Downsizing: Common Sense in Decision-Making May Lead to a Trap

Authored by Steve Holden and Larry Ball. Published in the Sacramento Business Journal October 2011.

In today’s economy, many companies have been forced to downsize their workforce in order to cut costs.  Common sense would indicate that terminating the employees with the highest salaries might be the best method for dealing with the economic reality.  Cutting those with the highest salaries may make it possible to save more jobs.

When one California company recently faced this situation, it determined that the most cost effective and simplest method would be to terminate the highest paid employee in each of its four departments. The company did not use any additional criteria in making its decision to layoff the four employees, who just all happened to be over 40 years of age.  The workload of the laid off employees was absorbed by the younger, existing employees that worked for less pay.  The company did not realize that using salary as the sole basis for terminating the employees would subject it to age discrimination claims under California’s Fair Employment and Housing Act (“FEHA”).

Both the federal Age Discrimination in Employment Act (“ADEA”) and the FEHA prohibit an employer from discriminating against employees who have reached their 40th birthday.  The FEHA, however, provides greater protection and broader remedies than the ADEA.  The FEHA prohibits discrimination in salary, employment benefits and other “terms and conditions of employment” and permits emotional distress damages, punitive damages and has no statutory limit on damage awards.

An employee may establish an age discrimination claim under both the ADEA and the FEHA by showing that the employer engaged in disparate treatment (intentional discrimination) or that the employer’s action had a disparate impact (a facially neutral policy that adversely impacts older employees).  Under the ADEA, however, an employer can defeat an age discrimination claim by showing that the employee was terminated based on reasonable factors other than age, so long as the reasonable factors were not a pretext for intentional discrimination.  This is not so under the FEHA, which affords employees more protections than its federal counterpart.

The California Court of Appeals held in Marks v. Loral Corp., that employers were permitted to layoff those employees with higher salaries, even if it meant that younger employees would be retained in their place with a disparate impact on the older workers.  The California State Legislature responded by rejecting the Marks v. Loral Corp. decision.  The Legislature adopted a broad disparate impact theory of liability when it passed California Government Code Section 12941.1 (later renumbered 12941).  That section states “the use of salary as the basis for differentiating between employees when terminating employment may be found to constitute age discrimination if using that criterion adversely impacts older workers as a group, and [the Legislature] declares its intent that the disparate impact theory of proof may be used in claims of age discrimination.”

You may be wondering, “What does terminating the highest paid employees have to do with age discrimination if the company is doing it for economic reasons?”  Under the FEHA, downsizing alone may not be an adequate justification for the termination of age-protected employees.  Just because a company’s reduction in force decision was necessary for economic reasons does not mean that the company refrained from engaging in age discrimination in its criteria for selecting which employees to layoff.  While the economic reasons for the terminations may have no relation to a discriminatory motive, using salary alone may have a disparate impact on the older employees as a group and discriminatory motive is not required under a disparate impact theory of liability.

What does this mean for the company that decided to terminate the highest paid employee in each of its four departments?  It means that to establish a prima facie case of age discrimination using the disparate impact theory, the terminated employees’ only need to show that the company’s use of salary as the sole criteria in choosing who to layoff impacted the older workers as a group.

The company will also have a greater obstacle to overcome the employees’ age discrimination claims under the FEHA than it would under the ADEA.  Under the ADEA, the use of salary criteria would most likely satisfy the “reasonable factor other than age” defense.  Under the FEHA the company must prove that there exists an overriding legitimate business purpose such that using salary as the criteria is necessary for the safe and efficient operation of the business and that the salary criteria fulfills the business purpose it is supposed to serve.  Even if the company is able to prove this, the use of salary as the criteria for a termination decision may still be impermissible if there exists an alternative practice which would accomplish the business purpose equally well with a less discriminatory impact.

To avoid age discrimination liability when downsizing, employers should scrutinize the business purpose for the layoffs, carefully document the business justifications, carefully select the criteria used for choosing which employees to layoff and make sure the criteria used meets the employers business reason for downsizing.  Employers should also avoid using salary as sole basis for determining which employees to layoff and ensure that the legitimate business purpose for selecting the employees to layoff does not adversely impact older workers as a group