The Severance Story in Startups

Most start-ups have disruptive businesses / business models and in the course of scaling business, teams are ramped up. There is an all-round good news of amazing startup ideas, cheer of unicorns, and funding frenzy. We also hear of a few start-ups facing difficulties in raising new rounds of funding, cash crunch, restructuring business / business models, which may require right-sizing of teams.

Working in a startup gives employees a steep learning curve and many a time wider exposure / perspective to work itself. These skills make it easy for employees to land another job quickly, which in-turn gives employees an ability to take the risk of joining start-ups.

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Making course corrections in business, is comparatively easier than dealing with human aspects. While employees have challenges of looking for a new job, dealing with EMIs etc., it is equally challenging for the founding team. In one incident, a co-founder of a Mumbai based food-ordering app was held hostage by the laid-off employees, for more than 36 hours; in another incident, a Mumbai based real estate listings platform has cut down 600 jobs gaining a lot of negative publicity.

In another case, a startup retrenched nearly 50% of its people strength. The founding team worked with utmost care and caution, such that there has been no employee complaint or news (negative or otherwise). The management and senior leadership ensured that labour law compliances were met, fiduciary relationship between the employees and organization were maintained, contractual obligations under the employment agreement were adhered to and importantly, promises made of salaries were kept. It went further, they detailed the list of employees’ skills and mapped it with organizations which may need those skills. They had a list of recruiting agencies that the employees could reach out to. The day and time of breaking the news to the employees were meticulously planned given the holiday season around the corner.

News such as these, do take the employees by surprise, especially when the company is doing well and / or have raised funding recently. Managing that surprise has to be thought through apriori. Equally important for the leadership team, is to think through repercussions on productivity of continuing employees and reputation of the organization so as to continue attracting top talent later on.

Termination of service as referred above is called ‘retrenchment’ under the Industrial Disputes Act, 1947 (“ID Act”), which shall be applicable to ‘workmen’ as defined thereunder. The ID Act defines a workman as any person (including an apprentice) employed in any industry to do any manual, unskilled, skilled, technical, operational, clerical or supervisory work for hire or reward, whether the terms of employment be express or implied. However, following are the few important exemptions under Section 2(s) of the ID Act:

  1. Any person employed mainly in a managerial or administrative capacity
  2. Any person being employed in a supervisory capacity, drawing wages exceeding Rs.1600/month, with functions mainly of a managerial nature

Generally, the ID Act requires the employer to obtain prior permission of the labour department for retrenchment of beyond 100 workmen and employer is required to follow the “first in, last out” rule as per the held law. Accordingly, the employer has to start terminating with the last person employed in that category. There are no similar rules for non-workmen. (Note: In Karnataka, vide notification no. LD 53 LET 2013, Companies operating under the banner of IT/ITeS are exempted from the applicability of the Industrial Employment (Standing Orders) Act, 1946).

There is differentiation of Workmen and Non-Workmen and Courts have managed to lay down some aspects distinguishing between the two:

  • If there is a contractual relationship between master and servant (these are words used in this judgment), i.e. the servant under the supervision, direction and control of his master, would be considered as workman. (Hon’ble Supreme Court in Chintaman Rao vs. state of Madhya Pradesh)
  • A person employed in managerial capacity or administrative capacity cannot be considered as a workman. (Hon’ble Supreme Court in Ved Prakash Gupta vs. M/s Delton Cable India (P) Ltd., [AIR 1984 SC 914])
  • Canteen employees upon being dismissed from service had approached the Labour Tribunal, wherein, it was held that departmental canteen is not an industry and in order to classify an employee as workman the condition precedent is that he is employed in an industry. (Hon’ble Supreme Court in Bombay Telephone Canteen Employee’s Association vs. Union of India & Anr. (1997 (2) LLJ 647))
  • Person involved in such a nature of work wherein a considerable amount of mental inputs related to creativity and imagination is required cannot be regarded as a workman. (Tata Sons Ltd. vs S. Bandyopadhyay (2004) IIILLJ 125 Del)

Retrenchment, under ID Act, can be done only if company is virtually abolishing the said post. In case the company attempts to hire for the same post, opportunity to the worker retrenched has to be given first.

Any establishments, which vide a notification issued by State Government, is declared as a commercial establishment, are governed and fall under the ambit of state-specific Shops and Establishment Acts.

It is also required that employers provide a reasonable cause for retrenchment and provide notice period or wages in lieu as provided by the state legislations applicable. Companies are required to provide a one month notice period or wages in lieu of such notice period, for termination of the employees under the full time employment; Hon’ble Supreme Court in S.S. Shetty Vs. Bharat Nidhi Ltd., (AIR 1958 SC 12), have made it clear that even if there is an illegal termination of an employee by a private employer, at best the employee is entitled to the salary for the notice period. However, there have been instances where Companies have offered a severance pay to the employees, which is above these mandatory requirements, which labour department/courts do consider favourably, should there be any employee complaints.

The courts have considered mismanagement, misconduct, loss of confidence, dereliction of duty, change of business as common grounds of termination of employment. In case of a dismissal, misconduct of an employee does bereave him/her of the notice period or wages in lieu. However, proper enquiry should be conducted to prove his misconduct and the employee should be given an opportunity to be heard, wherein, upon occurrence of such scenario, the onus is on the employer to prove the misconduct of employee.

Discharging or dismissal of an employee on maternity leave or absence due to a physical disability tantamount to an illegal act by the Company is unlawful. Recently, Madras High Court imposed an injunction on the dismissal of an IT services company’s employee while she was absent on maternity leave.

As per the ID Act, Labour Courts or Industrial Tribunals depending upon their jurisdiction hear matters specified in the Schedules to the ID Act. For employment-related complaints relating to non-workmen, Civil Courts have jurisdiction to hear the complaints. Hon’ble Supreme Court have upheld that the employment in private sector is governed by the terms and conditions of employment, the public policy principles or administrative law principles do not apply to such private employment (Binny Ltd. & Anr. Vs. V. Sadasivan & Ors., (2005) 6 SCC 657).

When start-ups are developing their employment agreements, policies, employee hand-book it is worth the time of the founding team to ensure that the policies and agreements are as per various laws and cover the legal risks. Given below is a brief checklist (not comprehensive) that provides an overview of various legislations and consequences of non-compliances.

Be fair and do great!

Acts Section Liability of the employer Validity: period of continuous employment
Industrial Disputes Act, 1947 Section 25F 1 month’s notice in writing or wages in lieu + severance pay: 15 day’s average pay (for every completed year of service) one year to be calculated if six months of service have been completed in that year. for employees in continuous service for not less than 1 year 6 months or Rs. 1000 or both
Karnataka Shops & Establishments Act, 1961 Section 39 1 month’s notice in writing or wages in lieu (except in case of misconduct) for employees in continuous service for not less than 6 months employee has right to appeal ; Fine: Rs. 1000 for first offence and Rs. 2000 for a subsequent offence
Delhi Shops & Establishments Act, 1954 Section 30 1 month’s notice in writing or wages in lieu (except in case of misconduct) for employees in continuous service for not less than 3 months employee has right to appeal ;     Fine : Rs. 25-250
Bombay Shops & Establishments Act, 1948 Section 66 30 days notice in writing or wages in lieu (except in case of misconduct) for employees in continuous service for not less than 1 year employee has right to appeal ; Fine: Rs.1000 – Rs.5000
Bombay Shops & Establishments Act, 1948 Section 66 14 days notice in writing or wages in lieu (except in case of misconduct) for employees in continuous service for less than 1 year but more than 3 months award by court: reinstatement of employee or back wages
Employee’s State Insurance Act Rajiv Gandhi Shramik Kalyan Yojana ensure employee receives Unemployment Allowance after termination if he qualifies for ESI i.e. 50% of max wage up to 1 year, Medical care for self & family from ESI hospitals during that 1 year, Vocational training provided for upgrading skills (expenses on fee and traveling) all these expenses shall be borne by ESIC wage coverage: Rs. 15000/month N.A.
Payment of Gratuity Act Section 4 Payment of gratuity @ 15 days wages for every completed year of service for employees in continuous service for 5 or more than 5 years 6 months up to 2 years of imprisonment
Employee’s Provident Fund Act Section 17A and 17 (2B) (c ) credit/transfer the Provident Fund upon termination of employment N.A. 6 months and Rs. 5000
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