel engaged under such arrangements?

Jennie Mansfield:

Thanks, Jon. I think another perhaps less material change is the introduction of pay transparency laws, which are still worth a level of due diligence. You will remember that those new workplace rights include the right of an employee to disclose, or not disclose, their remuneration or terms and conditions of employment that are reasonably necessary to determine remuneration outcomes. This extends to include a right to ask another employee about their remuneration and terms and conditions of employment. While it does not seem material, if those provisions are still in a template employment contract, I think it is worth calling out because employers who issue contracts with those clauses in them will be contravening the Fair Work Act and may face civil penalties. So, it may not be a problem in terms of past breaches. However, as you say, a buyer who quickly rectifies tends to get the benefit of that diligence. The impact of this amendment has been something that we have been noting in our reports, in circumstances where the contract template has not been updated.

Jon, to get back to some larger, and more material, observations about the changes. I know you have done a lot of work in sectors where there are big changes coming to rates of pay, and there's the possibility of multi-employer bargaining. Often we're not asked specifically to comment on that crystal ball gazing in a due diligence context, but what would you say to employers who are looking at buying businesses that operate in the kind of industry affected by those changes?

Jon Lovell:

Jennie, it is a really important point and probably a good way to close out this podcast episode. Just as we were observing at the top, many of the changes we are facing now represent the most significant changes to our workplace relations system in decades. The legislation passed through Parliament several years ago, but only now is it starting to wash through the system. So, we look at very significant processes before the Fair Work Commission, which are very likely to result in significant increases at this stage; unfunded increases to minimum wages across a range of sectors. We are also starting to see multi-employer bargaining, perhaps with a few fits and starts, becoming a feature of the system, and the very real possibility that organisations that are competitors, or performing similar functions within an industry, are being brought together and sat down at a common bargaining table with obvious potential effects on efficiency, productivity, and comparative advantage for those businesses. You are right, it is not a usual topic of a due diligence report per se, but these are issues that many of our clients in relevant sectors are thinking about very closely, and they are material issues that are being considered in the go, no-go decision as to whether an acquisition should proceed. I think that underscores the significance of these changes and the potential effects they might have on the competitiveness of, at least, some businesses.

Jennie Mansfield:

Thanks, Jon, for those observations. That seems like a good place to wrap up.

Jon Lovell:

Thanks, Jennie. It's been a pleasure and hopefully, our listeners have come away with one or two insights.

Jennie Mansfield:

Thank you for listening. To hear more Ashurst podcasts, and to ensure that you don't miss any future episodes in our Industrious Conversations series, subscribe now on Apple Podcasts, Spotify or your favourite podcast platform. Also, please do reach out to our Employment team if you would like to discuss this topic further. We hope you will join us next time to gain insights from other members of our leading Employment team here at Ashurst, as we continue to explore key developments in industrial relations in Australia. Until then, thank you for listening, and goodbye for now.