#CostaRica 🇨🇷 #BDS_Article: U.S. Ruling on the Validity of Non-Compete Agreements Could Affect Their Enforcement in Costa Rica
Since 2003, the legality of post-employment non-compete agreements has been under scrutiny in Costa...
The increase in business transactions and strategic alliances between companies invariably creates a greater need for reliable information, with particular attention to the workforce that may be affected. For those making decisions that involve transferring employees from one organization to another, it is essential that conclusions regarding labor or legal matters be supported by objective evidence and extensive traceability. An effective way to achieve this is through a labor audit or due diligence process.
It is common in negotiations between companies to find that the relevant commercial agreement is robust and supported by thorough financial and market assessments, while the analysis of employer substitution, governed by Article 37 of the Labor Code, is comparatively weak or even overlooked. This is highly relevant to the transaction because organizational knowledge regarding a particular task or business is just as important as the people capable of doing it.
Article 37 provides as follows: “Employer substitution shall not adversely affect existing employment contracts to the detriment of employees. The former employer shall be jointly and severally liable with the new employer for obligations arising from employment contracts or by law existing prior to the substitution date, for a maximum period of six months. Upon expiration of this period, liability shall remain solely with the new employer.”
Accordingly, it is important for the company assuming responsibility as the new employer to understand that, once this period has elapsed, it will bear full liability toward employees.
Therefore, in the context of an alliance, separation, or acquisition involving companies, particular attention should be paid to the past, present, and future circumstances of the employees. A labor audit is the appropriate means of understanding the extent of the liabilities being assumed. It should focus on identifying potential contingencies, quantifying known liabilities and determining whether any undisclosed liabilities exist, and assessing legal and financial risks, while also considering the possibility of intervention by the Ministry of Labor and Social Security, either on its own initiative or in response to inquiries from employees.
In this type of employer substitution process, it should be considered that Costa Rican labor law understands employer substitution as a change in the employer (whether an individual or legal entity), without affecting the continuity of existing employment contracts. Consequently, the substitution does not entitle employees to request termination of their contracts. This means that, when an employer substitution takes place, the terms and conditions of employment agreed upon with the former employer must be maintained and respected.
To illustrate the position taken by the courts regarding employer substitution, the following excerpt from Judgment No. 002459-2025 of the Labor Chamber of the Supreme Court of Justice is particularly relevant:
“Employer substitution entails a change in business ownership resulting from various legal transactions, without such transfer preventing the continuation of business activities. This concept presupposes the existence of different employers with individual responsibilities from which separate or joint obligations toward employees may arise, given that the latter remain unaffected by changes that may occur in corporate ownership. It may be said that, within the employment relationship, employees occupy a more significant position than the employer, since the latter may be readily replaced without affecting the terms or existence of the employment contract, whereas the same cannot be said of the employee.”
Our experience advising companies when labor claims arise—often years after employer substitution processes have taken place—leads us to recommend that, when consolidating a transaction between the former and successor employers, a robust labor audit should always be conducted. Such an audit should focus on providing information regarding potential issues or complications, while also addressing the possibility of taking corrective action to mitigate contingencies in the short or medium term. This can be achieved by consolidating information that may prove relevant in the future.
In light of the foregoing, the successor employer should bear in mind that the former employer's joint and several liability is limited in time. Therefore, in order to gain a detailed understanding of the actual status of employees' terms and conditions of employment and their future implications, and to complete the transaction as safely as possible—with a clear understanding of which matters present low, medium, or high levels of risk—it is advisable to conduct a thorough review to ensure compliance with labor legislation and social security obligations.
There is no question that bilateral agreements are important in business transactions. However, when labor rights and employer liability are involved, particular attention must be paid to these issues without losing sight of the perspective of the person who may ultimately be asserting their rights: the employee. This is particularly important when dealing with employment relationships that date back many years.
As an analogy for this type of process, I would like to borrow a phrase from a close friend who is a chef: “To make a good cake, you need a skilled hand and knowledge of the right ingredients; it is not enough for it to look good—it must also taste excellent.”
Without a doubt, in employer substitution processes, the methodology used in the labor audit is important, but it is not the sole factor—having a 'good recipe' alone is simply not enough.
Efraín Zapata Muñoz
Partner, BDS Asesores
