What Is the Retrenchment Compensation That Companies Must Pay?

Retrenchment compensation is a legal requirement under Indian labor laws, particularly the Industrial Disputes Act, 1947, for employees who are retrenched due to redundancy, company closure, or other financial reasons. Retrenchment compensation is designed to provide financial security to employees who lose their jobs due to factors beyond their control.

Retrenchment Compensation Under the Industrial Disputes Act, 1947:

Eligibility for Retrenchment Compensation:

Employees Covered: Employees who have been employed for more than 240 days in the last 12 months are eligible for retrenchment compensation under the Industrial Disputes Act. This provision applies to employees working in factories or industrial establishments, as well as certain other workplaces.

Conditions: The retrenchment must not be due to misconduct, disciplinary action, or voluntary resignation. The termination must be for reasons such as redundancy, business closure, or restructuring.

Amount of Retrenchment Compensation:

Calculation Formula:

The retrenchment compensation is calculated as follows:

Retrenchment Compensation = (15 days’ wages) × (Years of Service)

15 Days’ Wages:

The employee is entitled to 15 days' wages for each completed year of service.

Years of Service:

The total number of years worked by the employee in the company. If the employee has worked for less than a year, the compensation is calculated on a pro-rata basis.

Wages for Calculation:

The compensation is based on the average wages the employee earned in the last three months before retrenchment. Wages include basic salary, allowances, and any other regular earnings but exclude bonuses or one-time payments.

Example:

If an employee has worked for 5 years in a company and their monthly wage is ₹30,000, the retrenchment compensation would be:

• Daily Wage: ₹30,000 / 30 days = ₹1,000
• 15 Days’ Wages: ₹1,000 × 15 = ₹15,000
• Total Retrenchment Compensation: ₹15,000 × 5 years = ₹75,000

Notice and Compensation in Lieu of Notice:

Notice Period:

The employer must give one month’s notice before retrenching an employee or pay compensation in lieu of notice.

Payment in Lieu of Notice:

If the employer does not provide notice, they must pay the equivalent of one month’s wages to the retrenched employee.

Severance and Additional Entitlements:

Other Dues:

The employee is also entitled to any unpaid dues, such as earned leave, gratuity (if applicable), or any bonuses that may be due to them.

Gratuity:

Employees who have worked for 5 years or more may also be entitled to gratuity under the Payment of Gratuity Act, 1972. This is a separate entitlement from retrenchment compensation and is calculated based on 15 days of wages for every year of service.

Procedure for Retrenchment:

Government Approval:

In establishments with more than 100 employees, retrenchment cannot occur without the approval of the appropriate government (central or state). The employer must seek approval before proceeding with retrenchment.

Last in First Out (LIFO):

The employer must follow the LIFO (last in, first out) rule when retrenching employees, i.e., employees who joined last should be the first to be retrenched. However, employers may also choose based on factors such as seniority or skill, provided the decision is justified.

Reemployment and Right of Reentry:

If the employer hires new employees within one year after retrenching workers, retrenched employees have the right to be reemployed on a priority basis.

Reemployment Priority:

If the company resumes hiring, retrenched employees must be given preference for reemployment.

Exemptions:

Employees on Temporary or Casual Basis:

Employees hired on a temporary or casual basis, or those with less than 240 days of service, may not be eligible for retrenchment compensation under the Industrial Disputes Act.

Employees on Fixed-Term Contracts:

If an employee has a fixed-term contract, retrenchment compensation may not apply unless otherwise specified in the contract.

Example:

A factory has to retrench an employee who has worked for 3 years with a monthly wage of ₹20,000. The retrenchment compensation will be calculated as:

• Daily Wage: ₹20,000 / 30 days = ₹666.67
• 15 Days’ Wages: ₹666.67 × 15 = ₹10,000
• Total Retrenchment Compensation: ₹10,000 × 3 years = ₹30,000

In addition, the employer must provide a one-month notice or pay ₹20,000 as compensation in lieu of notice.

Conclusion:

Retrenchment compensation ensures that employees who lose their jobs due to factors like redundancy or business closure are financially supported during the transition. Under the Industrial Disputes Act, companies are legally required to pay 15 days' wages for each completed year of service to retrenched employees, along with any applicable severance pay, notice period compensation, and unpaid dues. Both employers and employees must understand these provisions to ensure compliance with labor laws and protect their respective rights during retrenchment processes.