Pay Cuts During the Financial Downturn

In these days of financial turbulence, all companies are coming under increasing pressure to reduce costs. Many have responded by cutting staff numbers. Other businesses are attempting to avoid redundancies and are choosing to implement a package of salary cuts instead. This allows them to retain valuable employees so as to be ready to operate at full capacity as soon as the business climate improves. Forward-thinking employers are maintaining a dialogue with their employees, leading to the successful negotiation of new terms, helping both parties to weather the temporary storm.

Some employers have chosen a more confrontational strategy and have resorted to Article 74 of the Labor Code to force through wage reduction in the belief that it gives them the freedom to unilaterally amend the terms of an employee's employment contract. In an example of "my way or the highway," an increasing trend is for employers to send edicts to their employees, informing them that their salaries would be cut in two months' time because of the "global financial crisis and run-down of sales."

The legitimacy of such actions by employers is questionable.

Under Article 74 of the Labor Code, employer-initiated amendments of employment terms are allowed only when changes in organizational or technological work conditions have occurred and rendered the existing contractual terms unsustainable.

As follows from Article 74, neither the financial performance of the company nor the "global financial crisis" can, on their own, be regarded as a lawful basis for imposing salary cuts on employees. However, if financial problems lead to, for example, structural re-organization of production, then the amendments to employment contracts may indeed fall within the scope of the law. The employer should note that such amendments may not worsen the employment terms as compared with any collective bargaining agreement, and the job function of the employee should remain the same.

Where an employer seeks to impose new terms unilaterally, the employee is still entitled to disagree and, in this event, the employer must offer the employee another vacant job (if available) appropriate to the employee's skills and qualification, or a lower position. In the event that no vacancies exist or the employee declines the alternative offer, the employee's employment contract is to be terminated under paragraph 7 of Part 1 of Article 77 of the Labor Code.

Ruling No. 2 of the RF Superior Court Plenary Session dated 17 March 2004 has given guidance on how the law should be applied. It states that the onus is on the employer to prove the occurrence of such organizational or technological changes that necessitated the amendment of the employment contracts. The view of the Superior Court is that, if no such evidence has been provided, the employment termination under paragraph 7 of Part 1 of Article 77 cannot be recognized as lawful.

The consequences of getting it wrong are severe. If the court determines that any such salary cuts were imposed illegally, the employer may have to re-instate the employee at his or her previous salary level and pay any accrued interest. It may also suffer an administrative penalty or, at worst, a suspension of operations for up to 90 days.

With market conditions as they are at present, there is an understandable tendency to panic. As far as employment is concerned, knee-jerk reactions taken in the heat of the moment, and often in ignorance of the law, can have serious long-term consequences for employers and employees alike. Amid the crisis, the importance of getting sound legal advice cannot be exaggerated.