Now more than ever, the pandemic has underscored how the availability of healthy and motivated employees is essential to the success of a business. This is even more true for tech companies like software and video game developers who rely heavily on the talent of their employees in all areas to make the product successful.
Employee engagement, physical and mental health, and strong performance should thus be a top priority for a buyer or investor interested in acquiring all shares, or assets of tech company or to invest in it, whether a minority investment, joint venture or majority investment.
In a series of three short blog articles, we will focus on specific key employment law and compliance issues that repeatedly occur and which buyers and investors need to be aware of when acquiring a stake in software producers and video game developers. These key topics are
- Discrimination, Unequal Treatment and Harassment
- Crunch (in the video game industry understood as to work overtime to publish a game on schedule), and
- Worker/employee Misclassification.
The articles will help potential buyers identify and resolve these issues in tech M&A. In our experience, these topics tend to be neglected and ignored although they typically involve a significant financial liability and possible criminal exposure. Buyers should thus ensure that these high risk topics do not fall through the cracks when buying or investing in tech companies.
Discrimination, Unequal Treatment, Harassment
1. A wide range of mistreatment exists
Employees can be mistreated in several ways. Such mistreatment ranges from a behavior making employees feel unwelcome at work to criminal behavior such as sexual harassment. We will assess the following kinds of mistreatment in this article:
- Sexual Harassment
- Hostile work environment – including not taking women seriously, making jokes about women, questioning women’s capabilities with regard to the video game development, and
- Financial discrimination – including gender pay gap, worse career opportunities.
- How mistreatment is regulated under German Employment law
In general, there are no specific rules protecting exclusively women from discrimination or harassment. German laws on discrimination and harassment apply equally to all individuals, irrespective of their biological gender, their sexual identity and/or their sexual preference. As the current news are predominantly reporting on women as victims of discrimination and harassment, this article will focus on this gender group. However, the following rules apply to all individuals.
- Sexual Harassment as defined in the German Act on Equal Treatment
(1) Conduct of sexual nature
Sexual Harassment is defined by the German Act on Equal Treatment as an unwanted conduct of a sexual nature, including unwanted sexual acts and requests to carry out sexual acts, physical contact of a sexual nature, comments of a sexual nature, as well as the unwanted showing or public exhibition of pornographic images. This unwanted conduct must have taken place with the purpose or effect of violating the dignity of the person concerned, in particular where it creates an intimidating, hostile, degrading, humiliating or offensive environment. We will show at a later stage that unwanted conduct of sexual nature virtually always violates the dignity of the person concerned.
The decisive element of the statutory definition is the term “unwanted conduct of sexual nature”. Even though the law gives (non-enumerative) extensive examples of what conduct of sexual behavior can be, there is still vast misunderstanding. Whereas most accurately consider physical contact as sexual harassment, in particular if the perpetrator touches primary and secondary sex organs, an astonishing number of employees are unclear when it comes to non-physical assaults, such as verbal humiliation embedded in a sexual context. Touching “non-critical” body parts is generally seen as potentially “inappropriate” conduct, but typically not regarded as “sexually intended”.
Not having had any “sexual intentions” is often used as a defense in litigation. The federal labor court, however, has held that the perpetrator’s sexual motivation is not required for a finding of sexual harassment. “The failed flirt” is rarely the reason in legal disputes. Instead, the perpetrator is often seeking to exercise his status and/or hierarchical power over the victim by humiliating her. Therefore, the federal labor court has held that a heterosexual man who bruises the testicles of his colleague commits sexual harassment, even though he was sexually not interested in his colleague.
As already mentioned, physical conduct of a sexual nature (which is also a criminal offence in Germany since 2016) is just one category amongst others. Non-physical conduct of a sexual nature can also be considered as sexual harassment, e.g. comments on the appearance or the outfit of a woman, sexually suggestive remarks and gesturing, sexually suggestive “jokes”, showing of pictures with sexual content and so on.
(2) Conduct must be unwanted
Sexual harassment requires that the conduct is unwanted. To effectively protect victims, the question of whether the conduct is unwanted or not does solely depend on the victim’s feelings. The perpetrator cannot excuse himself by stating that he erroneously believed that his conduct was not unwanted.
Even sexually connoted jokes that are told in a larger group can embarrass a person or put her in an uncomfortable position and hence qualify as sexual harassment. This applies even if the victim was not the direct addressee of the joke, but the joke noticed the victim only by accident.
Incidents such as sexist or even rape jokes or displaying posters of lingerie models at desks or as desktop backgrounds clearly constitute a sexual harassment, if involuntarily noticed by another person. Even the work product of a tech company can indicate potential sexual harassment. For example, some video games are criticized for reducing women on their physical appearance and having sexist tendencies.
(3) Preventive and reactive measures to be taken by employers
Therefore, it is imperative and even stipulated by law that employers take necessary actions to prevent sexual harassment at the workplace by implementing preventive measures (e.g. policies and training) and reactive measures (e.g. investigation and persecution of potential misconduct). Apart from the negative publicity, failures to implement a robust compliance system can lead to joint liability for the perpetrator and his or her employer, if the victim claims damages.
When it comes to disciplinary measures against the perpetrator, individual circumstances and the seriousness of the offense must be taken into account. Whereas the federal labor court decided that sexual harassment can justify a termination of contract, even with immediate effect, this does not mean that every sexual harassment justifies termination. As last resort (“ultima ratio”), termination is only permissible if no other milder disciplinary measures are acceptable. Whereas a formal warning might be sufficient for a sexually connoted joke, a termination of contract with immediate effect can be justified, if a supervisor touches the breasts of his direct.
This differentiated German law approach towards sexual harassment (i.e. taking the seriousness of the specific action into consideration) may conflict with a “zero tolerance” policy implemented on a group company level, in particular if under such “zero tolerance” policy the perpetrator’s employment agreement has to be terminated irrespective of the severity of the harassment. Resolving such conflicts can have high financial implications, such as settlement payments if the perpetrator’s action does not give sufficient reason to effectively terminate the employment agreement under German law. Because of the financial and reputational risks associated with cases of sexual harassment, a purchaser should have a great interest identifying perpetrators and corrupt working environments in a due diligence process before acquiring a business (see below).
- Harassment as defined under German law
The employer is not only obliged to protect its employees from sexual harassment, but also from other types of harassment, which are not of a sexual nature. In colloquial language, such harassment is referred to as “bullying” or – in Germany – “Mobbing”.
Similar to the definition of sexual harassment pursuant to the German Act on Equal Treatment, harassment is an unwanted conduct in connection with race or ethnic origin, gender, religion or belief, disability, age or sexual orientation with the purpose or effect of violating the dignity of the person concerned and of creating an intimidating, hostile, degrading, humiliating or offensive environment.
Although under the German Act on Equal Treatment, the unwanted conduct must be based on the aforementioned discriminatory reasons, it is common law practice to apply these rules also to cases without a discriminatory background.
Whereas unwanted conduct of a sexual nature is deemed to create regularly an intimidating, hostile, degrading, humiliating or offensive environment and is therefore not analyzed in depth by courts in this regard, ordinary harassment must create such hostile environment in order to be considered misconduct.
Hostile environment requires a certain duration and permanence of the unwanted conduct. Separate actions of bullying usually do not justify as severe misconduct but have to be considered altogether to qualify as one misconduct. If one or two actions qualify as misconduct for other reasons (e.g. insult or battery), then the employer can – of course – take disciplinary actions to protect the victim from further wrongdoing.
The unwanted conduct is manifold and can include intentional ignoring of a person (e.g., not greeting), making jokes, publicly criticizing with the intent to humiliate the person, disinformation (e.g., not sharing group invites) etc. Having a “Boys Club Culture” in the company is certainly a grievance likely to create a hostile environment for female and diverse colleagues.
Establishing cases of harassment is often difficult, not only because the burden of proof lies with the victim, but also because perceptions can differ or result from misunderstandings. Depending on the individual, a person might perceive a critic as reasonable; another person might perceive such critic as an insult.
The employer is obliged to take necessary preventive measures, in particular the employer must provide and request regular trainings to alert employees and stop them from unlawful behavior. The employer should also set a good example with campaigns fighting discrimination of all kinds, in particular with respect to gender discrimination, and promoting diversity.
- Financial discrimination and the gender pay gap
For several years, the gender pay gap is being discussed vividly not only in Germany, but also on a global level. It is a well-proven fact that women are earning less than their male colleagues in similar positions. We can also find high pay gaps in the software and video game industry. In order to bridge this gap, the German legislator has implemented the Remuneration Transparency Act (Entgelttransparenzgesetz). According to this statute, the employer is obliged to grant the same remuneration to female and male employees if they are performing the same or equivalent jobs.
In companies with more than 200 employees, the employee (irrespective of gender) has the right to request from the employer the average remuneration details from their opposite-sex colleagues working in the same position. If the employee’s remuneration deviates negatively from the average salary of the opposite-sex colleagues, then this information can be used to prove a gender discrimination claim and enable the employee to request the difference amount from the employer.
In addition, in companies with more than 500 employees, the employer is invited, but not obliged to have his pay schemes reviewed on a regular and voluntary basis to evaluate whether it complies with the obligation to equal pay.
- Legal consequences and financial implications of financial discrimination and (sexual harassment)
As already mentioned, in case of financial discrimination, the employee is entitled to the difference amount of the salary gap.
In case of (sexual) harassment the employee does generally not suffer from material damages (except for medical costs in severe cases, if the misconduct causes personal injury). However, under German law, employees are also entitled to compensation for immaterial damages.
Sexually harassed women are entitled to not only claim damages from the persons who assaulted them but also from the employer who failed to take preventive and reactive measures. The amount of claimable damages is in general unlimited and needs to be sufficiently high to compensate the victim.
However, as the concept of “punitive damages” does not exist in Germany, the compensation awards are not comparable to those in jurisdictions applying the concept of punitive damages such as the United States and usually range between EUR 2,000 to EUR 30,000.
This could change in the future, as a new, not yet implemented, law which introduces a criminal liability of companies for criminal acts of its representatives and certain employees (Verbandssanktionengesetz) in Germany, may result in penalties to be paid by the companies for criminal behavior in connection with sexual harassment. The currently discussed penalties can amount up to EUR 10,000,000 or 10% of the company’s revenues. In this case, the misconduct must also qualify as criminal offence. Relevant criminal offences in connection with (sexual) harassment are libel, defamation, battery, physical sexual harassment, sexual abuse and rape. Whether or not sexual harassment can be characterized as a criminal behavior that falls under the new law will need to be specified in the final wording of the law or determined by the courts. Fortunately, misconducts which also qualify as criminal offence are rather the exception than the rule.
Financial risks would not only stem from potential claims by the victim, but may also arise when it comes to disciplinary measures against the perpetrator. In contrast to Anglo-American jurisdictions, employees with a tenure of more than six months working in a business with more than 10 employees enjoy protection from termination by the German Termination Protection Act. Under the Termination Protection Act, employers may only terminate the employment relationship, if the termination is socially justified. In case of an employee’s misconduct, a termination usually requires a prior formal warning alerting the employee that he might face a termination of contract, if he commits the wrongdoing again. Certainly, in the case of a severe sexual harassment, which involves bodily contact, a termination without a previous formal warning might be justified. However, in the case of verbal sexual harassment, the labor courts in Germany might also consider the wrongdoing as not sufficiently severe to justify an immediate termination. The employer then finds himself in a situation, where he may fail to achieve either of two aims: He has to protect the victim and fight sexual harassment on the one hand, but he is also obliged to impose “reasonable” disciplinary measures which could mean that he cannot terminate the employment with the perpetrator. In this context, it is also not helpful that the full burden of proof for the sexual harassment lies with the employer. Hence, many cases in court end with a settlement agreement which includes a severance amount for the perpetrator, if the court indicates that they consider a termination as not justified. Such outcome has certainly a negative impact for the employer’s reputation.
Discrimination and Harassment in an M&A setting
We have seen that discrimination and harassment includes a wide array of misbehavior. Actions that are perceived by some people as minor or negligible misconduct can legally be characterized as harassment. The consequences of such incidents can be severe for the employer both from a financial and reputational perspective. The same is true for a potential investor, intending to acquire or invest into a business.
In light of these relevant risks, it is surprising that discrimination and harassment issues are rarely investigated and/or addressed in M&A transactions in Germany. The legal due diligence and the purchase or investment documents touch these issues – if at all – often only indirectly.
(a) Legal due diligence seldom covers discrimination and harassment
The legal due diligence in an M&A transaction rarely includes a review or assessment of discriminatory behavior or harassment at the target company. The subject is typically only addressed indirectly, e.g. by asking if there are any ongoing or threatening litigation cases. Even if a compliance due diligence is conducted, such compliance due diligence is usually limited to anti-corruption and bribery topics but not employment compliance.
In light of the numerous cases that have been revealed in the recent past, the buyer should strongly consider focusing on these topics already in its due diligence. Since it is not a standard due diligence item, the buyer has to face the difficulty of touching a sensitive topic with the seller. The buyer’s zero tolerance policy should be made clear to the seller. As such, buyer will want to communicate its questions in this regard cautiously but also with sufficient firmness.
The buyer should for example take a close look at the work culture at the company in general, and specifically ask about trainings and employment handbooks and policies, which are provided to the employees. The seller should also be asked if it regularly monitors the employees’ behavior with regard to harassment or discrimination (e.g. via software such as Pipeline, a software platform for employers that both identifies and analyzes bias in the workplace) and whether a whistleblower hotline or similar measures exist. If there are any indications of existing harassment or discrimination incidents at the company, the buyer should consider conducting interviews with the management and/or employees on this topic. This would, however, be a highly sensitive request, which the seller most likely will not consent to. If the buyer is allowed to conduct such interviews, they need to be treated with high confidentiality and prepared with appropriate legal but also psychological expertise.
(b) Transaction Documents often address discrimination and harassment only indirectly
Similar to the legal due diligence, discrimination and harassment topics are usually not specifically covered in the transaction documents, i.e. the sale and purchase agreement (SPA) or the investment agreement.
If no discrimination and harassment issues were identified in the due diligence, the buyer should request that appropriate representations and warranties are included in the warranty section of the respective transaction document. As mentioned before, there is so far no market standard for such representations and warranties addressing the harassment and discrimination risks, in particular at tech companies such as video game developers. If at all, such risks are currently only warranted indirectly by representations and warranties pursuant to which seller warrants that there is no ongoing or threatening litigation or that the company complies with applicable laws.
Such standard compliance with laws guarantees by the seller are very often limited by materiality and knowledge qualifiers. This means that the guarantee only covers material laws and the seller gives the guarantee only subject to his or certain other persons’ knowledge that material laws are not breached. The German Act on Equal Treatment or the Remuneration Transparency Act should generally qualify as material laws. However, since the term material laws is subject to interpretation this opens room for discussions with the seller if the buyer claims that discrimination and harassment cases which the buyer identified after closing constitute of a breach of the general compliance with laws warranty. Also in cases where the buyer wants to cover a wider range of cases of discrimination, the compliance with laws warranty does not help the buyer. The knowledge qualifier also limits the buyer’s protection since discrimination and harassment are typically not widely known but instead occur in secret or concealed. As such, the respective persons who are listed as relevant for the seller’s knowledge in the transaction documents may not have the relevant knowledge about these issues and the buyer’s claims for damages would be excluded. The same applies to the litigation guarantee which provides only very limited protection as long as discrimination and harassment cases are not yet subject to formal investigations or proceedings.
In light of the above, the buyer should consider requesting specific representations and warranties in the transaction documents, which directly address discrimination and harassment issues. Under such representations and warranties, the seller should guarantee that the target company has appropriate measures in place to prevent discrimination and harassment. Ideally, the seller should guarantee that no discrimination or harassment occurs at the target company. A purchaser-friendly warranty on the issue of discrimination and harassment could for example be worded as follows:
“The Target Company has during the past [two] years prior to the Closing Date treated its employees and/or candidates applying for employment in accordance with the German Act on Equal Treatment, the Remuneration Transparency Act and/or equivalent laws applicable to the Target Company’s operations in foreign countries.
The Target Company has implemented appropriate measures to prevent, discover, assess and resolve any discrimination and/or sexual as well as non-sexual harassment vis-à-vis and between employees of the Target Company. In particular, the Target Company provides appropriate employee handbooks and/or trainings to its employees in order to prevent discriminating and/or harassing activities at the Target Company. The Target Company has appropriate reporting and tracking methods (e.g. whistleblower hotline, tracking software) in place, which allow the Target Company’s employees to report discrimination and/or harassment to the competent person and which allow the Target Company to regularly monitor and timely resolve cases of discrimination and/or harassment at the Target Company.”
If the buyer identified discrimination and harassment issues at the target company, the buyer needs to decide if he wants to proceed with the transaction despite the identified risks, which may have a significant financial and/or reputational impact on the investment in the future. This decision will mainly be based on the severity of the identified issues and also if key employees are involved. If the buyer decides to continue with the transaction, the buyer should protect himself against possible claims which the affected employees (both perpetrator and victim) may bring against the company. Ideally, if possible, the buyer should request that the seller resolves the identified (and unidentified) issues between signing and closing, e.g. by terminating the employment agreements with the persons who discriminated or harassed other employees or by mutually settling possible claims of the victims. Additionally, the share purchase agreement or the investment agreement should include a specific indemnity according to which the seller has to indemnify buyer for all damages, including legal fees and possible severances paid to the perpetrator, and losses, costs, penalties and fines that buyer and the company suffer as a result of the discrimination and harassment. This protects the buyer against direct financial damages. However, monetary protection against future detrimental effects on the business (lost profits) and/or reputational risks incurred because of discrimination and harassment can most likely not be achieved through an indemnity in the transaction documents. Such risks should be taken into account in the valuation of the target’s business and may even result in the decision not to purchase the target company (deal breaker).
(c) Post-Merger Integration
At closing, the buyer assumes all opportunities and risks related to the target company. This includes all risks associated with discrimination and harassment. The warranties and indemnities provide protection to the buyer only with respect to breaches that occurred prior to the closing (or signing). Therefore, the buyer should immediately after closing intensify its review of the target company’s compliance with discrimination and harassment laws. Additionally, proper trainings, handbooks and compliance tracking software should be implemented at the target company if they do not exist at the target company yet. As with all other compliance issues, there may be a certain time period after closing during which the buyer can argue that the former owner caused compliance issues and that the implementation of proper compliance cannot be there from day one. However, after approximately three to six months, proper compliance has to be implemented at the target company and then maintained going forward. Otherwise, the risks associated with compliance breaches at the target company will eventually have to borne by the buyer.