In 2022-23 the Tech Industry saw mass layoffs. Indian Directors have a duty to employees and are responsible for monitoring hiring and firing.
Table of Contents
- Introduction
- Hyman Minsky
- Something Went Wrong
- Business Judgement Rule
- Ticked-Off Shareholders
- Pissed-Off Employees
- Socialism v. Capitalism
- Lessons from Caremark, Marchand and Centro
- Best Practices
Introduction
In January 2023, Marc Benioff the CEO of Salesforce, announced that the company would layoff over 10% of its global workforce. At the time he said:
“I’ve been thinking a lot about how we came to this moment. As our revenue accelerated through the pandemic, we hired too many people leading into this economic downturn we’re now facing, and I take responsibility for that.” [1]
Perhaps none of the laid-off or to-be-laid-off Salesforce workers will give Benioff any credit for his honest assessment – 10% of a global workforce is a massive number whether you look at it in absolute or relative terms.
Benioff was not the only Tech CEO who apologised for mass layoffs. Sundar Pichai, the CEO of Google, issued a public letter to Google employees in January 2023 announcing layoffs of 12,000 workers across Google offices. He also analysed the reason for the sudden and massive layoff as over-exuberant hiring during the pandemic which led to being caught off guard by the subsequent economic downturn. [2]
In fact the whole of the Tech industry has followed suit with mass layoffs in 2023. India’s Tech sector has not been spared either. There are estimates that over 20,000 Tech workers have been laid off primarily by startups since the start of 2022. [3]
Hyman Minsky
The argument seems to be that during the pandemic the Tech sector took advantage of easy stimulus money to ramp-up hiring but didn’t expect the abrupt economic downturn of 2022-23 which necessitated cost rationalisation.
This is a bizarre argument. The existence of business cycles is well-known. Hyman Minsky, an American economist, propounded one of the most famous frameworks to describe how business downturns happen. In an article on Minsky, the BBC paraphrased his theory [4] as:
“He believed that during periods of economic stability, banks, firms and other economic agents become complacent. They assume that the good times will keep on going and begin to take ever greater risks in pursuit of profit. So the seeds of the next crisis are sown in the good time.”
Minsky’s idea certainly seems to apply to the global Tech sector which believed that the good times would keep going and took massive risks in the form of unconstrained hiring.
However, this article will not analyse the substance of the layoffs themselves which is best left to businessmen, legislators and regulators. From the legal point of view, the right question to ask is – Is there a liability? Who owes it? To whom is the liability owed?
Something Went Wrong
Despite Benioff’s and Pichai’s ‘mea culpas’ any layperson would acknowledge that something went wrong in the Tech sector. Firing double-digit percentages of your workforce or workers in the thousands is nothing short of a disaster. There are some significant ramifications for any company that does mass layoffs:
- Large one-time severance costs
- Reputational damage
- Reduced survivor morale and faith in employer
- Reduced faith in Management
- Increased risk of litigation
- Increased risk of regulatory oversight
- Increased risk of competitors taking up disgruntled former employees
A Latin maxim that fundamentally underpins much of legal thinking is ‘ubi jus ibi remedium’ i.e. where a right has been violated, the law provides a remedy. Based on the ramifications listed above, there are clearly several rights that were violated by mass layoffs.
Therefore, there does seem to be some sort of liability as a result of mass layoffs.
Business Judgement Rule
As discussed above, mass layoffs hurt the laid-off employees, the company and shareholders. There is certainty that mass layoffs create a liability. However, who owes the liability and to whom are tougher questions to answer.
The ‘Business Judgement’ rule that we discussed in an earlier article (“Directors Beware article”) is followed across the world. In short, this rule means that employees who have acted in good faith and with due care for their employer cannot be held at fault for the consequences of their actions. This obviously applies to Senior Management.
As discussed in the earlier article, the Business Judgement rule is a high bar for a litigant to overcome. As an example, if a litigant sued a Tech CEO, said CEO could simply point to his peers in the industry and argue that as the exuberant hiring and later firing of workers was par for the course for the Tech industry, he acted as a reasonable Tech CEO. Said Tech CEO would not need to prove his exceptional skills but simply that he acted in good faith.
While some Tech companies may fire their CEOs for incompetence over mass layoffs, those managers would be effectively immune to lawsuits due to the Business Judgement Rule.
Ticked-Off Shareholders
Shareholders would also be unlikely to sue their investee company as it would be detrimental to the value of their own portfolios. As an investor, even if you suspect something rotten in one of your investee companies, your instinct would be to slide the rubbish under the rug until the share price stabilises and then to exit before things get worse. However, long-term shareholders such as the descendants of founders or the founding family may have a longer-term view of their investment and may intercede in the governance of the company through legal means.
Pissed-Off Employees
It is the laid-off employees who have the greatest cause to sue. In a previous article (“Employee Misconceptions article”), we had discussed that employees are more likely to sue if their immediate prospects for new employment are low. In a global economic downturn, as currently persists, the risk of such a suit is elevated.
However, in the case of employees, the question is whether they have the right to sue. Presumably, every employment contract lays down the terms of termination and the former employer would have followed those terms and the applicable law. If an employee is fully aware of his possible termination as per contract, then can he still question the decision of the company to fire him? As long as the company has not breached the terms of the employment contract or applicable laws, it is hard to see that any terminated employee has grounds for a suit. In fact in our research we turned up very few examples of lawsuits by laid-off employees seeking reinstatement.
One of the few examples was an interesting American case[5], in which the United States Steel Corp. decided to close down its plant in a town called Youngstown. The steel plant was essentially the sole employer and thus the basis for the entire town. The terminated workers sued to save the plant. They offered two main arguments:
- That the Company’s Management had promised to keep the plant open if its profitability improved thereby the plant was protected under promissory estoppel.
- An ingenious argument that since the existence of the town was dependant on the steel plant, the town had acquired property rights over the steel plant in the nature of an easemen. Therefore the plant could not be summarily shut down without the town’s acquiescence.
The Court held against the workers and shied away from granting a property rights precedent.
So shareholders are unlikely to sue and employees cannot sue. Does this mean the company and its officers will go scot-free? In the US and other Western countries they probably will. However, India is an avowedly socialist country with a different statutory regime.
Socialism v. Capitalism
In the US, which is a true Federation, different states have their own corporate laws. Many American corporations prefer to incorporate in the state of Delaware due to its more corporation-friendly regime. Delaware’s (and other states’) corporate law makes it clear that Directors owe a fiduciary duty of loyalty and care to the Company and its stockholders [6]. The Delaware Court of Chancery (and many other American courts) which often deals with corporate legal issues has on numerous occasions held that a Director’s fiduciary duty of care extends to stockholders and not to other stakeholders [7].
In India, the statutory regime is completely different. The Companies Act 2013 which governs private and public corporations expressly states under section 166 (2) that:
“A Director of a company shall act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of environment.”
Therefore in India, Directors have an express duty to keep employee interests in mind. While Management remains protected by the Business Judgement rule, Directors have a greater duty in the eyes of the law.
This does not mean that employees in India are more likely to sue Directors than in the US. For example, if a laid-off employee does file a suit against the Board of his former employer, could he reasonably ask for the relief of reinstatement? We don’t believe that any court would be churlish enough to grant such a relief. While the Board of a Company no doubt fails it employees in a mass layoff, the layoff itself is a fact of business and is undoubtedly in response to failing economics. It is far more likely that a court/tribunal would seek to investigate how the company came to arrive at the decision for layoff and what role the Board played or did not play in overseeing Management decision-making. The result of such an investigation could be the removal of Directors but is not likely to burden the company with reinstatement of laid-off employees. In other words a court is not likely to question the necessity of the layoff itself but it can certainly question the human errors or process errors that resulted in the layoff.
Would a laid-off employee seek to sue Directors with the only feasible relief being an investigation into top-level decision-making at the former employer? It seems unlikely. As we discussed in the Directors Beware article, it is in fact the authorities themselves that might take action against Directors. We believe startups are particularly at risk of such action. The political calculus is clear – thousands of disgruntled, recently laid-off employees are easy votes to be lapped up. A government might hesitate to act against larger corporations especially those that have consistently patronised political parties or contributed significantly to GDP. However, startups who are usually loss-making and use their substantial capital mainly to fund those losses and not for political patronage would be easy-pickings. That is not to suggest that such action will occur any time soon. The current economic climate is too fragile for any government to come across as ‘anti-business.’ However, it is a threat that Directors should not ignore for their own sakes.
Lessons from Caremark, Marchand and Centro
While, we have argued that Directors are more likely to be sued in India after mass layoffs than in the West, there are lessons that can be drawn from the West. In the Directors Beware article we had discussed the Caremark and Marchand cases in which the American courts stated that while Directors would not be liable for decisions that went wrong, they could be liable for not acting in good faith. The courts held that an indicator of failure in duty of care could be if Directors had failed to set up any processes or systems to effectively oversee Management or if they had repeatedly failed to monitor such processes or systems.
In Australia in the Centro case the court held Directors liable for signing off on financial statements without applying their own minds. The courts in that case argued that statute expressly required Directors to apply their own reasoning to financial statements before endorsing them i.e. a clear and objective test. A similar reasoning could be applied in India in the aftermath of mass layoffs. If a Director or Directors are not able to adduce evidence they had applied their minds in the matter of large-scale recruitment by the company or in examining business risk factors, the courts could hold that they failed in their duty towards employees as per section 166 (2) of the Companies Act.
Best Practices
From the Caremark/ and Centro cases, Indian Directors should note that key elements of duty of care are:
- Systems and processes
- Critical evaluation of information
In engineering courses, typically teachers judge an exam answer not on the correctness of the final answer but on the structure and thinking of the steps that the student took to arrive at the answer. A Director’s duty of care follows the same pattern.
Specifically with regards to a company’s recruitment strategy, we recommend that Directors take the following steps:
- Mutually agree with Management that hiring above a certain threshold each quarter would need the Board’s prior approval or at least prior notice to the Board. Currently in many cases, Boards may not even be discussing company-wide hiring practices with Management.
- Examine higher-than-normal recruitment volume in the context of Management’s scenario analysis.
- Question assumptions behind Management’s forecasts for the industry and economy. The Board should focus on the impact of different scenarios on various stakeholders including employees.
- Any mass layoffs must be a matter for the Board to consider even in the case of private companies and even where the to-be-laid-off employees do not fall within the purview of labour laws such as the Industrial Disputes Act.
- The Board must incorporate a Bayesian approach to events such as mass layoffs. For example, any mass layoff event should necessarily mean that the Management’s or Board’s previous assumptions were incorrect and those faulty assumptions should be identified and rectified for the future.
- The Board must hold itself and Management accountable for an event such as a mass layoff. The Board must lead an investigation into actions and decisions that led to the layoff and take some tangible action as a result of the investigation. The action should not be vindictive or for the sake of an audience but meaningful. For example, in the case of the Tech industry, Boards must examine the follow-the-herd mentality of Management.
‘Don’t miss the forest for the trees!’ We have used this refrain as the title of this article to remind Directors that frames of reference are important in how they view business-decisions. Mass layoffs may seem rational if one only looks at cost rationalisation. However, they can be a massive potential liability if one sees them as large-scale system failures.
References
- “Salesforce Layoffs Showcase Bad Recruitment Strategy – CGI.” The Corporate Governance Institute, www.thecorporategovernanceinstitute.com/insights/news-analysis/salesforce-layoffs-showcase-bad-recruitment-strategy/. Accessed 8 Mar. 2023.
- Pichai, Sundar. “A Difficult Decision to Set Us up for the Future.” Google, 20 Jan. 2023, blog.google/inside-google/message-ceo/january-update/.
- Soni, Pavan. “The Co-Founder Dilemma: To Have or Not To.” Inc42 Media, 1 Dec. 2017, inc42.com/features/indian-startup-layoffs-tracker/co. Accessed 9 Mar. 2023.
- BBC. “Did Hyman Minsky Find the Secret behind Financial Crashes?” BBC News, 24 Mar. 2014, www.bbc.com/news/magazine-26680993.
- Local 1330, United Steel Workers of America v. United States Steel Corp., 631 F.2d 1264, 1280 (6th Cir. 1980)
- “Delaware Business Law: An Explanation of Fiduciary Duties.” Lexology, 26 Nov. 2021, www.lexology.com/library/detail.aspx?g=f57aaed6-3031-45cc-a15e-433b29e18185. Accessed 9 Mar. 2023.
- Revlon, Inc. v. MacAndrews Forbes Holdings, Inc., 506 A.2d 173, 182 (Del. 1986)
