As businesses, federal, state, and local governments adopt mitigation measures resulting from the coronavirus crisis, many companies are looking at all available cost-cutting options. Among the austerity measures under consideration are pay cuts and benefit reductions for executives and others employed under employment agreements.
Implementation of salary and hourly wage reductions require businesses to consider more than whose pay should be cut and by how much. In making changes, businesses must remain compliant with federal, state, and local wage and hour laws, EEO laws, contractual notice and consent requirements and tax laws and regulations.
Wage and Hour Issues
With limited exceptions, all employees are entitled to be paid a minimum wage for work performed during a particular workweek. This minimum wage requirement applies both to exempt and non-exempt employees. With the exception of a limited class of small business owners, the Fair Labor Standards Act does not permit employees, regardless of level of compensation, to work for free, even if the employee offers to do so voluntarily. If an executive’s compensation is cut to zero, that can only be accomplished by having the executive go on unpaid leave.
Do Changes to Compensation or Other Conditions Trigger “Good Reason” Severance Rights?
For an employee with an employment agreement, the employer’s right to unilaterally cut his or her pay will be dependent on the language of the agreement. For example, if the agreement states that the employee’s base salary will be “no less than” a certain annualized amount, involuntary reduction of the salary puts the employer in breach of that agreement, unless the agreement otherwise confers on the employer the discretion to reduce the compensation or the employee consents to the change.
Many executive employment agreements provide employees with severance rights in the event the employee resigns for Good Reason. Good Reason to resign nearly always includes, by definition, a “material diminution in the employee’s base salary.” Although some agreements provide an exception for across-the-board salary reductions for one or more classes of employees, without such an exception or a written waiver of “good reason” by the affected employee, a reduction of pay may trigger severance compensation liability (subject to an employer’s right to notice and cure).
If the Executive agrees to a temporary or permanent reduction in compensation or other changes to his or her contractual rights, that consent must be properly documented in a signed amendment or waiver.
Tax Considerations
Businesses also must be careful in implementing reductions in compensation that promise, guarantee, or otherwise create an expectation that the executive will be made whole at a later point in time. Such an arrangement could constitute a deferral of compensation that does not meet a recognized exemption under Section 409A of the Internal Revenue Code. A 409A violation subjects the executive to serious adverse tax consequences. Employers and executives should always consult with their attorneys, accountants, or executive compensation consultants before amending their executive employment agreements, obtaining waivers, or putting any such plan into place.
