In part two of our series of blog articles on Key Employment Law Topics in Video Games M&A (see part 1 here), we will focus on the working time of employees in tech companies and video game developers, and in particular on so called “crunch.”
Covid-19 – Delays of game publication may lead to intensified crunch times after the pandemic has eased.
What does crunch mean?
The Cambridge Dictionary defines crunch as “a difficult situation which forces you to make a decision or act” or “a situation in which there is not enough of something”. Both definitions fit also to a crunch during the development of software or videogames. The common understanding of crunch in the gaming industry is to work overtime to achieve certain milestones during the game development process and in particular to launch a game on schedule. But it also involves working on weekends and public holidays and not being able to take vacation. It is characteristic for crunch that the overtime worked during crunch exceeds the standard overtime by far. Crunch usually occurs in short and condensed time periods in which many extra hours are put in. In extreme cases, crunch can extend over a long time period of several months with the overtime hours constantly heavily exceeding the standard overtime. Insofar one could say that due to a sudden increase of work and an insufficient number of employees or insufficient planning the decision is made to work overtime.
How is crunch regulated under German Employment law?
Crunch as such is not regulated under German employment law. German employment law does neither know the term nor the concept. Published case law using the term crunch also does not exist.
Crunch as factual phenomenon in the gaming industry must therefore be analyzed within the existing general legal framework of working time and holiday regulations. In Germany, working time has two legal dimensions: A regulatory dimension and a civil law or contractual dimension.
The regulatory provisions on working time are included in the German Working Time Act (Arbeitszeitgesetz). The most important rules with respect to crunch are:
- The general maximum working hours per day are 8 hours.
- The employer may extend the daily working time on a working day to 10 hours if, within a period of six calendar months or 24 weeks, the average daily working time on a working day does not exceed eight hours.
- Working time exceeding 10 hours is not permissible.
- 11 hours of rest between two working days (rest period) is mandatory.
- Sunday work and work on public holidays is generally not permissible. Certain exceptions to this rule exist, but these exceptions will not apply to software development in most cases.
According to recently implemented German employment law, the employer is obliged to record any working time exceeding 8 hours per day. As German working time is also regulated by EU law, some legal scholars are of the opinion that the latest decision of the European Court of Justice (ECJ, dec. 14.5.2019 – C-55/18) requires the employers to record any working time. The German government, in particular the Ministry for Labor and Social Affairs on the one hand and the Ministry for Economy on the other hand are heavily in dispute about the legal implications of the ECJ`s decision on German employment law.
There is no dispute, however, on the employer’s legal obligations to ensure that the existing regulations on working time described above are complied with. The employer has to pro-actively ensure that the employees are not violating the working time laws. The employer cannot excuse breaches of working time by declaring that he was not aware of overtime work performed. Even if the employee has acted against an explicit instruction by the employer, the employer cannot justify the breach, if the breach was committed on several occasions, the employer has not implemented proper measures to avoid such breach and – once it has come to his knowledge – has not taken disciplinary measures against the employee and/or his manager monitoring the working time.
Violating the provisions of the Working Time Act constitutes an administrative offence. The competent authority can impose a fine of up to EUR 15,000 per breach. Furthermore, the local authority can seize any financial benefit deriving from the breach. For example, if the employer does not pay for the overtime work, the amount of the hypothetical overtime payment can be added to the payable fine. If the employer does save headcounts by systematically letting employees perform overtime work, the authority may also consider saved overhead costs for an additional headcount.
In severe cases, breaches of the German Working Time Act can even constitute a criminal offence punishable with imprisonment of up to one year: The employer commits a criminal offence, if the employer intentionally breaches the aforementioned provisions and – by that – intentionally or negligently endangers the employee’s health and/or ability to work or if the employer persistently violates the provisions of the Working Time Act.
With respect to crunch, such a severe case is not far-fetched: If the project plan for a game development process explicitly takes Crunch times into consideration right from the beginning and Crunch periods require – for example – daily working hours above 10 hours, working on Sunday or public holidays, then this could be an indication of a persistent violation of the Working Time Act.
Apart from the regulatory provisions, crunch also needs to be looked at from a contractual perspective between the employer and the employee.
In this case, two aspects need to be considered separately: First, can the employer order overtime work and prohibit the employee from taking vacation during crucial development phases? And second, if so, what are the employee’s rights?
Right to instruct the employee to perform overtime work and prohibit vacation
By law, the employer is entitled to determine the place, time and means of how the employee performs his work. With respect to overtime work, it is advisable and also common practice in Germany to include provisions in the employment contract which allow the employer to require overtime work. This right to require overtime work requires, however, a respective business need. Furthermore, the employer may not exercise this right abusively. Since overtime work may not – in any case – exceed 10 hours per day and the regular full-time working time is 8 hours, this only becomes relevant, if the employer orders overtime work of up to 2 hours per day during a longer period of time.
With respect to vacation, the employer can also reject the employee’s request of vacation, if the employer has a compelling business reason to do so. Critical development phases shortly before a release of a product could justify such rejection, provided that the employer has communicated the ban on taking leave sufficiently in advance.
Rights of the employee regarding overtime work
Generally, the employer can neither ask the employee to perform overtime work for free nor giving up his statutory vacation claim.
Contractual provisions stipulating that no overtime compensation will be paid are generally not enforceable. As a result, employees will be entitled to overtime compensation at the average salary unless a collective bargaining agreement applies. Instead, contractual provisions should specify the actual number of overtime hours being compensated by the base salary. Furthermore, the number of such overtime hours should not exceed 20% of the agreed working time. Any additional overtime work should be compensated either with time off or additional remuneration. The accumulating financial risks with respect to overtime work are, however, mitigated, if the employment contract includes lawful exclusion clauses stipulating that any claims shall forfeit, if not being asserted within a period of 3 months by either party.
Furthermore, if an employee earns a total annual salary corresponding to, or above, the annual earnings threshold of the statutory pension insurance (i.e., at present EUR 82,800 gross/year in West Germany and EUR 77,400 gross/year in East Germany), according to certain court decisions, it is permissible to agree that all overtime work is compensated by the salary.
The employer may not unilaterally take away the employee’s statutory or minimum vacation. Although the employer can reject the employee’s request to holidays for a certain period, he remains nonetheless obliged to grant the vacation at a later point in time. This even applies if the employee is not explicitly asking for the vacation later on. According to firm case law by the ECJ and the Federal Labor Court, the employer is obliged to pro-actively ask the employee to take his remaining vacation entitlements. If the employer does not do so, the employee does not forfeit his vacation entitlements, even not after the relevant prescription periods.
From an acquisition perspective, it is – therefore – of utmost importance to review the overtime and/or vacation accruals of the target company.
How to deal with crunch in an M&A setting?
Similar to harassment, crunch can have severe financial and reputational consequences for the employer and/or the acquirer of the target company. It is thus crucial for a potential investor, intending to acquire or invest into a tech business to uncover if crunch occurred in the business and to resolve these issues when making the investment.
Due diligence to focus on working time data
The buyer should request information regarding regular working time, overtime, overtime accruals, outstanding vacation and vacation accruals in course of the legal and financial due diligence. In German companies such data is usually available in the payroll or HR system. Additionally, the seller should be asked if working time policies are in place and how overtime is measured at the company.
The seller should also disclose what the reasons for overtime and untaken vacation are. In particular, seller should specify if overtime hours are spread over a longer time period (e.g. 2-3 hours per week) due to regular business tasks taking longer than expected. Or if the overtime hours are condensed within a short time period (e.g. 2-3 or more hours per day) as result of a crunch.
If there are any indications or signs of crunch occurring at the developer, this should be analyzed in more detail in the Q&A process. Buyer should in particular investigate if the crunch is based on systemic issues at the tech company or the game developer. This can include understaffing, insufficient office and IT equipment, a misconcepted project plan, inherent miscoordination, etc. These issues can usually only be resolved by high investments into employees, project planning and also work culture. This may not only cause the need for financial investments but will likely also have an effect on future revenues (valuation) and bind resources of the seller that are of a non-monetary kind.
If no overtime or no involuntarily untaken vacation has been identified during the due diligence, seller should be requested to provide respective representations and warranties in the transaction documents such as the share purchase agreement or the investment agreement. Such warranty can be given either as a specific warranty or as part of an overall warranty by which seller declares that the sold company always acts in compliance with all applicable laws. A specific purchaser-friendly warranty may be worded as follows:
“The Target Company has in the past fully complied with the German Working Time Act (Arbeitszeitgesetz) and the German Federal Vacation Act (Bundesurlaubsgesetz) 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 overtime work and prohibition of vacation. In particular, the Target Company has appropriate working time policies, tracking tools, and reporting methods in place which allow the Target Company to regularly monitor and timely resolve cases of breaches or threatening breaches of the German Working Time Act (Arbeitszeitgesetz) and the German Federal Vacation Act (Bundesurlaubsgesetz) or equivalent laws at the Target Company.”
If overtime or outstanding vacation has been identified in the due diligence, buyer should assess in detail the reasons for this. Depending on the reasons and the severity of such reasons, the overtime and outstanding vacation claim can be dealt with in various ways.
Overtime and vacation accruals may be considered in the valuation and/or the closing adjustment of the purchase price. The accruals may be financial positions which are deducted from the equity value as debt-like items.
However, if the due diligence reveals that the overtime or untaken vacation time occurs in the form of crunch and/or in such manner that it appears to be a systemic issue, more protective measures should be considered. In particular, buyer should consider requesting an indemnity in the share purchase agreement. Such indemnity entitles buyer to be compensated by seller for negative consequences in connection with the crunch. Such indemnity should cover all damages, costs, penalties, fines and losses resulting from the crunch having occurred prior to closing. In particular, fines and penalties imposed by authorities for breaches of the German Working Time Act as well as claims for damages asserted by the affected employees against the buyer or the developer studio should be reimbursed by the seller. Buyer may even consider to request compensation of costs and expenses for actions which are taken by buyer and the company in the future to resolve the issues which resulted in crunches in the past. This could include the acquisition of new IT hard- and software or the hiring of new employees.
As part of the post-merger integration, the buyer will need to assess how the acquired business and its employees can be integrated into the organization of the buyer in such way that any crunch, including potentially unlawful overtime and untaken vacation, can be eliminated or avoided as of the closing.
From a corporate perspective, the buyer may have to decide if the replacement of the management of the acquired tech company is required or if instructions given as shareholder to the management of the company are sufficient. In addition and similar to the post-integration measures with regard to discrimination, unequal treatment or harassment, appropriate post-closing compliance measures should be taken such as the implementation of an employee handbook, working time policies and supervision of worked time.