Consdering Employment Cost Reduction Strategies Before Layoffs
In light of the uncertainty with respect to recent changes to federal funding initiatives and their potential impact, nonprofit organizations are facing difficult questions regarding the continued viability of their operations in this current climate due to budgeting and/or funding considerations.
While layoffs are a common and sometimes inevitable approach taken to realize cost savings, organizations should be mindful of other viable options to achieve this goal while minimizing the impact on its employees and the attendant legal exposure of employment terminations.
Below are options that employers may wish to consider to reduce personnel expenses, from least to most drastic. Each option has its own advantages and disadvantages. Some options can be employed concurrently or in succession, depending on the actual or expected effectiveness.
Freezes in hiring, promotions and transfers.
Least drastic option that allows for short-term labor cost savings while avoiding economic and morale costs of hours/pay reductions or layoffs.
But freezes alone may be insufficient to address cash-flow and resource shortages, and delaying promotions may result in morale issues.
A primary downside with this option (as with the other stopgap measures such as reduction of hours/pay) is that higher performing employees may decide to voluntarily resign. While that helps with short-term cost savings, it could result in loss of talent that hurts the organization in the long-run. As such, some employers may want to consider offering high-performing or valuable employees incentives to remain employed (i.e. a retention bonus). However, employers should seek counsel in crafting such arrangements to avoid running afoul of deferred compensation tax and exempt organization rules.
Reduction of working hours.
Employers may consider reducing employee work hours to reduce labor costs. This option is better suited to employers with a large workforce of hourly, non-exempt employees, because it can be quickly and efficiently implemented by simply scheduling fewer hours upfront.
Due to wage requirements that limit an employer’s ability to deduct exempt employee salaries based on hours worked, reducing work hours does not automatically create a corresponding reduction in pay. However, there are lawful ways to reduce exempt employee working hours in connection with a salary reduction (See Reductions in pay discussion below).
It’s important to note that reducing employees' hours of work or the amount of required work does not excuse compliance with the federal or any applicable state wage and hour laws. For example, if hourly non-exempt employees are required to occasionally work longer workdays due to a broad reduction in staffing availability, that could entitle them to overtime wages. Employers must also still adhere to meal and rest period and recordkeeping requirements.
Employers should also consider the impact of reduced working hours on employees' eligibility under certain benefits plans. Depending on the terms of the plan, a reduction in hours may result in a loss of eligibility and create a COBRA qualifying event.
Reductions in pay.
Employers generally have the discretion to lawfully lower employee pay, so long as those reductions are done prospectively and do not constitute a forfeiture of earned wages for work that has already been performed.
Moreover, pay reductions must not reduce pay below the required minimum wage (for non-exempt employees) or the required minimum salary threshold (for exempt employees).
The current federal minimum exempt salary is $35,568 (or $684 per week), whereas the California minimum exempt salary is $68,640 per year (or $1,320 per week). Each employee who is classified as exempt must be paid no less than this minimum salary in order to be properly classified as such. If an exempt employee's salary is reduced below the applicable minimum exempt salary threshold, that employee will be converted to a non-exempt employee, and must receive all associated benefits and protections. For example, the employer will need to track the non-exempt employee's hours of work and pay applicable overtime. In certain states, any newly non-exempt employees will also need to receive other types of benefits (e.g., meal and rest breaks in California) and to receive certain notices about overtime eligibility.
Note that employees may not agree to "defer" wages or suspend salaries, and all employees performing work must be paid at least the applicable minimum wage for all time worked.
For exempt employees, a salary reduction may be paired with a corresponding reduction in hours to part-time status – e.g., 60% pay for 60% work. This may be done on a temporary basis due to economic conditions, provided the minimum exempt salary threshold is met. Employees would potentially be eligible for some unemployment insurance benefits under this scenario.
But note that the FLSA generally prohibits partial day deductions from exempt employees' salaries, and improperly deducting pay from an exempt employee's salary can have serious consequences. For exempt employees, the reductions should not fluctuate day-to-day or even week-to-week, which could result in the loss of exempt status. Rather, the reductions should be instituted prospectively for a defined period of time, with the ability to be extended as circumstances continue to evolve, and documented in an updated offer letter or other written agreement with the employee.
When circumstances improve, employers may increase compensation again to retain employees. However, employers must be careful not to make any explicit or implied promises that such reductions will be "made up" to employees in the future. Doing so could create deferred compensation tax risk to the individual employee and the organization.
If pay reductions are imposed on only some but not all employees, employers must consider if protected classes are disproportionately impacted by the pay reductions, and whether such decisions could expose the organization to discrimination claims. Decisions as to which employees will be impacted (and to what extent) must be supported by legitimate business reasons and, ideally, reviewed by legal counsel.
Employers will need to memorialize any reduction in pay in writing, and certain states require a specific form to be timely provided (e.g., California employers must provide non-exempt employees with a notice that complies with California Labor Code section 2810.5) within 7 calendar days of the change.
For employees who have severance and/or change in control entitlements, consider if the reduction in pay could reasonably trigger the "Good Reason" right to such entitlements. As it is likely that employees with such severance rights are executives or other higher-ranking employees, considering asking these individuals to (temporarily) waive their entitlements.
State work sharing programs. A number of states offer work sharing programs that provide an alternative to layoffs. For example, in California, employers who need to reduce hours and wages by 10% to 60%, and who meet other specific requirements, may apply to California's Work Sharing program. Under this program, affected employees may receive a percentage of their weekly unemployment insurance benefit in an amount equal to the reduction in normal hours and wages for that week. However, employers must apply and be approved to participate in such plans, and not all employers may be eligible depending on the circumstances. Moreover, during economic downturns, state governmental authorities may face a significant backlog of requests from employers and may not provide timely approvals to employers seeking immediate relief.
Voluntary termination programs. Employers may also consider offering employees a voluntary termination program, whereby employees can agree to resign in exchange for severance benefits. Severance benefits typically consist of a cash payment equal to their base pay or health benefits continuation for a fixed period (i.e. 2-4 weeks is customary). If employees opt for it, a voluntary termination program creates potentially significant cost savings, while allowing employees to evaluate their current needs and future plans and be part of the decision. A potential drawback is that higher performing employees may decide to opt-in while underperforming employees choose to remain, leaving the organization with a disproportionate loss in talent and performance. That risk can be mitigated by offering voluntary termination to only certain departments or workgroups; however, a targeted offering should be carefully structured to avoid potential disparate impact discrimination claims (i.e. offering the voluntary termination program only to older employees could invite risk of age discrimination claims).
Furloughs. If the above measures are not effective in meeting budgetary considerations, employers may want to consider the more drastic step of a furlough. In a furlough, employees are directed to stop performing any work for a specified period of time. While furloughs have been popularized as a consequence of government shutdowns, private employers may also use them to manage the operational budget. Furloughs offer some advantages over a layoff by providing short-term labor cost savings without having to formally terminate employment. This effectively spreads the cost reductions over the larger workforce and ideally minimizes attrition and the loss of key talent. However, furloughs may only slow, but not halt, attrition, as employees may ultimately be forced to seek other employment to earn a living. In addition, certain employees facing financial difficulties may in fact prefer to be terminated in order to receive a payout of accrued vacation and/or severance pay.
While employers who temporarily suspend or reduce operations will only have to pay non-exempt employees for hours in which they actually perform work, exempt employees are generally entitled to payment of their full salary in any week in which they perform any work. As such, exempt employees should be furloughed in full week increments, whereas a furlough for non-exempt employees can be for a partial week.
All employees who are on furlough should also be expressly prohibited from performing any work for the employer, otherwise the employer may open itself up to potential off-the-clock wage claims and associated damages and penalties. For this reason, employers may wish to implement protocols to address furloughed employee activity, such as restricting or limiting IT access. These protocols also guard against any attempts to steal company property or trade secrets.
Furloughs and temporary shutdowns that last for six months or more can implicate the federal WARN Act notice requirements, which entitle employees to 60 days' advance notification (or pay in lieu of such notice). In addition, states may treat temporary layoffs differently.
Notably, in California, even a temporary furlough of less than six months may trigger the California WARN Act (Cal-WARN). The federal and state WARN Acts are highly technical and their specific application is beyond the scope of this article– any employer conducting furloughs or layoffs should navigate these complex requirements with the assistance of counsel before moving forward.
Employees who are furloughed may be eligible for unemployment insurance benefits, though specific eligibility requirements vary depending on jurisdiction.
Furloughs may trigger a COBRA-qualifying event. Employers should consult with their health insurance carriers concerning benefits eligibility during the furlough.
Vesting of equity awards may or may not automatically continue during a furlough, and employers should carefully review applicable equity plans.
Layoffs. If the above measures are not effective, layoffs may be necessary as a last resort measure to drastically reduce personnel costs and eliminate redundancies.
Layoffs can also offer additional cost savings in certain states where accrued and unused vacation or paid time off may be forfeited upon employment termination.
However, layoffs can increase potential legal exposure to the organization as employees are more likely to seek counsel to bring legal challenges relating to discrimination, wrongful termination, and/or violations of wage and hour laws.
This risk can be mitigated by offering affected employees severance benefits in exchange for a release of claims; however, note that special requirements and procedures apply to releases in the context of a layoff of multiple employees, so you should consult legal counsel on the drafting and implementation of severance agreements.
To further rebut claims of discrimination, employers should consult with legal counsel to conduct a disparate impact analysis to determine if the layoff selections disproportionately impact employees in protected groups (i.e. age, gender, race).
Mass layoffs (i.e. layoffs of 50 or more employees) may also trigger an employer’s obligation to provide 60 days’ advance notice under the federal WARN Act and/or similar state laws, and therefore employers should consult with legal counsel well in advance of the anticipated layoff to understand these obligations. Federal and state WARN Acts are highly technical and their specific application is beyond the scope of this alert.
