Challenge:

Outside the US, human resources cost-savings strategies, like pay cuts, can trigger unexpected legal problems.

According to a New York Times article called “More Companies Are Cutting Labor Costs Without Layoffs” (December 22, 2008), “employers have found an alternative to slashing their work force. They are nipping and tucking it instead.” Indeed, multi-country reductions-in-force and layoffs (discussed in our December 2008 Global HR Hot Topic) may be a strategy of last resort: Multinationals trimming worldwide personnel costs often turn first to softer measures such as pay cuts, benefit cuts, hours cuts, pay freezes, forced paid vacation, unpaid leaves, and temporary shut-downs. However, employment-related cuts are tricky outside the US, where they run into the vested/acquired rights hurdle (discussed in our January 2009 Global HR Hot Topic).

Of these cost-cutting measures, pay cuts in particular often involve unique complexities. When considering a straight pay cut (that does not alter compensation structure), in most (but not all) jurisdictions a five-step analysis is necessary:

1 Verify that pay cuts are not flatly illegal (as in Italy and Panama) or against public policy (as in Brazil).

2 Comply with minimum wage laws, statutory benefits mandates, and employment contracts: The pay cut cannot push any employee’s pay below minimum wage or deny any “statutory entitlements” (mandatory benefits), and the pay cut implementation must comply with applicable individual and collective employment agreements (unless the agreements get renegotiated and reformed).

3 Articulate a demonstrable, genuine, and pressing economic need that justifies the pay cut.

4 Determine whether employee consent is necessary, and collect consents where it is. In most countries the vested rights principle empowers an employee whose pay is cut unilaterally (by a material amount) to sue for constructive discharge or breach-of-employment-contract. But in many (not all) countries a valid, uncoerced, and properly-executed consent, release, or employment-agreement-amendment extinguishes this claim. The challenge is how to get employees to consent. As to employees who withhold consent, have a backup plan—which sometimes has to be a layoff with full severance/notice pay.

5 Follow the country-specific local procedures and rules that modify or add to the above four steps.

Pointer:

Cut pay only after taking five steps that factor in the specific barriers to pay cuts in each affected country.

This final step, step 5, focuses on the localcountry level. What are these country-specific local procedures and rules? Some examples:

  • Brazil: Permanent pay cuts violate public policy in Brazil and are effectively impossible. Temporary pay cuts of up to three months are possible only if the employer demonstrates serious financial problems and wins buy-in from both the (mandatory) trade union and the local government labor authority (Delegacia Regional do Trabalho). Not surprisingly, employers in Brazil tend to bypass pay cuts in favor of more locally-viable cost-cutting strategies such as temporary facility shutdowns (férias coletivas).
  • France: A multinational trying to cut French employees’ pay must demonstrate “real and serious” economic need at two levels, the French affiliate and the “group” (parent and subsidiaries in same line of business). Even an employer able to make this case must then follow strict procedures: Write affected employees a letter in French proposing the reduction and explaining the economic need; mail the letter by registered mail with return receipt inside France; give employees one month to decide whether to accept the reduction. Employees cannot be terminated for refusing, which of course gives them little incentive to consent. In 2009, France took steps toward implementing government programs to compensate employees for so-called “partial unemployment” (reduced hours).
  • Hong Kong: Only the process above (steps 2-4) is necessary in Hong Kong.
  • Italy: Italy flatly prohibits reducing pay, even with consent of the employee or trade union. Italy Sup. Ct. Dec’n 11362 (May 8, 2008) interpreting civil code § 2103. As such, pay cuts are considered impossible.
  • Japan: Lay-offs are extremely difficult in Japan, a last resort. Pay cuts are a secondto- last resort. To cut pay, only the process above (steps 2 – 4) is necessary, but is subject to strict scrutiny: An employer must demonstrate real financial necessity and show cost-cutting steps already taken. Employees who refuse consent can sue, challenging the employer’s economic justification. If they win, the remedy is reinstatement at the old wage rate plus back pay.
  • Panama: Panama effectively prohibits reducing remuneration, and so even an employee consent to a pay cut is not necessarily enforceable. However, a Panamanian has only a two-month statute of limitations window to sue contesting a pay cut. Employees who consent (preferably in writing) should not be able to challenge the cut after two months.
  • Peru: Only the process above (steps 2 – 4) is necessary in Peru. The employee consent document itself should specify an “objective cause” for the reduction.
  • Singapore: Only step 2 above is necessary in Singapore; employee consent is not even necessary as long as after announcing but before implementing the pay cut, the employer waits out each employee’s contractual pre-termination notice period.
  • Spain: Collective agreements commonly set minimum wages for specific positions higher than that statutory minimum wage; a pay cut cannot dip below the contractual rate. Memorialize employee consents by amending individual employment agreements.
  • UK: Avoid announcing a pay cut in the UK as a fait acompli. Invite each employee to a meeting and explain the economic need for the pay cut and why the cut is the mildest of more severe options. Seek signed consents. Make clear the date of any proposed cut. Employees who refuse a cut might leave, claim constructive dismissal and seek dismissal notice/pay. If an employee will not accept the pay cut, then the only sure route is “termination and reengagement” on lesser terms.

Pay cuts can be a less-disruptive alternative to layoffs—indeed, some governments (Germany’s, for example) actually pay generous “partial unemployment” or “short-time work subsidies” to employees subject to hours/pay cuts. But worldwide, implementing pay cuts requires careful attention to local law, and the taking of appropriate steps.