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Downsizing Matters

August 19, 2019 News

To hedge against the risks of downsizing, a company may adopt and incorporate into its business protocol certain protective measures which include, but are not limited to, the following: (1) developing and following comprehensive and even-handed policies concerning the evaluation, monitoring and termination of employees; (2) pursuing severance agreements by and between the company and an employee who is terminated; and/or (3) purchasing an Employment Practices Liability Insurance (EPLI) policy. Each of these is discussed briefly below.

Company Policies Relevant to Evaluation, Monitoring and Terminating Employees

Company employees should be on a level playing field with one another, each equipped with a basic understanding of the rules that apply to all. Fair and equitable treatment of employees is paramount. A company should be aware that there are federal and state laws that afford guarantees against discrimination to certain individuals who fall within “protected classes.” Under these laws, it is illegal for private companies to discriminate against certain individuals with regard to any aspect of employment, including the training, monitoring, evaluating and firing of employees.

For instance, Title VII of the Civil Rights Act of 1964 (“Title VII”) prohibits employment discrimination based on race, color, religion, gender, or national origin; the Americans with Disabilities Act of 1990 (“ADA”) prohibits employment discrimination against qualified individuals with disabilities, and the Age Discrimination in Employment Act of 1967 (“ADEA”) protects individuals who are forty years of age or older against employment discrimination. Title VII and the ADA cover all private employers that employ fifteen or more individuals, while the ADEA covers all private employers with twenty or more employees. In addition to these federal laws, individual states have enacted statutes to protect against employment discrimination that is comparable, but not always identical, to the federal laws (e.g., no federal law currently protects against discrimination based on sexual orientation but a large number of states have enacted laws that do). Employers need to be aware of the state and federal laws that impact their employment practices and then customize their policies accordingly.

A company that fails to treat its employees fairly leaves itself vulnerable to legal attacks by employees who have been discharged. Defending against these attacks is expensive and time-consuming, and, frankly, could minimize any cost-savings that the company may have sought to achieve by downsizing. Even if a lawsuit is never filed, defending against an administrative charge of discrimination can be very onerous for an employer. The federal laws against employment discrimination are enforced by the U.S. Equal Employment Opportunity Commission (the “EEOC”), and the state laws are enforced by similar state agencies. Any individual who believes that his or her employment rights have been violated may file a charge of discrimination with the EEOC or state agency, and all administrative remedies must be exhausted before a private lawsuit may be filed in court.

The meter starts to run against the employer the minute a discharged employee files a charge with the EEOC or state agency. For instance, as part of an EEOC investigation, a company will bear the expense of submitting a “statement of position” (telling the company’s side of the story), responding to requests for information (producing copies of personnel policies, the fired employee’s files, the personnel files of other individuals, and any other relevant information), permitting on-site visits, and making employees available for witness interviews.

The company will likely continue to incur costs even after the agency investigation ends. If the EEOC determines that there is no reasonable cause to believe that discrimination occurred, which is often the case, then the fired employee may still file a lawsuit against the company. If, however, the EEOC finds that discrimination occurred, then the parties are invited to resolve the dispute through an informal process known as “conciliation.” The conciliation process works much like mediation and provides an opportunity to resolve the employee’s claim before legal and administrative costs become more burdensome. Where conciliation fails, the EEOC has the authority to enforce violations of its statutes by filing a lawsuit in federal court and, in essence, litigating the matter for the employee. If the EEOC decides not to litigate, the employee may file his or her own suit in federal court. Damages for employment discrimination include compensatory damages, costs, attorney’s fees, expert fees, and punitive damages.

A company is better positioned to avoid and/or defeat employment discrimination claims if it can demonstrate the measures it has taken to treat all employees fairly. Written personnel policies delineating the rules of employment tend to show that the company has uniform expectations for all employees. Each employee’s personnel file should contain written evaluations, attendance records, complaints, reprimands, and other materials that bear on the overall effectiveness and performance of the employee. Further, a company may benefit from creating, and strictly following, a protocol for terminating employees. In sum, on all employment issues — especially those concerning the termination of an employee — a company should be aware that it may one day need to prove in an administrative proceeding, or in court, that the employee was treated fairly and terminated for legally appropriate reasons.

Severance Agreements

When a company suspects that an employee may have cause to file an administrative claim and/or lawsuit, it may attempt to resolve the matter preemptively through a confidential severance agreement. These agreements may be used to eliminate bad employees who should be terminated and other employees who are being let go for economic reasons. Severance agreements commonly memorialize the terminated employee’s relinquishment of all legal rights against the company in exchange for money. As further consideration for payment of severance, the employee may be required to refrain from making disparaging remarks about the company, its employees, directors and managers to either the public or media. Severance agreements take many forms and are usually tailored to the circumstances existing between a particular company and a particular employee.

Severance agreements mitigate the risks of laying off an employee upfront. The motivating force behind many claims and lawsuits is a need for money. When an employee is terminated, particularly in the current economic climate, the employee may be in a position where there is little downside to making an employment claim. The sums to be paid by the company under a severance agreement can range from a few week’s salaries or wages to several months of pay. The benefits of severance agreements are a certainty, elimination of bad employees, and leaving a positive impression on former employees who may eventually return to work for the company.

Employment Practices Liability Insurance (EPLI)

To further insulate itself against the risk of paying employment discrimination claims, a company may choose to purchase an EPLI policy, which provides coverage for many types of employment-related claims including, but not limited to, sexual harassment, discrimination, wrongful termination, deprivation of career opportunity, retaliatory treatment of employees, failure to adopt adequate workplace policies, and negligent hiring. Additionally, some EPLI policies actually insure against punitive damages (if allowed under state law). Coverages afforded under EPLI and Comprehensive General Liability (CGL) policies are not the same. The most important difference between the two types of policies, and the main reason for the development of the EPLI policy, is that most CGL policies contain employment-related exclusions. Therefore, employers who have only standard CGL policies are likely to be left holding the bag when employment-related administrative claims and lawsuits are filed against them.

EPLI coverage may be purchased as stand-alone policies or through endorsements to Directors and Officers (D & O) coverage. Most EPLI policies are claims-made policies, under which coverage is conditioned on a claim being asserted against the insured during the actual policy period. Further, most EPLI policies limit their coverage for defense and indemnity to a single policy total, rather than one policy limit for indemnity and another separate policy limit for defense. Consequently, if a company is susceptible to high-value claims, it is extremely important to ensure that the company has high coverage limits to prevent defense costs from eroding the available indemnity limit. EPLI policies typically cover claims against the insured company and its directors, officers, and employees. However, the definition of “employee” can vary from policy to policy.

Additionally, EPLI policies commonly contain “intentional acts” exclusions, which significantly impact the breadth of coverage afforded under the policies. In considering a claim of racial discrimination in 2005, the United States Fifth Circuit Court of Appeals held that racial discrimination can be either intentional or unintentional. Accordingly, if an EPLI policy provides coverage for wrongful acts and excludes intentional wrongful acts, a claim for intentional discrimination could be excluded under the policy. The Fifth Circuit noted:

It is well settled that claims for racial discrimination may allege either ‘intentional’ or ‘unintentional’ acts. Specifically, ‘[i]n the context of Title VII litigation, we recognize two types of discrimination claims: disparate treatment and disparate impact.’ ‘Disparate treatment refers to deliberate discrimination in the terms or conditions of employment,’ whereas disparate impact claims ‘does not require proof of intent to discriminate.’ As written, the policy can readily be interpreted to extend coverage for claims alleging disparate impact discrimination while excluding coverage for disparate treatment discrimination.

Coleman v. Sch. Bd. of Richland Parish, 418 F.3d 511, 520-21 (5th Cir. 2005). Therefore, a company should attempt to procure broader coverage and be careful not to rely on its EPLI policy as a catchall for every type of employment-related claim that it may face.


According to statistics published by the EEOC, as the U.S. economic climate has worsened, the number of administrative claims for employment discrimination has grown significantly, and the number of employment-related lawsuits has remained high. These claims are costly to defend and may result in substantial awards against employers. With these things in mind, companies should continue to contemplate the potential risks of downsizing. With enough thought and preparation, future employment-related costs can be reduced.