This is a question we are often asked. There was a series of cases in 1980s and 1990s which was generally thought to have clarified the position. If a company is facing serious financial difficulties (perhaps not so serious that the only way of saving the business would be by reducing pay, but very serious nonetheless), then, subject to an employer following the correct procedure, it can be possible to insist upon a salary reduction. If the employees refuse, then their existing contracts of employment may be brought to an end, and they can be offered fresh terms matching the old, save for salary, which is at the reduced level.
So we thought the position was relatively settled. However in a case before the Manchester Employment Tribunal, an employee won his case against an employer who had insisted upon a pay reduction of 5%. The Claimant was one of only two employees holding out against the proposed variation. When his contract was brought to an end, the Tribunal held the dismissal to be unfair. In doing so, it seemed to misunderstand completely the leading case on the test as to how serious the situation has to be, before an employer can reasonably insist upon a salary reduction.
However, the Employment Appeal Tribunal, in a decision released this July, has overturned the original judgment and set the matter straight. It confirmed there is no necessity for the employer to show that the financial situation was so desperate that the only way of saving the business was to enforce a pay reduction. It is also not for the Tribunal to assess whether or not an employee is reasonable or otherwise in choosing to reject the reduction. Rather it is for the Tribunal to assess whether the employer acted reasonably in seeking the variation. By way of illustration, it may be perfectly possible for an employee to act reasonably in declining to accept a reduction (for example, because of his personal financial circumstances) but for an employer, nonetheless, to act reasonably in insisting that he does (accept the variation). A Tribunal may take into account the effect of the reduction on the employee, but that does not mean that the ultimate test is one of reasonableness so far as the employee is concerned.
This therefore means that in practice, where reasonable it is still open to an employer to call upon its workforce to accept a reduction in pay. The Tribunal will, however, look to see that in doing so it is in accordance with equity, and in that respect one important factor may be whether management, as well as the employees, have been asked (and have agreed) to take a cut.
One good way of showing that an employer has acted reasonably, as the writer used to his advantage in winning a case before the Manchester Employment Tribunal some years ago, is to commission an independent report from a firm of accountants as to the financial plight in which the business finds itself, and to test, through that report, how a reduction in pay might seek to resolve those difficulties. A Tribunal is then unlikely to want to go behind that independent analysis.
Given the continuing depth of the current recession, this is something that may have to be borne in mind by companies that are continuing to find trading conditions difficult, and are looking to revise their costs structure, as a means of avoiding having to let people go.