Labour Code Reforms: High Stakes Implications For Transactions And Deal Strategy

1. INTRODUCTION

5 years in the making, yet enforced with limited prior warning, India's Labour Codes [the Code on Wages, 2019 (“Wage Code”); the Code on Industrial Relations, 2020 (“IR Code”); the Code on Social Security, 2020(“SS Code”); and the Code on Occupational Safety, Health and Working Conditions, 2020 (“OSHWC Code”) collectively “Labour Codes”] landed on businesses with a disruptive force. What many expected to be a gradual compliance shift has turned into a fundamental reset for dealmakers. For transactional lawyers, Private Equity and Venture Capital (PE/VC) investors, corporate development teams and in-house counsels, the Labour Codes are not just labour law reform. They alter diligence outcomes, reshape valuation models, recalibrate risks and redefine how transactions are structured, negotiated and integrated. This analysis cuts through the complexity to explain why labour law is now a core deal variable, not an administrative afterthought.

2. REDEFINING THE WORKFORCE: THE FIRST DOMINO IN DEAL RISK

The Labour Codes have radically widened the ambit of individuals covered by labour laws in India. The Wage Code extends the wage compliances to all employees, including managerial and supervisory personnel, without salary thresholds. In addition to all the rank-and-file employees, the IR Code now includes sales promotion staff, working journalists, and supervisory employees earning wages up to INR 18,000 per month in the protected category of “worker”. The SS Code goes even further, bringing the gig workers, platform workers, home-based workers, self-employed workers in the unorganised sector, and fixed-term employees within the regulatory net.

Targets may be carrying a hidden workforce that has never been costed or documented as “employees”, yet now attract obligations across wages, Provident Fund (“PF”), Employees State Insurance (“ESI”), bonus and leave. Workforce definition has therefore become a value driver and a deal breaker. Hence, diligences must now focus on workforce classification and associated risks. Valuation models will need to factor in the increased labour costs owing to larger base of employees and workers now covered under the Labour Codes.

3. THE 50% RULE: SALARY STRUCTURE AND TRANSACTIONAL EXPOSURE.

If the expanded workforce definition sets the stage, the 50% rule delivers the financial shock. The Wage Code fundamentally changes how compensation has traditionally been structured in India, shifting compensation design from a contractual formality to a material consideration in transactions. By mandating that allowances cannot exceed 50% of wages, the Wage Code removes the allowance-heavy salary structures that many Indian companies have relied on for years. Any components (such as HRA, conveyance allowance, statutory bonus, overtime allowance, commission, special allowance, employer PF contributions etc.,) in excess of 50% of wages shall be deemed to be part of wages. This rule increases the base for calculating PF, ESI, gratuity, bonus and other statutory benefits. The Wage Code also brings non-cash benefits into the equation, treating remuneration in kind as wages up to 15% of total wages payable.

What the Indian Courts have consistently indicated through precedents, that allowances which are routinely paid across the board are a part of employee's remuneration, is now fixed in law. This clarity, however, comes with a risk. Under the Wage Code, employees will now have a 3-year limitation period to raise claims for unpaid or underpaid wages, which means in this scenario companies could be held accountable for payroll errors made in the past.

For dealmakers, this translates into immediate valuation and risk consequences. Allowance-heavy salary structures will require immediate restructuring, and diligence must go beyond current compensation to review historical wage and benefit compensations for compliance with the new framework. Any unidentified or unresolved non-compliance at closings may create contingent liabilities, directing purchasers to likely demand specific indemnities, price adjustments, or escrow hold-backs for wage structure issues.

4. GIG WORKERS & AGGREGATORS: WHEN TURNOVER MEETS COMPLIANCE.

Through the SS Code, there has been a huge transformation in how the law treats platform-based workers. Gig workers and platform workers have been brought into the social security system for the first time.

For the aggregator companies, or digital intermediary, this is not only a matter of compliance but also an immediate financial commitment. It is the aim of the SS Code that the aggregator companies will contribute not less than 1% and not more than 2% of their turnover every year towards the notified schemes of the Central Government, for social security purposes.

The impact that these numbers may create in the case of businesses that engage millions of gig workers will be even more alarming. For instance, an aggregator company with an annual turnover of INR 1,000 crores will have to shell out an additional statutory contribution ranging between INR 10-20 crores. The impact that this will create in the case of sectors like e-commerce, ride-sharing, food and grocery delivery, content and media will include a novel cost structure.

For aggregator models, which were operating on thin margins, this is not just a minor accounting exercise but a significant one. There might be substantial liability that impacts unit economics, operating margins, and ultimately, valuation. The dealmakers cannot treat ignore this line of costs as they have become a critical factor in transaction value and risk.

5. FIXED-TERM WORKERS AND GRATUITY: THE EBITDA IMPACT

As per the SS Code, workers employed under fixed-term contracts can now avail of gratuity benefit after completing only 1 year of fixed-term employment, with pro-rata entitlements in case of service that is shorter than the original qualifying period of 5 years.

Consequently, any business models and EBITDA projections that had previously factored in the concept of “lean and flexible” staffing would require recalibration to account for these periodic and recurring gratuity payments. Buyers would need to thoroughly evaluate workforce composition, fixed-term contract and legacy gratuity accruals. Such workforce structures that once appeared lean may now conceal a significant layer of contingent liabilities, forcing buyers and investors to reassess valuation, risk allocation, and post-transaction integration plans.

6. NEW NORM FOR CONTRACT LABOUR: WHEN OUTSOURCING BECOMES A DEAL RISK.

The OSHWC Code has transformed how companies can deploy contract labour, restricting their use to non-core activities and mandating such deployment only through licensed contractors. Contract workers engaged in core activities pose severe absorption risks for companies. In the IT sector, for example, companies routinely engage software developers, testers and DevOps engineers through staffing agencies to work alongside permanent employees on core delivery and product development functions. Such arrangements, which were earlier treated as standard workforce flexibility, now carry compliance and absorption risks.

Although such exposures always operated in the background, the OSHWC Code now expressly builds them into the statute, making the principal employer liability for contractor breaches far more explicit. Robust diligences must now closely scrutinise contractor arrangements, licensing and core/non-core deployments.

7. ADDED RESPONSIBILITY FOR LABOUR WELFARE RESPONSIBILITY

The OSHWC Code creates a binding obligation on employers to issue appointment letters in the prescribed format and ensure annual health checkups for all employees. While many employers already followed these as best practices, the Labour Codes now mandates them, creating recurring compliance costs.

8. THE 300-WORKER THRESHOLD

The IR Code has increased the threshold for application of standing orders and for prior government approval before closures, lay-offs, and retrenchments of specified establishments, from 100 to 300 workers. While this shift offers greater operational flexibility for mid-sized establishments, it also introduces a new strategic inflection point for dealmakers.

While the 300-worker limit gives more flexibility, dealmakers still need to plan for when that number is crossed, because major obligations begin from there.

9. FINAL SETTLEMENT IN 2 DAYS: PAYROLL READINESS BECOME NON-NEGOTIABLE.

The Wage Code now imposes an obligation on employers to complete full and final settlement for an employee within 2 days of termination, including for resignations and mutual separations. This is no longer a back-end payroll function but a statutory deadline with direct compliance consequences.

The change poses a significant operational risk. Many companies are not equipped to calculate, approve and disburse final dues within 48 hours, particularly in businesses with complex payroll structures or decentralised HR systems. As a result, buyers must make “settlement process readiness" a condition precedent for closing. Inability to meet the legal 2-day mandate could attract substantial penalties (including fines ranging from INR 20,000 to INR 40,000, and in the case of repeated contraventions, prosecution carrying imprisonment of up to 1 month, significantly higher than the earlier penalty framework under the Payment of Wages Act, 1936, where fines typically ranged between INR 1,500 and INR 7,500) disrupt post-closing integration, making payroll capability a transaction-critical consideration.

10. WORKING HOURS AND LEAVE: CAN UNIFORMITY FOR PRODUCTIVITY?

The OSHWC Code stipulates uniform working hour and overtime norms across establishments, creating immediate mismatch with several existing State-specific Shops and Establishment laws. While labour remains a concurrent subject, the Labour Codes do not and cannot repeal State-specific Shops and Establishment legislations. Recently, many States have increased working hours for ease of business and to attract investment, but the Labour Codes effectively have reduced the standard working hours by 1 or 2, creating a direct tension between compliance and productivity.

Employees may now request shorter working hours, while investors continue to expect high productivity and optimised labour costs. Until further clarifications, this reduction in working hours is sure to keep the waters troubled for all targets and industries where every hour matters.

In addition, the OSHWC Code modifies leave rules by allowing annual encashment of unused leave and eliminating lapses of such unused leave. While this is beneficial for employees, it introduces a new recurring cost for employers. The combined impact of shorter workdays and mandatory leave encashment can materially increase labour costs, forcing companies to reassess staffing models, productivity projections, and consider technology solutions, including automation and Artificial Intelligence (“AI”) and AI related tools to maintain efficiency

11. WORKER RE-SKILLING FUND AND GRIEVANCE REDRESSAL COMMITTEE (“GRC”): POTENTIAL IMPACT ON TERMINATIONS?

Mandatory constitution of the GRCs with specific constitution on the one hand protects companies from labour department involvement in disputes by providing an additional opportunity to resolve grievances with employees. However, on the flip side it creates higher administrative responsibility on employers and increases the timeline for any terminations that are likely to be contentious. In the context of terminations, especially owing to redundancy or restructuring, companies now have to contribute an amount equal to 15 days of wages last drawn by the worker as Worker Re-skilling Fund (“Fund”). While this Fund and related rules/ schemes is yet to be established and enforced, a “no cause” termination can become twice as expensive as it was earlier. Deals that rely on restructuring/ sizing down may now be deterred by the high costs and higher burden of reconciliation and resolution of disputes.

12. PENALTIES THAT BITE: THE NEW ENFORCEMENT REALITY

The Labour Codes have dramatically increased penalties across board, transforming what were once minor regulatory oversights into serious financial exposures. Under the IR Code, for instance, the penalty for contravening retrenchment conditions can now attract fines up to INR 2 lakhs, a quantum leap from the mere INR 100 under the Industrial Disputes Act, 1947.

While compounding mechanisms have been introduced and imprisonment has been restricted to repeated offences, the magnitude of these penalties was posed to alter the risk-reward equation. Unfortunately, despite the sharp increase in statutory penalties the actual cost of non-compliance remains modest by global standards, but still significant enough to warrant careful diligence and deal protection in form of specific indemnities, escrows or more.

13. SECTOR SNAPSHOTS: ILLUSTRATIVE IMPACT ACROSS KEY INDUSTRIES

The Labour Codes affects different industries in distinct ways, forcing a rethink of workforce, compliance and cost structures and examples below are illustrative rather than exhaustive. Manufacturing industries must reassess outsourcing arrangements in light of core-activity restrictions and revisit the applicability of standing orders, while also complying with significantly higher safety and welfare compliance costs under the OSHWC Code.

Construction, logistics, and other project-based services that rely heavily on fixed-term and contract labour will see a sharp rise in employment costs, particularly due to gratuity eligibility and social security obligations. Aggregator businesses must factor in mandatory contributions under the SS Code and incorporate Labour Code readiness tests into their operating models.

Construction and EPC companies face heightened contractor compliance and inter-state migrant worker welfare obligations, directly impacting project economics.

The IT and ITES companies engaging consultants for core functions may need to restructure their workforce and comply with standing orders if threshold limits are triggered under the IR Code.

Hospitality, hotels, cleaning and security providers will face unique challenges because many of the guest-service and operations roles which are core functions cannot freely be outsourced under the new core/non-core framework, increasing reclassification and absorption risks. On the other hand, retail and e-commerce businesses relying on large pools of fixed-term workers in fulfilment centres will have to plan for higher social security costs and tighter contractor oversight. Healthcare and pharma companies will face material exposure due to expanded safety, welfare and staffing requirements for outsourced clinical and technical personnel. BFSI players use large scale outsourced sales teams, collection agents and KYC support and must now evaluate whether these functions qualify as “core”. Telecom, data-centre, infrastructure and renewable-energy businesses must also account for elevated safety and compliance for contract labour, which directly influence bid strategies, project pricing and integration planning.

14. CONCLUSION

What nobody expected has happened: the sudden enforcement of the Labour Codes has pushed labour law from the sidelines to centre stage in deal negotiations! Parties are now debating whether these changes constitute a “force majeure” or a “change in law”. Where transaction documents are silent, this debate will now shape the risk allocation, pricing and performance obligations of the parties.

For dealmakers, two clear shifts can be witnessed. First, transactional diligence obligations will expand significantly. Buyers and investors must now look beyond traditional statutory filings and must examine workforce classification, wage structures compliance audits, PF and ESI contribution shortfalls, gratuity exposure, contractor and gig worker models, standing order applicability, and OSHWC compliance readiness. Risk pertaining to labour has therefore become a core commercial variable now, directly influencing valuation models, deal timelines and post-closing integration strategies.

Second, transaction documentation must be strengthened. Term sheets, share purchase agreements and asset purchase agreements must now expressly address Labour Code compliance through targeted representations, warranties, indemnities and conditions precedent. Increased negotiations are expected for creating protections around historical wage structures, PF and ESI shortfalls, contractor misclassification, gig worker contributions, retrenchment exposure and OSHWC liabilities. Valuation models will have to now account for elevated labour cost curves, aggregator contributions and post-merger integration costs.

As India continues to implement and refine the Labour Codes through rules and state-level notifications, transactional practitioners will have to remain vigilant to regulatory developments and maintain flexible compliance frameworks capable of adapting to evolving interpretations and enforcement priorities.

In this new era of India's labour landscape, successful transactions will belong to teams that understand not just the law but also the operational and financial psychology behind it.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.