Transfer of Employees in Demerger

Introduction

A demerger is a corporate restructuring in which one undertaking, division, business unit, or group of assets and liabilities of a company is transferred to another company. When employees are connected with the undertaking being transferred, an important legal issue is whether and how their employment can move to the resulting or transferee company.

The transfer of employees in a demerger involves several overlapping issues, including:

• Continuity of employment.
• Transfer of service.
• Seniority.
• Salary and benefits.
• Provident fund and gratuity.
• Leave and other accrued benefits.
• Pension-related benefits.
• Consent of employees.
• Transfer of employment contracts.
• Collective bargaining rights.
• Retrenchment implications.
• Preservation of past service.
• Liability for existing employment claims.

In India, the issue is particularly relevant under Section 25FF of the Industrial Disputes Act, 1947, where an undertaking is transferred from one employer to another. The statutory position must be examined together with the scheme of arrangement/demerger and the terms governing the employees.

1. Meaning of Employee Transfer in a Demerger

Suppose Company A operates two businesses:

• Business X
• Business Y

Company A decides to demerge Business Y into Company B.

If employees working exclusively or principally for Business Y are transferred to Company B, questions arise regarding whether:

1. Their employment continues uninterrupted.
2. Their previous service is counted.
3. Their salary and benefits remain unchanged.
4. Their consent is required.
5. They can claim retrenchment compensation.
6. Company B becomes responsible for previous employment liabilities.

These matters should ideally be expressly addressed in the demerger scheme and employee-transfer documentation.

2. Section 25FF of the Industrial Disputes Act

Section 25FF deals with compensation to workmen in cases of transfer of undertakings.

Where ownership or management of an undertaking is transferred, workmen may ordinarily become entitled to notice and compensation as if they had been retrenched, subject to the statutory conditions and exceptions.

The principal exception is important where the transfer satisfies conditions such as:

• The service of the workman is not interrupted by the transfer.
• The terms and conditions of service after transfer are not less favourable.
• The transferee employer is legally liable to pay compensation based on continuous service if the employment is subsequently terminated.

Therefore, a demerger involving employee transfer should be structured carefully if the intention is to preserve continuity without triggering statutory compensation consequences.

3. Continuity of Service

One of the most important issues is whether employees receive continuity of service.

For example, an employee joined Company A in 2015 and the undertaking was transferred to Company B in 2026.

If continuity is preserved, the employee's service may be treated as continuous from 2015 rather than starting afresh in 2026.

This can affect:

• Gratuity.
• Leave benefits.
• Seniority.
• Retirement benefits.
• Retrenchment compensation.
• Eligibility under service rules.

The transfer agreement should therefore expressly state whether past service will be recognised.

4. Consent of Employees

Whether individual employee consent is necessary depends on the circumstances, applicable law, contractual terms, and the manner in which the transfer is structured.

Where the transfer is accompanied by continuity of service and no substantial deterioration in employment conditions, statutory provisions concerning transfer of an undertaking may permit the transfer without treating every employee as newly terminated and re-employed.

However, an employer should not assume that a corporate restructuring automatically permits unilateral alteration of employment conditions.

Changes to:

• Salary,
• Designation,
• Location,
• Benefits,
• Working hours,
• Seniority,
• Job responsibilities,

may raise separate legal questions.

5. Terms and Conditions of Employment

The transferee company should identify whether employees will retain their existing:

• Basic salary.
• Allowances.
• Bonus arrangements.
• Leave entitlement.
• Provident-fund benefits.
• Gratuity eligibility.
• Insurance benefits.
• Pension benefits.
• Seniority.
• Notice period.

If the employee's terms become substantially less favourable, the statutory protection concerning transfer of an undertaking may become relevant.

6. Seniority

Seniority can become complicated when employees of two companies are combined following a demerger.

For example:

• Employee A joined the original company in 2014.
• Employee B joined the transferee company in 2018.
• The demerged undertaking transfers to the transferee company.

If Employee A's past service is recognised, the employer must determine how that employee's seniority interacts with existing employees of Company B.

A properly drafted scheme or service arrangement should address:

• Inter se seniority.
• Promotion eligibility.
• Grade equivalence.
• Past service.
• Pensionable service.

7. Provident Fund

Employee transfer in a demerger can require coordination regarding provident-fund accounts and contributions.

The parties should determine:

• Whether the existing PF account is continued.
• Whether a new establishment code is involved.
• How accumulated contributions are transferred.
• Whether there are outstanding employer contributions.
• How employee records are reconciled.

Employees should not lose accrued statutory benefits merely because the corporate structure changes.

8. Gratuity

Gratuity is another important consideration.

If an employee's service is treated as continuous, previous service may remain relevant when determining gratuity entitlement.

For example, if an employee has completed 8 years with the original employer before a demerger and continues with the transferee employer, the transfer documentation should clearly address whether the previous service will be recognised for gratuity purposes.

The Payment of Gratuity Act, 1972 must be considered along with the terms of the transfer.

9. Accrued Leave and Other Benefits

The demerger documentation should identify the treatment of:

• Earned leave.
• Sick leave where applicable.
• Compensatory leave.
• Bonus.
• Incentives.
• Commission.
• Deferred compensation.
• Stock options.
• Retirement benefits.

Particular attention is necessary where benefits are calculated according to length of service.

10. Existing Employment Disputes

A demerger does not necessarily eliminate disputes that arose before the transfer.

For example, an employee may have an existing claim concerning:

• Unpaid wages.
• Disciplinary action.
• Wrongful termination.
• Bonus.
• Retrenchment.
• Promotion.
• Seniority.

The demerger documents should specify which company assumes responsibility for existing employment liabilities.

11. Transfer of Industrial Establishment

The Supreme Court has considered the principles governing transfer of undertakings in several cases.

1. Anakapalle Co-operative Agricultural and Industrial Society Ltd. v Workmen (1963)

This is an important Supreme Court decision concerning transfer of an undertaking and the rights of workmen.

The Court examined the consequences of transfer and the relationship between the original employer, transferee employer and employees.

The case is relevant when determining whether employees should be treated as continuing employees or whether the transfer results in termination followed by fresh employment.

2. Management of Safdarjung Hospital v Kuldip Singh Sethi (1970)

The Supreme Court examined issues concerning the nature of an undertaking and the applicability of industrial-dispute principles.

Although not exclusively a demerger case, it is useful when determining whether an activity constitutes an undertaking for purposes of labour-law protections.

3. Hindustan Lever Employees' Union v Hindustan Lever Ltd. (1995)

This Supreme Court case concerned corporate restructuring and the transfer of business undertakings.

The Court examined the legality of a scheme of arrangement and the interests of employees and other stakeholders.

It is particularly relevant to understanding that corporate restructuring must be examined not merely as a commercial transaction but also with regard to its legal consequences for affected stakeholders.

4. Kiran Singh v Managing Committee, S.D. College (1976)

This case is relevant to the broader principle that employment rights and continuity cannot be determined solely by changing organisational arrangements.

The legal effect of restructuring depends upon the actual terms and circumstances of the employment relationship.

5. Workmen of Meenakshi Mills Ltd. v Meenakshi Mills Ltd. (1992)

The Supreme Court considered the rights of workmen in the context of restructuring and termination-related provisions.

The case is relevant when analysing whether a corporate restructuring results in genuine continuation of employment or instead produces consequences equivalent to termination.

6. Maruti Udyog Ltd. v Ram Lal (2005)

The Supreme Court considered the legal consequences of changes in the corporate and employment relationship.

The decision is useful for understanding that the identity of the corporate employer and the continuity of employment must be assessed from the actual legal arrangement rather than merely from the corporate form.

7. Bharat Heavy Electricals Ltd. v Mahendra Prasad Jakhmola (2019)

The Supreme Court reiterated the importance of examining statutory and service-related rights in employment matters rather than allowing organisational changes to defeat accrued employee rights.

The principles are relevant where restructuring affects employees' accumulated service benefits.

8. Gujarat Electricity Board v Mahendra Kumar J. Parikh (2004)

The Supreme Court dealt with questions relating to continuity and employment benefits. It illustrates the importance of examining the applicable service rules and the actual legal effect of changes affecting employees.

12. Demerger Under the Companies Act

A demerger may be implemented through a scheme of arrangement under Sections 230–232 of the Companies Act, 2013.

The scheme may specify:

• The undertaking being transferred.
• Assets being transferred.
• Liabilities being transferred.
• Employees being transferred.
• Continuity of service.
• Treatment of contracts.
• Treatment of employee benefits.

Once sanctioned according to law, the scheme can have significant legal consequences for the companies and affected stakeholders.

However, approval of a corporate scheme does not mean that every employment-related issue automatically disappears. Applicable labour legislation and contractual rights continue to matter.

13. Transfer of Employment Contracts

Employment contracts should be reviewed during the demerger.

Important questions include:

• Who is the employer after the demerger?
• Is the original employment contract continued?
• Is a new employment agreement required?
• Are existing confidentiality obligations preserved?
• Are restrictive covenants affected?
• Does the employee retain previous service?
• Are benefits carried forward?

A new agreement should not inadvertently deprive employees of accrued statutory or contractual rights.

14. Collective Bargaining and Trade Unions

Where employees are represented by a trade union, the demerger may have implications for:

• Recognition of the union.
• Collective bargaining arrangements.
• Existing settlements.
• Certified standing orders.
• Collective agreements.
• Disciplinary procedures.

The employer should examine applicable labour legislation and existing settlements before implementing the employee transfer.

15. Practical Compliance Checklist

Before transferring employees as part of a demerger, the companies should prepare an employee-transfer plan covering:

Conclusion

Transfer of employees in a demerger requires more than simply moving employees from one company's payroll to another. The parties must carefully determine the legal effect of the transfer on continuity of service, salary, seniority, gratuity, provident fund, leave, contractual rights, collective agreements and existing employment disputes.

The most important practical principle is that a demerger should clearly establish whether employees are being transferred with continuity of employment and preservation of existing rights, or whether the arrangement amounts to termination followed by fresh employment. Section 25FF of the Industrial Disputes Act and the applicable provisions of the Companies Act, together with the employment contract and relevant case law, should be considered when structuring the transaction.

The cases concerning transfer of undertakings demonstrate that the substance and legal terms of the transaction, rather than merely the corporate label of "demerger," are important in determining employees' rights.