Media McKasson & Klein


Legal Issues for California Employers in a Downsizing Economy

There is no doubt the U.S. economy is in trouble and that jobs are being lost on a daily basis. Many California companies (and elsewhere in the Nation) have had to face the unpleasant reality that they must lay off staff to survive financially. This unfortunate “economically dictated reduction” may have been due to poor management, lost or non-renewed contracts, changing customer demands or increased international competition, but the impact is unavoidable.

From a legal perspective, the overarching issue is to protect the Company from litigation that may arise from a downsizing. Whether or not to sue the Company will often depend on how the downsizing is handled, which does not always involve legal considerations.

A decision to downsize assumes the Company has carefully conducted a study of its current workforce and workload, and has come to the conclusion it has no alternative. So, what next?

  1. What should a company do if it is at this point?
  2. How does a company plan for and go through this process?
  3. What can a company do for those employees that have been laid off?

Step 1: Exhaust the Alternatives

As an initial matter, the Company can do several things before restructuring or laying off staff and cutting jobs (obviously, it should freeze new hiring)1; for example, it could:

  • Terminate poor performing employees
  • Restrict employees from working overtime
  • Reduce the pay of existing employees by a certain percentage (e.g. 20%)
  • Reduce working hours per day or week
  • Make employees take their vacation days

Note: The last two bullet points are a form of layoff that allows employees to receive partial unemployment benefits.

If affordable, the Company should also offer a severance package to certain employees in exchange for a full release, to protect against future lawsuits.

Step 2: Develop a Plan

First, establish why the Company needs to reduce staff levels. For example, does it have too many salespeople for the job at hand? Or did the Company lose a specific contract for sale of Blue Widgets – if so, does it still need the department that manufactures and sells those Widgets? Can Blue Widget staff be transferred to the Green Widget department?

Once the reason for downsizing is clear, set it out in writing (e.g. “loss of business/sales”).

Second, develop a fair, honest/truthful & objective methodology for the layoffs. Make sure the alleged economic reason for the layoff is NOT a pretext for getting rid of (and discriminating against) a protected class of employees e.g. older workers or women on pregnancy leave.

Be creative and sophisticated as the Company’s circumstances allow. There is no hard & fast rule.

Criteria might include: LIFO (last-in, first-out), coupled with a percentage e.g. 10% of employees let go (this may work for larger companies, but not as well for small to mid-size entities); elimination of positions by job title or classification; objective & provable productivity levels; calculation of work to be done & number of employees needed for each segment of work. The list is not exhaustive.

Third, make sure the basis for the plan stands up to objective court scrutiny to avoid claims:

    • Discrimination

Allegation by terminated employee of improper lay off due to age, race, religion, gender, national origin, etc. (i.e. member of protected class). The Company must show there was “good cause” for termination, via proof of “fair and honest cause or reason, regulated by good faith.” The employee can then try to rebut the Company’s alleged good cause via evidence the reason alleged was merely a pretext for unlawful discrimination against that person.

In Martin v. Lockheed Missiles & Space Co., Inc. (1994), 65-year old female employee sued for age discrimination, but the Company was held not liable. The court found “good cause” due to depressed company business, and company followed detailed written procedure where employees were ranked, based on performance evaluation & seniority.

    • Wrongful Termination

Breach of Written Contract – this involves a claim that the terminated employee’s employment was for a fixed period of time, and/or included guarantees for bonuses, stock options etc.

Breach of Implied Contract – internal policies & procedures at a company can be used to prove existence of implied contract not to discharge employees “without good cause:” Scott v. Pacific Gas & Electric. Co. (1995); as well as custom & practice within an industry. Colores v. Board of Trustees of Calif. State Univ. (2003).

In Malmstrom v. Kaiser Aluminum Corp. (1986), a laid off 60-year male worker alleged he had implied contract with company not to terminate him until retirement at age 65, other than for good cause, even though he signed “at will” agreement. However, the court held that the written agreement precluded any oral implied contract.

In Tomlinson v. Qualcomm (2002), a woman on pregnancy leave was terminated due to company-wide layoff and sued for pregnancy discrimination. The court ruled she had a written “at will” employment agreement which precluded any implied contract, and handbook policies did not supersede her contract or guarantee reinstatement after completion of her leave.

    • False Assurances

Even if there is a bona fide economic reason for layoffs, an employee recruited by false assurances or representations during hiring process (“the company is very strong/stable financially,” and “your job is secure”) could file suit. See Lazar v. Sup. Ct. (1996) (employee gave up secure job, moved family & purchased home, based on company assurances).

A claim could also arise if purchaser of a business promises to retain seller’s employees for specific time or pay severance benefits, but fails to do so; in that case, terminated employee is a 3rd party beneficiary of stock purchase agreement. Prouty v. Gores Technology Group (2004).

    • Violation of WARN & Cal WARN (companies w/+100 & 75 employees, respectively)
    • Breach or Violation of ERISA Plan

Fourth, consider all company documentation for those employees to be let go: Review each personnel file, including written employment contracts, as well as bonus, stock option and non-compete/confidentiality agreements. Follow the employee handbook and polices on layoffs and rehire. And be aware of any collective bargaining agreements.

Then document the reason(s) for each employee’s selection for layoff.

Step 3: Help with Transition

The layoff should be conducted in the same way as any regular termination with all associated documentation. Employees must be presented with final paychecks upon leaving the Company.

The Company could also consider the following:

  • Letter to confirm dates of employment & that employee let go due to downsizing (to speed up unemployment claims)
  • Letter of recommendation or electronic reference e.g. on LinkedIN (may have to modify reference policy)
  • Allow employee to make copy of contacts in Outlook (review & approve in advance)
  • Forward non-work related e-mails & telephone messages
  • Counseling and job search assistance

Finally, always bear in mind that this is a difficult time for the person being laid off, so act swiftly (avoid long, drawn out layoffs if possible), treat everyone with dignity but honesty, and do not make promises you cannot keep on future employment or rehiring.

1 Layoff often refers to “temporary displacement” while “downsizing” suggests a more permanent connotation. Other terminology may be “reduction in force” (or a RIF) or restructuring. In this article, layoff is used interchangeably with downsizing, and means separation of a permanent kind.

Article written by:
Neil Klein