The ripple effect: How India’s new Labour Codes will reshape M&A transactions

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 (‘Labour Codes’), marks a paradigm shift. 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 (such as higher employee benefits, stricter penalties). 

Here is how the new regime is likely to impact deal economics and risk allocation. 

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.  

To address this issue, the Hon’ble Supreme Court in the landmark judgment of Regional Provident Fund v. Vivekananda Vidyamandir (2019) held that allowances paid universally, ordinarily and necessarily to all employees must be included in ‘basic wages’ for provident fund calculations. Despite this clarity, inconsistent enforcement allowed aggressive wage structuring to persist. This widespread non-compliance often resulted in retrospective liabilities when regulators or courts intervened. In transactions, these risks were typically addressed through specific indemnities, representations, and warranties in deal documents, protecting buyers against exposure from past wage-related violations. Due diligence teams had to scrutinize payroll structures and assess contingent liabilities, which frequently influenced negotiations and risk allocation.  

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. 

‘Hidden’ Headcount: The expansion of the Worker Pool 

In previous regimes, certain categories of staff, consultants, and gig workers were not entitled to statutory benefits which meant that they did not receive benefits such as gratuity or provident fund contributions. The new Codes have changed the position. Given the changes in definitions under the new regime, it is essential from a transactional perspective, to re-examine the coverage of statutory obligations such as gratuity, provident fund, and retrenchment compensation which now apply to ‘Workers’ under the Code.  

Gig & Platform Workers: These workers have now been accorded formal recognition under the provisions of the Social Security Code. In accordance with this framework, digital aggregators are obligated to contribute an amount equivalent to 1-2% of their annual turnover towards a dedicated Social Security Fund. This fund has been specifically instituted for the welfare and protection of Gig and Platform Workers, ensuring the extension of social security benefits to this segment of the workforce. 

Fixed-Term Employees: They are entitled to receive benefits equivalent to those extended to permanent employees, thereby ensuring parity in terms of employment conditions. Notably, such employees are eligible for gratuity upon completion of just one year of continuous service, a provision aimed at enhancing job security and promoting equitable treatment within the workforce. 

Restructuring and Retrenchment: Easier Process, Higher Cost 

The legal position regarding the treatment of workmen during a transfer of undertaking remains largely unchanged under the Codes. The provision previously embodied in Section 25FF of the IDA has now been carried forward in Section 73 of the IR Code. It continues to state that workers are not entitled to retrenchment compensation as long as the following three conditions are satisfied: their employment remains continuous, the new terms of employment are not less favourable, and the new employer assumes liability for any future retrenchment. 

Under the previous regime, the new management following a merger or acquisition would undertake workforce rationalization measures to integrate the acquired workforce with its existing workers which were often delayed dure to regulatory approvals. 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. This exempts a much broader class of entities from the previous restrictive approval process. 

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 skill fund, in addition to the retrenchment compensation. 

Immediate Settlement: All dues must be cleared within two days of exit (down from longer traditional timelines).   

The increase in the layoff approval threshold from 100 to 300 workers significantly eases workforce restructuring, enhancing deal feasibility. Transactions involving smaller entities with fewer than 300 employees are now more appealing to M&A, PE, and VC investors due to reduced compliance hurdles. Lower regulatory delays enable smoother post-acquisition integration and greater accuracy in valuation modeling by minimizing execution risk. The relaxation of approval requirements allows acquirers to pursue synergy-driven workforce optimization with greater agility post-closing. 

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. However, 87 provisions also prescribed imprisonment as a penalty. Nevertheless, with nominal penalties and authorities’ apprehension to award stringent imprisonment, investors and acquirers often did not consider such issues or labour compliance as a material condition precedent to closure. 

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 ₹100,000. 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. Further, although, imprisonment has been reduced down to 22 provisions, 16 compoundable and 6 non-compoundable, the Codes provide a scheme whereby subsequent offences could lead to imprisonment, thereby increasing the likelihood of such imprisonment being imposed. Consequently, enforcement is strengthened from both monetary and punitive perspectives. 

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.  

Owing to the heightened compliance burdens and cost implications, these changes may influence capital allocation decisions, with investors potentially favouring sectors such as technology, artificial intelligence, and automation where workforce classifications under the Codes have limited applicability over labour intensive industries. 

The Acquirer’s Cheat Sheet: 

Re-Model EBITDA: Reassess EBITDA projections to incorporate potential increases in provident fund and gratuity obligations resulting from the ‘50% allowance cap,’ which mandates that at least half of total compensation be treated as basic wages for statutory benefit calculations 

Verify Classifications: Ensure that all categories of workers including gig workers, sales personnel, and fixed-term employees are correctly classified and included in benefit calculations under the revised labour codes. Proper classification mitigates compliance risks and prevents unforeseen liabilities during audits or due diligence. 

Fund the Exit: Allocate sufficient resources for contributions to the mandatory Re-skilling Fund and maintain liquidity to comply with the statutory requirement of completing final settlements within two days of termination during post-deal workforce rationalization. Proactive planning will help avoid penalties and ensure smooth execution of exit strategies. 

Indemnities: Move beyond standard indemnity language in transaction documents and incorporate specific indemnities to address risks related to wage definition changes and potential contractor misclassification. Specific indemnities provide greater protection against retrospective liabilities and regulatory exposure. 

[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]