Employee Compensation During Layoffs, Retrenchment, and Business Restructuring in India

Business restructuring, mergers and acquisitions, automation, cost optimization, and changing market conditions frequently require employers to reorganize their workforce. These business decisions may result in temporary lay-offs, retrenchment, closure of operations, transfer of business, or negotiated employee exits.

A common misconception is that all financial compensation paid upon termination is governed by a single labor law. Under India’s labor codes, however, employee payments are regulated under two distinct statutes:

1. The Industrial Relations Code, 2020 (IR Code) governs compensation arising from workforce restructuring, including layoffs, retrenchment, closure, and transfer of undertakings.
2. The Code on Social Security, 2020 (SS Code) governs statutory employment benefits such as gratuity, provident fund (PF), employees’ state insurance (ESI), maternity benefit, and compensation for employment injuries.

Understanding the distinction is essential because the IR Code primarily protects workers, while the SS Code extends several benefits to a broader category of employees, including many managerial personnel.

Industrial Relations Code: Compensation to employees

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The IR Code regulates compensation payable when employment is affected because of business decisions such as downsizing, redundancy, closure, or operational disruptions.

Unlike the SS Code, these payments are not employment benefits accrued over time. They arise only when specific employment events occur.

Layoff compensation

A layoff refers to the employer’s temporary inability to provide work due to reasons such as a shortage of raw materials, power shortages, machinery breakdown, accumulation of inventory, natural calamities, or other connected operational reasons.

Eligible workers with at least one year of continuous service are entitled to compensation equal to 50 percent of basic wages plus dearness allowance for every day of lay-off (excluding weekly holidays).

However, compensation is not payable where workers refuse suitable alternative employment, fail to report for work, or where the lay-off results from certain specified circumstances under the Code.

Retrenchment compensation

Retrenchment refers to termination initiated by the employer for reasons other than disciplinary action.

Before retrenching an eligible worker, an employer must provide one month’s written notice or wages in lieu of notice, pay retrenchment compensation, and notify the appropriate government authority.

The statutory compensation equals 15 days’ average pay for every completed year of continuous service or part thereof exceeding six months.

IR Code also incorporates procedural safeguards, including the “last-in, first-out” principle and preferential re-employment of retrenched workers where recruitment occurs within one year.

Importantly, expiry of a fixed-term employment contract is not treated as retrenchment under the IR Code.

Closure compensation

Where an undertaking permanently closes, eligible workers with at least one year of continuous service are generally entitled to compensation equivalent to retrenchment compensation.

If closure results from unavoidable circumstances beyond the employer’s control, compensation may be limited to three months’ average pay. However, the Code expressly excludes financial losses, business difficulties, accumulation of unsold stock, expiry of licenses or leases, and certain other commercial reasons from being treated as unavoidable circumstances.

Transfer of business

Where ownership or management of an undertaking changes, workers are generally entitled to retrenchment compensation unless:

• Employment continues without interruption
• Service conditions remain no less favourable
• The new employer assumes liability for future retrenchment compensation.

Gratuity is not retrenchment compensation

Gratuity is frequently confused with retrenchment compensation because both may use a similar calculation methodology.

However, they arise under different laws and serve different purposes.

Retrenchment compensation under the IR Code compensates eligible workers for involuntary job loss arising from workforce reduction.

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Gratuity under the SS Code rewards long and continuous service and becomes payable when statutory eligibility conditions are satisfied, regardless of whether employment ends due to resignation, retirement, retrenchment, death, disability, or expiry of an eligible fixed-term contract.

For fixed-term employees, the Draft Model Standing Orders for the service sector clarify that completion of the contractual tenure does not constitute retrenchment under the IR Code. Nevertheless, such employees remain eligible for gratuity under the SS Code if they satisfy the statutory conditions. This distinction reinforces that gratuity and retrenchment compensation are separate legal entitlements rather than interchangeable payments.

CLICK HERE: India Gratuity Rules: Calculation, Tax Treatment, Compliance

Which employees are covered for financial compensation?

The scope and applicability of the two codes differ widely. For instance, the IR Code grants statutory lay-off and retrenchment protections only to individuals classified as workers.

The definition generally includes employees performing the following tasks:

• Manual work
• Technical work
• Operational work
• Skilled or semi-skilled work
• Clerical work
• Certain supervisory functions

However, it expressly excludes persons employed mainly in managerial capacity, administrative capacity, and supervisory positions above the prescribed wage threshold.

Consequently, many corporate managers, department heads, senior executives, and directors are outside the statutory retrenchment compensation framework.

The SS Code, by contrast, applies many of its benefits, including gratuity, to the broader category of employees, meaning managerial personnel are generally eligible for gratuity, provident fund, and other applicable SS benefits where statutory conditions are met.

Workforce restructuring: Different compensation obligations under each code

Employers undertaking restructuring exercises should separately assess employee compensation for layoff and retrenchment obligations under both labor codes.

In the IR Code, employers must determine whether the restructuring constitutes a layoff, retrenchment, closure, or transfer of undertaking and whether the affected individuals qualify as workers entitled to statutory compensation.

Under the SS Code, employers must evaluate statutory obligations relating to gratuity, provident fund, employees’ state insurance, employee compensation, and other applicable SS benefits, irrespective of whether retrenchment compensation is payable.

For managerial employees, severance packages are generally governed by employment contracts, appointment letters, company HR policies, or negotiated settlement agreements rather than the IR Code.

Employer checklist: Calculating employee compensation for layoff and retrenchment

Before implementing layoffs or retrenchment, employers should first determine whether the affected individual qualifies as a worker under the IR Code, as statutory layoff and retrenchment compensation generally applies only to workers with at least one year of continuous service.

Compensation should be calculated as follows:

1. Lay-off compensation: 50 percent of the worker’s basic wages plus dearness allowance for each day of lay-off (excluding weekly holidays).
2. Retrenchment compensation: 15 days’ average pay for every completed year of continuous service or any part thereof exceeding six months.
3. Closure compensation: Generally equivalent to retrenchment compensation, unless the limited statutory exception for unavoidable circumstances applies.

In addition to retrenchment compensation, employers should separately assess statutory obligations relating to gratuity, provident fund, leave encashment, unpaid wages, bonuses, and other contractual or statutory dues, as these are governed under different laws.

Key takeaways on employee compensation for layoff and retrenchment

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India’s labor codes distinguish between compensation arising from employment termination and benefits arising from SS legislation.

The IR Code governs statutory compensation payable to eligible workers affected by lay-offs, retrenchment, closure, or transfer of undertakings. The Code on SS governs employment benefits such as gratuity, provident fund, employees’ state insurance, and other SS entitlements.

For employers planning workforce restructuring, compliance requires evaluating obligations under both Codes separately. While workers may be entitled to statutory retrenchment or lay-off compensation under the IR Code, managerial employees generally rely on contractual severance arrangements, although they continue to remain eligible for applicable SS benefits, including gratuity, under the SS Code.

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