Employer Substitution in Costa Rican M&A: Why Timing and Structure Matter
In my view, that is too late.
The employment structure should be analyzed while the transaction itself is still being designed: which assets are being transferred, who will assume the business, what liabilities will be allocated to each party, and how business continuity will operate after closing.
This becomes particularly relevant when employer substitution is being considered.
Employer substitution can provide an efficient alternative to terminating and subsequently rehiring employees. But its usefulness depends on whether the transaction actually supports the legal requirements for the transfer and whether implementation preserves the employment rights protected under Costa Rican law.
Employer substitution is based on continuity
Article 37 of the Costa Rican Labor Code provides that an employer substitution may not adversely affect existing employment contracts.
It also establishes joint liability between the former and new employer for obligations arising from the employment contracts or the law before the substitution, for a period of six months. After that period, liability remains solely with the new employer.
The Supreme Court’s Labor Chamber has explained that employer substitution involves a change in business ownership that, in principle, does not terminate employment relationships where there is a transfer and continuity of the business activity.
The legal logic is therefore different from terminating employment relationships and creating new ones.
In a properly structured substitution, the employer changes while the employment relationship continues.
Why can this matter in an acquisition?
From an M&A perspective, the first issue usually considered is cost.
If employment relationships continue, the company may avoid the immediate cost of terminating an entire workforce and subsequently rehiring those employees.
But cost should not be the only consideration.
Continuity can also have operational value.
It may preserve seniority, accumulated institutional knowledge and workforce stability, while reducing the disruption associated with terminating and rehiring employees.
This can be particularly relevant where operational knowledge, certifications, customer relationships, plant operations or specialized processes have direct economic value.
Costa Rican case law has recognized situations in which the transfer of a productive unit allowed the business activity to continue and supported the existence of an employer substitution. The courts have considered both tangible and intangible elements of the business and the actual continuity of the operation.
Therefore, the analysis should not begin with the question: "How much would it cost to terminate and rehire?”
It should begin with: "What is actually being transferred?”
Start with the transaction structure
The first question is what type of transaction is being implemented.
Not every acquisition automatically creates an employer substitution.
The corporate structure and the economic reality of the transaction matter.
The parties should determine who the employer is before closing, who will be the employer after closing, which assets or organizational elements are being transferred, whether the business activity continues, and what actually happens to the workforce.
Costa Rican case law has emphasized the change in business ownership and continuity of the productive activity.
The transaction documents and the operational reality therefore need to be consistent.
A structure that says one thing on paper while the business operates differently can create significant evidentiary risk.
The second analysis: what employment conditions are being transferred?
Employer substitution should not be used as a mechanism to restart employment relationships under less favorable conditions for employees.
Article 37 protects continuity and prevents the change of employer from adversely affecting existing employment contracts.
Before closing, I would recommend mapping at least:
- base salary and variable compensation;
- seniority;
- vacation balances;
- corporate benefits;
- bonuses;
- company cars or allowances;
- insurance;
- internal policies incorporated into employment relationships;
- individual agreements;
- collective instruments, where applicable;
- solidarista associations and related implications;
- historical labor liabilities;
- administrative or judicial proceedings; and
- any particular employment condition that could create a material difference between the existing workforce and the buyer’s structure.
This is often where the analysis becomes more complex than simply reviewing employment contracts.
Compensation differences can change the solution
Assume that the buyer has a different compensation structure.
The question is not simply whether there is a difference.
The parties need to understand the legal implications of that difference, how it affects each employee group, and what mechanisms are available to manage the transition.
A gradual transition, negotiated adjustments or mediation may need to be considered when the transaction involves changes that cannot simply be imposed as part of the change in employer.
In one acquisition I advised on, differences in compensation and the absence of a solidarista association meant that a standard employer substitution structure was not sufficient. We designed a mediation process that allowed agreements to be reached with approximately 100 employees and facilitated the closing of the transaction.
That experience illustrates an important point for M&A teams: the legal structure and the workforce implementation should be designed together.
Cost must be analyzed together with exposure
Employer substitution may involve lower immediate transition costs than terminating and rehiring a workforce.
That does not automatically make it the best alternative.
The buyer must understand the liabilities it is assuming.
The former employer remains jointly liable for six months with respect to obligations arising before the substitution.
There are also specific social security liabilities that should be analyzed separately. Costa Rica’s Social Security legislation provides for joint liability in certain transfers or leases of businesses concerning outstanding employer or employee contributions.
For that reason, labor due diligence should connect directly with the transaction documentation.
It is not enough to identify the liability.
The parties should determine who will bear it, how it will be documented, what protections are available, and which contractual mechanisms should be used to allocate risk.
There is a difference between an efficient substitution and a poorly designed one
Before closing, the parties should be able to answer questions such as:
Is there actually a transfer of a business or productive unit?
Who will be the new employer?
Which employment relationships continue?
Which conditions must be preserved?
What historical liabilities exist?
What compensation or benefits differences need to be addressed?
What happens with solidarista associations or other structures connected to the employment relationship?
How will the transition be documented?
How will it be communicated to employees?
Which liabilities remain with the former employer and which will be assumed by the new employer?
If these questions are answered only after the transaction structure has already been finalized, the available options may be considerably narrower.
When should labor counsel be involved?
My recommendation is to involve labor counsel during deal structuring whenever there may be a transfer of a business, assets or productive unit together with continuity of the workforce.
This allows Legal, HR, M&A and corporate counsel to work from the same structure.
It also allows the team to determine early whether employer substitution is actually workable or whether another alternative should be considered.
The benefit of early involvement is practical: the parties still have room to modify the transaction structure, negotiate liability allocation, prepare documentation and design workforce communications before closing.
Legal certainty also depends on implementation
In these transactions, legal certainty does not come simply from having a document titled "employer substitution.”
It depends on whether the legal structure reflects the actual transaction, whether protected employment conditions are preserved and whether sufficient evidence exists regarding what actually occurred.
The Supreme Court’s Labor Chamber has repeatedly considered the reality of the business transfer and the continuity of the business activity when determining whether an employer substitution exists.
For that reason, I consider employer substitution a transaction-structuring decision rather than a post-closing HR formality.
It can be efficient.
It can reduce transition costs.
It can facilitate operational continuity.
It can provide greater predictability for the parties.
But those benefits depend on one condition: the structure must be legally available and implemented consistently with the transaction that is actually taking place.
In M&A, that distinction matters.
A well-designed labor structure can facilitate closing and protect post-closing integration. A poorly analyzed structure can turn an apparently simple workforce transition into a liability that remains with the buyer long after closing.