Recent news about the economy has been depressing, to say the least: the highest unemployment rate in 15 years, a loss of 2.6 million jobs in 2008, and layoff after layoff announced by employers of all sizes. This year many employers are looking for cost-cutting measures that avoid layoffs.
Employers do have some attractive options when structured to avoid legal pitfalls. These include reducing pay, mandatory furloughs, and reduced hours.
Employers may consider reducing employee salaries, as long as that reduction is made prospectively- for an upcoming pay period- rather than retroactively. However, employment agreements, employee policy handbooks and collective bargaining agreements may constrain the employer's ability to reduce pay.
In addition, salary reductions may impact affected employees' 401(k) and other benefit plans, unemployment insurance, workers compensation, vacation accrual, and H1-B visa prevailing wage requirements. Salary reductions, moreover, that reduce pay to exempt employees below the minimum exempt pay thresholds' currently set at $455 per week under federal law (and higher in some states)- will jeopardize exempt status.
Employers also need to consider that any variation in the level of pay reductions or reductions that affect only some employees could trigger allegations of illegal discrimination.
Another alternative to reduce overhead is to shut down all or part of an employer's operations during slow times, such as creating three-day weekends or total shutdowns during holiday weeks. Mandatory furloughs are a viable alternative to layoffs if implemented properly.
Effect on Status of Exempt Employees
Exempt employees under federal law and most state laws must be paid the same minimum salary for each pay period. Moreover, if an exempt employee performs any work during a workweek that exempt employee must receive his or her entire salary for that week. Failure to compensate an exempt employee for a week where any work is performed jeopardizes that employee's exempt status.
However, if an employer furloughs an exempt employee for an entire workweek, then no salary is owed for that full week and the employee's exempt status is not affected.
Absolutely No Work Permitted
When employees are furloughed, employers should expect that they will not work. With the advent of Blackberries, the ease of remote connections, and the use of voicemail, it is likely that at least some exempt employees will-with the best intentions-check their voicemail, send an email, or otherwise conduct "work" while on furlough.
But an exempt employee is entitled to pay for any workweek in which he or she performs any work. Stated another way, the employer may not make deductions from an exempt employee's predetermined salary for absences "occasioned by the employer" or caused by "the operating requirements of the business."
Employers should therefore inform employees that work is not authorized during the furlough period without advance written approval. Preferably, the discretion to authorize work during the furlough should be limited to one or two high-level executives to minimize the potential that exempt employees would respond to subordinates- requests to perform work during the shutdown and thereby be entitled to pay for the entire week. Moreover, depending on the nature of the business, work may not be appropriate except in the case of an emergency.
Mandatory Use of Vacation/PTO During Furlough
Some employees on a mandatory furlough will want to draw from their vacation or PTO to supplement their income. Similarly, employers often want to compel the use of vacation or PTO during a furlough in order to reduce the liability from the company's books. Employers may provide employees the option to use accrued vacation or may mandate its use, but applicable laws may restrict the employer's options.
Mandatory use of vacation has the advantage of saving the employer's resources by using up paid vacation. While federal law tends to permit this practice, not all state laws allow the employer the discretion to mandate use of vacation during a work furlough. In California, for example, "use it or lose it" vacation policies are prohibited, and "reasonable notice" must be provided before an employer can deprive an employee of accrued vacation or paid time off (PTO).
Mandatory vacation use also raises issues when some employees do not have sufficient vacation accrued to cover the entire furlough. If exempt employees do not use vacation for the entire week and do some work during that week, then the employer could face liability for pay for the entire workweek or loss of exempt status for that employee.
An employer can permit advances of vacation but will need to determine how its policy and the governing state law treat the negative vacation balances should some employees quit or be terminated before that advanced vacation pay is earned.
Many states require that the employee agree to-in advance-any deduction from wages upon separation from employment, including deductions for negative vacation balances. Other states simply forbid such deductions regardless of any agreements between employee and employer.
Voluntary use of vacation/PTO generally is the safest course for an employer to take. That way, if exempt employees want to be paid during a furlough, they have to voluntarily "burn" their PTO - without jeopardizing the employees' exempt status.
If exempt employees choose NOT to utilize their PTO and they do not perform any work, the employees' exempt status is still protected, and the employer gets the added benefit of entirely avoiding the payment of the employees' salaries - a nice cost-saving measure in tough economic times.
What About the Union?
Employers considering mandatory furloughs-with or without compelled use of vacation or PTO-should also consider the impact of collective bargaining agreements (CBA) on these policies. Depending upon existing provisions of their CBAs, employers may have an obligation to bargain before implementing a furlough or requiring use of vacation or PTO during the furlough.
A third option is to reduce the work schedule and corresponding pay of all employees, including exempt employees, for example, by 20 percent or one day a week. Although the exempt employees would work some portion of the week, their pay has now been reduced. Clearly such a pay reduction would threaten the exempt status if the 20 percent cut brings the employee's salary below the required threshold amount. An employer also may not deduct 20 percent of compensation from an exempt employee's paycheck during a current pay period based on a reduction in work time.
Can the employer reduce the pay and work schedule of an exempt employee for future pay periods if the employee receives at least the statutory minimum on this reduced schedule? The answer is not clear.
One court said such schedule reductions are not permitted, but a few courts later found that an employer can make prospective reductions in an exempt employee's compensation with a like adjustment in scheduled hours to accommodate its business needs. These courts reasoned that the governing federal regulations do not preclude prospective reductions that are implemented for future work periods, as opposed to illegal deductions from pay for current or past work periods.
However, it is clear that employers may not manipulate payments by "sham practices" such as routinely informing exempt staff of the work schedule for the following week and making prospective adjustments accordingly.
An employer considering reducing the compensation and schedules of exempt employees thus must weigh the legal uncertainties of this approach under federal and applicable state laws. Accordingly, employers take the least risk by either: (1) reducing pay of exempt employees without dictating the hours they work or (2) instituting occasional week long furloughs.
Notification: When Do We Tell Employees?
If an employer decides to impose mandatory furloughs, pay reductions or reduced schedules, it should, of course, notify its employees in advance. While all states require advance notice, some specify the amount of notice for any reduction in compensation. For example, Missouri has a requirement of 30 days notice, while Maryland requires one pay period. Written notice is advisable to have a clear record of the information conveyed, even if state law does not require written notice.
In addition, employers must consider whether any employment agreement or applicable law requires not only specific written notice, but consideration for the modification to the terms of employment provided in that agreement. Even if the employees are governed only by employment policies that the employer reserves the right to terminate or modify, some states do not permit those modifications without the employees' express knowledge and consent.
However, most states permit an employer to modify a unilateral employment contract and deem that the employees' continued employment constitutes acceptance of the reduced compensation without any additional consideration.
In cases where furloughs are for longer periods or where work hours are cut significantly, employers should also be aware that federal WARN and some state WARN laws could apply. In most cases, the cut in hours would have to be 50% or more over a relatively lengthy period for such laws to apply.
Nevertheless, employers should discuss notice with counsel since written advance notice often is prudent both to comply with various statutes and to minimize claims of detrimental reliance on current pay levels.
Employers should consider whether furloughs, reduced hours or pay reductions present a viable alternative to layoffs - thereby keeping more persons employed, maintaining institutional knowledge for the inevitable upswing in the economy, and reducing the likelihood of lawsuits or grievances. A few smart practices will assist in a smooth process:
About the authors: Alison S. Hightower is a shareholder in Littler Mendelson's San Francisco office. Eric C. Bellafronto is a shareholder in the firm's San Jose office. Barry Y. Freeman is a shareholder the firm's Cleveland office. Bryan N. Smith is an associate in the Minneapolis office.