Economic downturns, business restructuring, and technological changes sometimes force employers to make difficult decisions about workforce reduction. In Malaysia, retrenchment is a legally recognized process, but it must be conducted properly to avoid unfair dismissal claims and potential legal liability. This guide explains everything employers need to know about lawfully retrenching employees in Malaysia.
What is Retrenchment and Redundancy?
Retrenchment refers to the termination of employment due to redundancy, where the employer no longer requires the employee's services because the job itself has become unnecessary. This is fundamentally different from dismissal for misconduct or poor performance.
Under Malaysian employment law, redundancy can arise from several legitimate business reasons, including company reorganization or restructuring, closure of business operations, technological changes reducing manpower needs, economic difficulties affecting business viability, and mergers or acquisitions resulting in duplicate positions.
The key principle established by Malaysian courts is that retrenchment must be a genuine business decision and not a disguise for victimization or unfair dismissal.
Legal Framework Governing Retrenchment
Several laws and regulations govern retrenchment in Malaysia. The Employment Act 1955 applies to employees earning RM4,000 or below monthly, or those engaged in manual labour regardless of salary. The Industrial Relations Act 1967 provides recourse for employees who believe their retrenchment was unfair. Additionally, the Employment (Termination and Lay-Off Benefits) Regulations 1980 prescribes minimum compensation for retrenched employees covered under the Employment Act.
For employees not covered by the Employment Act, their employment contracts and common law principles apply, though the Industrial Court may still hear unfair dismissal claims.
Selection Criteria: The LIFO Principle
Malaysian law requires employers to follow fair and objective criteria when selecting employees for retrenchment. The generally accepted principle is LIFO, which stands for Last In, First Out. This means employees with shorter service periods should be retrenched before those with longer service.
However, LIFO is not absolute. Employers may deviate from this principle based on objective criteria such as skills and qualifications necessary for remaining operations, performance records and productivity, disciplinary history, and the operational needs of the business.
If you deviate from LIFO, you must be able to justify your selection criteria objectively. The Industrial Court has consistently held that selection must not be arbitrary, discriminatory, or based on union membership or other protected characteristics.
Foreign Workers and Retrenchment
The Code of Conduct for Industrial Harmony provides that employers should not retrench local employees while retaining foreign workers in similar positions. The general expectation is that foreign workers should be released before local employees are retrenched, unless there are compelling operational reasons to retain specific foreign workers with specialized skills.
Notice Requirements
Employers must provide adequate notice before retrenchment takes effect. Under the Employment Act 1955, the minimum notice periods are four weeks if the employee has been employed for less than two years, six weeks if employed for two to five years, and eight weeks if employed for five years or more.
Employment contracts may stipulate longer notice periods, and employers must comply with whichever is more favourable to the employee. Alternatively, employers may provide payment in lieu of notice.
Notification to Authorities
Employers planning to retrench must submit a PK Form, also known as the Retrenchment Notification Form, to the nearest Labour Department at least 30 days before the retrenchment takes effect. This requirement applies regardless of the number of employees being retrenched. Failure to submit this notification can result in penalties and may affect the perceived fairness of the retrenchment exercise.
Termination Benefits and Compensation
Employees covered under the Employment Act who have completed at least 12 months of continuous service are entitled to termination benefits under the Employment (Termination and Lay-Off Benefits) Regulations 1980.
The minimum statutory rates are ten days' wages for every year of employment if the employee has been employed for less than two years, fifteen days' wages for every year of employment if employed for two to five years, and twenty days' wages for every year of employment if employed for five years or more.
These are minimum entitlements. Many employers offer enhanced packages, and employment contracts or collective agreements may provide for higher compensation. For employees not covered by the Employment Act, termination benefits depend on their employment contract terms.
Step-by-Step Retrenchment Process
To conduct a lawful retrenchment, employers should follow these steps. First, establish genuine redundancy by documenting the business reasons necessitating workforce reduction. This documentation will be crucial if the retrenchment is challenged.
Second, explore alternatives before proceeding. Consider options such as reducing overtime, implementing temporary pay cuts with employee consent, offering voluntary separation schemes, redeploying affected employees to other positions, or implementing temporary layoffs.
Third, develop fair selection criteria. If LIFO will not be strictly followed, document the objective criteria to be used and ensure they are applied consistently.
Fourth, consult with affected employees. While not strictly mandatory for non-unionized workplaces, consultation demonstrates good faith and may help identify alternatives.
Fifth, submit the PK Form to the Labour Department at least 30 days before the intended retrenchment date.
Sixth, issue termination letters clearly stating the reason for termination, the last day of employment, notice pay if applicable, termination benefits calculation, and payment of outstanding wages and accrued leave.
Finally, make all payments due on or before the last day of employment.
Common Mistakes to Avoid
Employers frequently make errors that expose them to unfair dismissal claims. These include failing to document genuine business reasons for redundancy, using retrenchment to remove specific employees rather than redundant positions, not following LIFO without objective justification, failing to submit the PK Form to authorities, retrenching employees and then hiring replacements for the same positions shortly after, and inadequate consultation or notice.
What Happens if Retrenchment is Challenged?
Employees who believe their retrenchment was unfair may file a complaint with the Industrial Relations Department within 60 days of dismissal. If conciliation fails, the matter may be referred to the Industrial Court. If the court finds the dismissal unfair, remedies may include reinstatement with back wages or compensation in lieu of reinstatement, typically calculated at one month's salary for each year of service.
Practical Advice for Employers
Proper planning and documentation are your best protection. Maintain clear records of business circumstances necessitating retrenchment. Apply selection criteria consistently and be prepared to explain your decisions. Treat affected employees with dignity throughout the process, as this reduces the likelihood of disputes. Consider offering outplacement support or enhanced packages where possible. Finally, seek legal advice before commencing retrenchment, especially for large-scale exercises or where unusual circumstances exist.
Conclusion
Retrenchment is sometimes unavoidable, but Malaysian law requires employers to conduct it fairly and transparently. By following proper procedures, applying objective selection criteria, providing statutory entitlements, and documenting your decisions, you can minimize legal risk while treating affected employees fairly.
Disclaimer: This article provides general information about retrenchment law in Malaysia and does not constitute legal advice. Employment situations vary, and the law may change. For advice specific to your circumstances, please consult a qualified employment lawyer.