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Employer Compliance Related to Severance Pay in India

Shubhangi Jain

| Updated: Oct 03, 2022 | Category: Labour Compliance

Severance Pay in India

Every employer is mandated to comply with several labour compliance requirements, one of which is with regard to severance pay. It is one of the world’s most widely applied compensation or income support programs. But it is the least understood concept in India, exposing the employers to numerous legal and reputational risks due to unawareness about the prescribed termination provisions of employees and the severance pay entitled by the employees in respect of the same.

The article discusses the Employer Compliance related to Severance Pay in India to help the employer to be aware of the various compliance requirements associated with the same.

What is Severance Pay?

Severance Pay refers to the compensation provided by the employer to the employee in case of termination of their employment by reasons of retrenchment, layoff or mutual agreement.  

When does an employee become entitled to Severance Pay in India?

An employee is entitled to severance pay when he becomes “severed”, which occurs in the following circumstances.

  • Constructive dismissal of the employee by its employer followed by the response of the employee by resignation in the prescribed time frame
  • Layoff of the employee by the employer for 35 or more consecutive weeks
  • Termination of an employee due to bankruptcy or insolvency of the company.
  • Layoff of employees due to the permanent closure of the business.

 Key Considerations for Calculating Severance Pay

The severance package can vary depending on the company. However, specific considerations must be kept in mind by the employer while determining the severance package or calculating the severance.

  • Salary of the employee during the employment 
  • Duration of employment
  • Designation of the employee at the company
  • Performance
  • And other pertinent factors

The Formula for Calculation of Severance Pay in India

Severance Pay can be calculated using the below-mentioned formula –

Employee’s weekly salary] x [Number of weeks](Number of years) = Total severance allowance.

What are the Constituents of a Severance Package?

A severance package contains the following components 

  1. The remaining regular pay of the employee
  2. An additional payment based on months of service
  3. Payment for unused vacation or sick leave
  4. A payment in respect of the notice period
  5. Medical, life insurance or dental 
  6. Some employers offer continuation insurance benefits, not inclusive of payment of bills.
  7. Stock options
  8. Retirement benefits
  9. Unemployment benefits – if they were fired for reasons other than serious misconduct.

What is the Employer Compliance related to Severance Pay in India?

The major legislations dealing with employer compliance with severance pay in India are –

(Payment of Gratuity Act, 1972)

The Act lays down the provisions of severance pay, stating that the employer is obligated to make the payment for an amount to an employee being in the continuous service of a minimum of five years in the event of termination by his employer.

Section 4 of the Payment of Gratuity Act, 1972[1] prescribes the rate at which the severance pay must be calculated, which is of 15 days salary last drawn by a concerned employee.

Industrial Dispute Act, 1947  

This legislation mandates the employer to pay compensation for retrenchment to the employee. Section 25F (b) of the Act states that the employee is entitled to receive severance pay from their employer as per the prescribed calculation formula.

In a landmark judgement the in the landmark judgement of M/S Muller& PhillipLtd Vs K.C Subs, the Hon’ble Supreme Court of India observed that retrenchment compensation is given with the intention to provide relief from unexpected and sudden elimination of the employment of the workmen/employee.

The compensation to the employee has been retrenched and eliminated but not dismissed. Therefore, such employees have the right to claim an amount in the form of compensation or gratuity under the above-mentioned labour laws. This compensation or gratuity can be treated as Severance Pay in India.

Apart from the above-mentioned labour laws, the provisions of severance pay are incorporated in various other labour legislations as well, which are discussed below –

Severance Pay in Case of Contract Labourers and Migrant Workers

The contractor and employer of migrant workers are obligated to make the payment of such wages before the expiry of the 2nd day from the date of such termination.

The following sections of the various legislations deal with the severance pay of contract labourers and migrant workers-

  • Section 66 of CLRA 1975
  • Section 49 (2) of BOCW (Regulation Of Employment And Conditions Of Service) Rules, 2009
  • Section 29, U.P. Inter-State Migrant Workmen (Regulation of Employment and Conditions of Service) Rules, 1983. 

Payment of Gratuity to the Safety Officers 

Section 4 of the U.P. Factories (Safety Officers) Rules, 1984, provides that the safety officers of a factory and the officers of the corresponding status are entitled to receive gratuity from their employer.  

Severance Pay for Workmen 

There are certain provisions regarding the industrial workmen ‘s severance pay in India as enlisted below –

Section 13, U.P. Industrial Employment Model Standing Orders, 1991

The section provides the following rules regarding severance pay-

In case any establishment has a unit outside the current state where the workmen are employed, the employer is prohibited from transferring such workmen to another state without obtaining prior consent from the workmen. In the event of closure of the Section and department or department, the employer must discharge the workmen with such benefits as are admissible to them under the law for the time being in force.

The employer must note that if the unit or the section of the department so closed starts functioning again, the workmen, such displaced workmen, would be entitled to return to service in the order of seniority.

Section 6K, 6N, U.P. Industrial Disputes Act, 1947

 The provisions of severance pay in India as per these sections are –

When a workman (except for a substitute or a casual workman) having their name on the muster rolls of an industrial establishment or is in continuous service of more than one year under an employer is laid-off, he is entitled to receive compensation for the same by the employer. The compensation amount must be equal to 50% of the total of the basic wages and dearness allowance that would have been payable to him had he not been laid off.

The compensation must be paid for all days he is laid off except the weekly holidays between such periods.

However, the compensation payable to a workman during twelve months should not be for more than forty-five days despite the above provision.

If workmen are laid off for more than forty-five days, continuously or intermittently, during twelve months, the workman would be entitled to compensation at the underlined rate specified above.

Suppose the lay-off period continues for one week or more post expiry of the first forty-five days. In that case, the employer is obligated to pay the workmen compensation for all subsequent days and week(s), except in case of any agreement to the contrary between him and the employer.

There are certain circumstances regarding the retrenchment of a workman and payment of severance, which are highlighted below-

  • The employer must provide to the workmen a one month’s notice in writing indicating the reasons for such retrenchment or provide compensation in place of serving such notice only if there is the absence of an agreement specifying a date for the termination of service.
  • The severance pay must equal fifteen days’ average pay for every completed year of service or any part thereof in excess of six months.
  • The employer must serve a notice in this regard in the prescribed manner to the State Government. 

Case Laws Regarding Severance Pay

There are certain case laws regarding severance pay which are elaborated below –

 Lalappa Lingappa v. Laxmi Vishnu Textile Mills (All India Reporter 1981 Supreme Court 852). It was held that if the service of the employee is interrupted due to reason of sickness, leave, Lay-off, strike, lockout or cessation of work and not due to any fault of the employee, such absence must not be considered as a break in the continuity of service. Payment of gratuity is not applicable to an employee who has been dismissed from the service due to misconduct. or indiscipline 

In the case of  Babu Ram V. Phoenix Mills (1999) (1) (labour law Journal 2 58). The court observed that the petitioner’s service had been terminated by dismissal. Hence it cannot be said that he was in continuous servicefrom the date ofemployment to thedate of superannuation.

Manju Saxena Vs Union of India & Anr. 

The Supreme Court has reiterated if a workman voluntarily abandons his service, it would result in the ceasing of Section 25F of the IDA 194 and its applicability to the employee as he could not be considered to be in “continuous service” at the time of the retrenchment.

“Once the voluntary abandonment on the part of the employee from the service has been established, she couldn’t be considered to be in “continuous service” as u/s S. 2(oo) the I.D. Act, 1947.. The act would cease to apply on her”, the Court stated.

What are the Benefits of Severance Pay?

There are several benefits of severance pay, such as 

  • Avoidance of lawsuit as the employee has been provided severance pay instead of the termination
  • Protection of the company’s proprietary information as the employees are under the obligation of not disclosing the same
  • Enhancement of the goodwill of the company due to the fact that the payment of severance pay shall lead to employee satisfaction making the employee portray a good image of the company in the market
  • Improvement in the workplace culture as the existing employees shall be relieved by being adequately compensated in case of any termination removing the employees’ fear about any injustice by the employer.
  • Recruitment of qualified personnel as the proper provisions of severance pay enhances the brand image of a company, thereby attracting better employees.
  • Better Customer Retention can be achieved because a good brand image in the market can improve the company’s goodwill, thereby enhancing customer retention.

Conclusion

The unclarity about the concept of severance pay among the employers might be due to the fact that even after being a part of the statutory compliance under the labour legislations for a long time, it gained momentum after the outbreak of the Covid pandemic owing to numerous terminations during the time. Nonetheless, the fact remains that it is quite essential for the employer to be aware of compliance requirements regarding severance pay to avoid any further legal complexities.  

Read our Article: Industrial Relations Code Bill 2019: an overview

Shubhangi Jain

Shubhangi has completed her B. A.LLB (H) with specialization in Business Laws from Amity University. She is particularly interested in legal research and writing and wishes to utilize her knowledge to create informative legal content. She has prior experience in corporate and criminal litigation and has great drafting skills. She has also published various research papers in reputed journals.

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