Legal Framework and Mitigating Risks Associated with Employee Downsizing in India SMM

Over the past couple of months, India Inc. has seen a spurt in employee downsizing, loosely termed as layoff. The impact is felt more prominently in the start-up sector where, in the face of reduced funding, there has been a significant cutback in the number of employees. The downsizing is done in a bid to save costs associated with employee expenses and to increase business profits.

However, India is still largely an employee friendly jurisdiction, with various legislations protecting the rights of employees. Termination of employment is strictly regulated under robust and complex labour laws. Therefore, to ensure a smooth exit of employees with minimum risk of future litigation, it is important to not only understand the laws surrounding termination of employment in India, but also the strategic avenues available to effect a downsizing.


By way of a general background, employees in India can primarily be divided into two categories, namely: (i) ‘workmen’ as defined under the Industrial Disputes Act, 1947 (“IDA”); and (ii) rest of the employees, generically referred to as non-workmen.

Usually it is assumed that only blue-collar employees, typically working on factory floors, are regarded as workmen. However, whether an employee is a workman or not has to be ascertained through multi-factor tests, such as the nature of duties, designation and reporting structure. The reason this distinction is of utmost importance is because, ordinarily, workmen are afforded a greater degree of legal protection and benefits under Indian labour laws. Particularly, the employment of workmen cannot be terminated other than in accordance with the provisions of the IDA. The IDA requires at least a month’s notice of termination (or pay in lieu thereof) to be issued to the workmen, together with the payment of a severance compensation (termed as ‘retrenchment compensation’). Employers are also required to submit an intimation of such retrenchment to the appropriate government.

The legal framework is more complicated for factories, mines and plantations which employ more than a prescribed number of workmen, typically ranging between 100 and 300 workmen across various states. Such units are required to obtain prior permission of the appropriate government before effecting a termination of employment of workmen. While the IDA is a central legislation with pan India application, various states have felt the need to amend it and the same must also be considered.

As compared to workmen, non-workmen are primarily regulated under their employment contracts and internal policies, subject to the state-specific Shops and Establishments Acts (“S&E Acts”), if applicable.  However, it is important to note that since the S&E Acts also apply to workmen, the employer will be additionally required to comply with the termination-related provisions contained therein. An employee eligible to seek protection under both the IDA and the local S&E Act can enforce his rights under either of the two statutes. The S&E Acts typically require one month’s prior notice (or pay in lieu thereof) for termination to be issued. However, some states also require for a ‘reasonable reason’ to be cited in order to effect a valid termination of employment, while others also require notice/intimation to be provided to labour authorities and payment of severance compensation to employees. Certain S&E Acts, however, exempt, inter alia, management and/or supervisory employees from their purview. Termination of such category of employees will be governed solely by their employment contracts and the internal policies of the company.

Another key aspect to note is that the legislations set out above are the minimum standards that are required to be met/followed in effecting a termination of employment. In the event the employment agreements or company policies provide for better benefits, the same would have to be followed.


In addition to the termination conditions discussed above, the principle of last-in-first-out rule (“LIFO Rule”) would also have to be followed in respect of workmen. This essentially means that the employer should retrench the workman who was the last person to be employed in that category. Employers can deviate from the LIFO Rule only where they can justify this on reasonable grounds and such reasons are recorded in writing.


Keeping the above laws and legal processes in mind, effecting a unilateral termination of employment may not always be the most practical step. The problem may be further complicated in organisations with trade unions (although employees often sign up with external trade unions, often with political backing) where the employees may resort to strikes or drag the employer to the relevant court to challenge the termination.

Many employers give their employees an option to resign as termination is more stigmatic.  However, there is legal risk for employers at a later date if employees claim that they were forced to resign. Indian courts often require employers to pay backwages (and in some cases order reinstatement) in case of forced resignations.

The other option for the employer and the employees is to enter into a mutual agreement to sever their relationship by way of executing a mutual separation agreement (“MSA”). The MSA typically provides for inter alia payment of a mutually agreed severance package/ex-gratia amount to the employees, in addition to all statutory and contractual dues. In return, the employees release the employer from any past and future claims arising from their employer-employee relationship. There are various factors to consider while determining the severance package/ex-gratia amount, however, at a minimum it must be equal to the retrenchment compensation amount.

A similar option would be to float a voluntary retirement scheme (“VRS”), by way of which employees are allowed to retire before their retirement age. The VRS offers an ex-gratia sum in addition to statutory and contractual dues. Various strategies may be used to incentivise employees to sign up to the VRS (such as an additional amount if a certain percentage of employees sign up within a specified date, early bird offers etc).

While the MSA and VRS routes may seem expensive, once you consider the retrenchment compensation amount that is included in the ex-gratia amount, the delta may not seem that significant. Both these options minimise the risk of the termination of employment being challenged in court.

The success of any downsizing exercise also depends on the way employee sentiment as well as the inherent reputational risk have been handled. A robust strategy in this regard is usually drawn up by the legal and HR teams to ensure that not only does the downsizing process go smoothly, but also that the company is prepared to handle any eventualities, be it a strike, negative publicity etc.

While the recent trend of downsizing seems to be picking up amidst the growing need for businesses to improve their margins, the importance of awareness relating to laws relating to termination can ensure that the process is being done smoothly and in a lawful manner.