Employment and Termination
Given the state of our economy, companies are looking for ways to reduce their cost of doing business. I have engaged my own staff to aid in a similar effort. As you might have guessed, their first suggestion was that I fire myself to reduce costs and increase their productivity. I have asked them to refocus.
In recent weeks, many of my clients have focused on saving via reductions in payroll. This often involves: hire freezes, reductions in entry level salaries and benefits, replacement of full time staff with part-time staff and/or independent contractors, and, of course, lay-offs without replacement. These actions implicate the need for legal planning in advance. In light of this trend, I thought that it would be useful to share a few private sector employment “rules of the road.”
Replacing full time workers with IRS W1099 independent contractors is a great way to eliminate the costs of benefits, withholdings, and support services. However, employment of 1099s is not risk free. Because of the IRS’s interest in employers collecting income tax withholding, it has promulgated rules regulating 1099 employment.
Businesses all too frequently designate staff as 1099s, but fail to ensure that its employment terms comply with IRS requirements. (1) A worker is likely a W-2 employee if you reserve the right to control the worker’s work or how they do it. (2) A worker is likely an employee if you control how the work is paid, whether expenses are reimbursed, and pay for the worker’s tools and supplies. (3) A work is likely an employee if you control the relationship with a written contract, pay benefits, the work is a key aspect of your business, and worker works solely for you.
The best way to avoid the legal issues associated with 1099s is to hire a staffing service that employs workers to support your business along with others. However, staffing companies also must offer (cheaper) benefits, turn a mark-up profit, and therefore price their services 30-50% higher than employing a 1099 directly. Your decision to reduce your risk of IRS harassment and personnel management costs comes with a price tag that reduces your savings.
Lay-offs are certainly another way to reduce costs. However, with or without the rehiring of cheaper labor, sizeable employers risk EEO claims if the race, sex, national origin, and age representation among those fired is significantly greater than it is in the overall work force (you) and labor force (everyone). A similar disparity in post lay-off rehires implicates the same problem. Prior to giving final approval for a lay-off, senior management should conduct a simple analysis for statistical disparity. If anomalies are apparent, the employer should review the effort to determine whether the lay-off is the result of genuine business necessity or should be restructured by department, re- organization, seniority, and demonstrable productivity.
A few precautions may mitigate risks. (1) Review your mid-level management termination selections to identify and correct lay-offs inconsistent with company policy, procedure and criteria. (2) Examine the terminations for disparately high minority representation that is not readily explained by bona fide termination selection criteria. (3) Document the objective business necessity of the criteria used to select those to be fired. (4) Monitor the age of those terminated and the age of any replacements.
A common thought is to fire the grey hairs (like me) with large salaries and replace them with cheaper workers. While these terminations may be justified, they present the “fire and hire” trap. If you fire a worker age 40 or more and replace them with a worker who is less than 40, the Age Discrimination Act and case law presume a prima facie case of discrimination. These terminations must be carefully analyzed and the reasons documented.
The termination of senior professionals, managers, officers, and partners raises additional concerns. Frequently, these workers enjoy rights which impact termination flexibility and cost savings. These rights can be created by contract, corporate or partnership formation documents, state law protections of minority owners, prior practices, ERISA, or implied by conduct. Disputes generally arise when employment contracts, severance package terms, and handbook or policy statements are ambiguous and the court is left to make determinations about the parties intentions based upon a study of the employer’s past conduct.
Firing partners also raises it own peculiar set of issues. Generally, partnership law mandates dissolution of a partnership when a partner leaves or is asked to leave. Some state courts and statutes will recognize provisions in a partnership agreement that allow the partnership to continue, but require a fiduciary accounting as to the value of the partnership interest almost as if there had been a dissolution.
The best way to mitigate the likelihood of a legal disaster is to craft clear and unambiguous formation and relationship documents that comply with the law. This is best done early on, before the entity has value and people are less ecumenical and more focused on maximizing the value of their perceived contribution. Straight up, these documents must be drafted by a lawyer, who along with the client, analyzes the entity and relationships.
I can no longer count the number of times that I have had to represent clients in needless litigation because they relied upon formation or relationship documents purchased on-line or cribbed from a friend or predecessor’s documents. These documents cannot and do not address the issues peculiar to your entity. Further, a lay person does not know and does not have the skills necessary to identify the issues which must be addressed and address them effectively. To be clear, the cost of drafting good relationship documents is usually 5 percent or less of the cost of defensive litigation. Come to think of it, why am I telling you this!
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