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February 20th, 2013
Was $70,000 Salary Reduction a “Constructive Termination” - or Did Employee Resign?
A recent federal appeals court decision on severance offers important guidance for employers and employees. In Scott v. Harris Interactive Inc., the executive's written agreement called for a starting salary of $220,000 and 6 months' severance on termination by the company without cause. Unhappy with the executive's performance, the company reduced the executive's duties, dropped his salary to $150,000, and changed his title. The executive resigned and demanded severance benefits but the company refused.
The executive sued the company in federal court in New York. He claimed the company's "unilateral removal of [his] job duties, change in his title, and $70,000 reduction in his salary were intolerable changes to [his] working conditions such that [the company] constructively discharged [him] from his employment." Among other things, the executive sought six months of salary, six months of continued healthcare benefits, and attorneys' fees and costs.
The trial court dismissed the case. It held that the employer "had the right to propose a prospective modification of the employment contract unilaterally" and that the executive "impliedly agreed to the proposed modification by continuing to work..." The trial court said the reduced salary and other changes "do not come close to establishing a constructive discharge." The trial court noted that a $150,000 salary compared favorably with the current salaries of US District Court Judges, US Senators and Members of the House of Representatives ($174,000 per year); US Magistrate Judges ($160,080 per year); and military personnel below two-star generals with 15 years of service (all of whom earn less than $150,000 per year in base pay) (citations omitted).
But the appeals court reversed the decision and ordered a trial: "The question of discharge versus resignation cannot be resolved simply by concluding ... that the reduced amount compares favorably to the earnings of other accomplished persons in the national workforce." The appeals court noted that "the reasonable expectations of the parties are also relevant" to the question whether an employee "was forced into an involuntary resignation."
What the decision means. In light of this important ruling, employers and employees should discuss with counsel the possibility that a salary decrease (or percentage decrease) may lead to a "constructive termination" under an employment contract. Doing so could go a long way to avoiding the cost and uncertainty of a litigation like this one.
If you have any questions about this decision, or about other employment and executive compensation issues, contact Gavin McElroy or any other member of the Executive Compensation and Employment Group at Frankfurt Kurnit Klein & Selz.
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