A business has some options when the need to downsize arises—the most common being furloughs and layoffs.
- A furlough is a mandatory temporary leave of absence for your employees.
- A layoff is a permanent termination of their contract with you.
Too many small businesses use these terms interchangeably, but it is important to understand the distinctions as there are legal consequences to doing either. They can both be considered when you need to reduce your overhead, but knowing when to do a furlough vs a layoff is necessary to ensure that you won’t face legal consequences while still saving enough money with your action.
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Furlough
Furloughs can be for full-time or part-time employees, and these temporary leaves of absence can last anywhere from a few days to several months. Businesses typically use furloughs during times of financial hardship or economic downturn, as they are a way to reduce payroll costs without resorting to layoffs, which is a more permanent solution.
The Families First Coronavirus Relief Act (FFCRA) requires covered employers to provide paid sick leave or expanded family and medical leave for certain reasons related to the coronavirus pandemic. If you have employees who are eligible for FFCRA leave, you cannot place them on furlough.
One of the biggest drawbacks to a furlough is that your employees on furlough may find another job, and you won’t be able to get them back. This can add hiring expenses, effectively eliminating any savings you may have had from the furlough. On top of that, furloughing employees doesn’t completely eliminate your payroll costs—you may still be on the hook for healthcare premiums and other benefits costs.
| PROS | CONS |
|---|---|
| Reduced payroll costs | Lowers employee morale |
| Preserves jobs | Businesses may need to cover benefits premiums |
| More flexible than a layoff | Potential legal liability |
| Employees may leave, causing hiring expenses to shoot up | |
How Furloughs Work
The first step in implementing a furlough is to determine how long the leave will last and how many employees will be affected. Once you’ve made the decision, develop a plan for how work will be completed during the furlough period. This may involve assigning tasks to other employees, hiring temporary workers, or using automation and technology to keep things running smoothly.
You’ll also need to have a plan for continuing health benefits, if applicable. Depending on your plan documents, you may be required to continue paying health premiums for any furloughed employee since they’re still technically employed by your company, even though they’re not working any hours.
Once the plan is in place, communicate the furlough to your employees. This includes letting employees know how long it will last, what their job responsibilities will be during the mandatory leave, and when they can expect to return to work. Employees may also be given the option to take unpaid vacation time or use other leave options during the furlough period.
Furloughing Exempt vs Nonexempt Employees
There’s a small but important point to make with furloughing different types of employees. Exempt employees, those ineligible for overtime pay under the Fair Labor Standards Act (FLSA), should be told that they are not allowed to do any work during their furlough. If an exempt employee works a single moment, they’re entitled to their full salary for the entire week.
You may also want to restrict nonexempt employees from doing any work during a furlough, but the consequences are less severe. For nonexempt employees, you only need to pay them for the time they work, effectively reducing their hours dramatically but still getting some level of productivity. This is an alternative option discussed in more detail below.
Check out our guide on exempt vs nonexempt employees to learn about more differences.
When to Use a Furlough
If you don’t have enough work for your employees, you can temporarily bridge that gap by furloughing affected employees for a brief period. On the other hand, if you’re furloughing employees because of an economic downturn and trying to be proactive in reducing your payroll costs, then consider how long you expect to have employees furloughed. If you think the economic situation may last a long time, you may be better off using a layoff.
There is no one-size-fits-all solution to reducing payroll costs. However, there are some circumstances in which a furlough may make sense for your business. It’s important to analyze your specific business needs to ensure you’re making the right choice.
Layoff
Layoffs are usually done in an effort to cut costs or save money. Sometimes, they are done in response to a decrease in business or a change in the economy. However, if you’re just experiencing a temporary downturn in business, a furlough may be a better option.
A major drawback to a layoff is potentially increased hiring costs. After you’ve weathered the economic problems your company faces, you’ll need to hire and train new employees. This could negate any payroll cost savings you may have had during your layoff.
| PROS | CONS |
|---|---|
| May help you avoid closing the business by saving money | May not solve financial problems |
| Allows you time to restructure your business | May damage your business reputation |
| Can hire new employees who may fit your business needs better | Hiring and training new employees may cut into any cost savings |
How Layoffs Work
There are two types of layoffs: voluntary and involuntary. Voluntary layoffs happen when employees voluntarily leave their positions, usually in exchange for some sort of severance pay. Involuntary layoffs happen when employees are forced to leave their positions, often with no severance pay.
Regardless of whether a layoff is voluntary or involuntary, you’ll need to identify the positions you want to eliminate. If you’re facing a reduction in work, start by eliminating the positions most affected. If you’re looking to reduce payroll costs while minimizing the impact to your business, you’ll need to conduct an analysis of highly compensated positions and the revenue they generate. The larger that gap, the more likely you are to eliminate that position.
Once the decision has been made, you’ll need to deliver the news to the affected employees. We recommend giving them as much notice as possible, at least two weeks. You will also work with those employees to determine their severance package and help them transition out of the company, including giving them information on benefits continuation as part of the Consolidated Omnibus Budget Reconciliation Act (COBRA).
When to Use a Layoff
Sometimes a layoff may be necessary. While the exact times you’ll consider a layoff will depend on your unique circumstances, here are four common times small businesses use layoffs.
Legal Considerations
Employment laws affect every business, especially when you’re dealing with employee separations—permanent or temporary.
WARN
The first thing you need to be aware of is the Worker Adjustment and Retraining Notification (WARN) Act. This federal law requires employers to give workers 60 days’ notice before a mass layoff or plant closure. The law applies to businesses with 100 or more full-time employees, as well as businesses with 50 or more full-time employees if they make up at least one-third of the workforce.
If you do not comply with the WARN Act, you could be subject to significant fines and penalties. While WARN immediately applies to layoffs, if a furlough lasts longer than six months, it may be considered an employment loss, subject to WARN Act requirements. As such, make sure you’re following proper procedure if your furlough lasts a long time. In addition, any workers laid off without proper notice may be able to sue your company for lost wages and benefits.
Federal & State Discrimination Laws
Another area of concern is discrimination laws. When making furloughs or layoffs, employers must be careful not to discriminate against protected groups of workers. Both federal and state laws prohibit employers from making decisions based on race, color, religion, sex, national origin, disability, or age.
Your best course of action is to base your furlough or layoff decisions on performance or other legitimate business reasons. It’s also a good idea to document these reasons, in case of any legal challenge from an employee. If you are found to have discriminated against a protected group of workers, you could be subject to costly fines and penalties.
Employee Lawsuits
There are a few different types of employee lawsuits that can crop up after a furlough or layoff. Here are some of the most common ones.
Wrongful Termination
The most common lawsuit after a layoff is wrongful termination. This occurs when an employee believes they were let go for an illegal reason such as discrimination or retaliation. If your company has kept detailed records, you may be able to defend your decision by providing evidence that the employee received multiple warnings and opportunities to correct their underperformance or that the position was eliminated for legitimate operational or financial reasons.
ADEA
Another type of lawsuit that can occur is an Age Discrimination in Employment Act (ADEA) claim. This happens when an older worker believes they were furloughed or laid off because of their age. The ADEA protects workers who are 40 years or older from age discrimination, so if an employee in this age range believes they were let go because of their age, they may have grounds for a lawsuit. You can again defend against an ADEA case by having robust documentation.
Breach of Contract
Lastly, there’s the possibility of a breach of contract lawsuit. This occurs when an employee has an agreement—usually as a written contract—that guarantees them certain job protections such as a certain salary or minimum number of hours worked per week. If an employer doesn’t uphold their end of the bargain, the employee may have grounds for a breach of contract lawsuit. This is more complex to defend against and we recommend speaking with an employment attorney to guide you. One of the best pieces of evidence you can provide, however, will again be a thorough documentation of the employee’s underperformance or a violation of any terms of their employment contract.
Check out our guide to employee management for tips and tricks on managing your employees.
Other Considerations
Furloughs and layoffs can be disruptive to your business. You may not be able to keep up with customer demand if it suddenly rises, reducing your company’s reputation in the long term.
On top of that, these can reduce morale and engagement for employees laid off or furloughed and those who are retained. The ones furloughed or laid off may wonder why they were chosen and become resentful, while those still working may be asked to take on additional work—possibly even work they’re not qualified for or don’t like—to cover the gaps. This can lead to resentment, disengagement, or even turnover.
Better Alternative: Reduction in Hours
If you’re facing a financial crisis, furloughs and layoffs aren’t your only options. Consider a reduction in hours, either for individual positions or your entire company.
Reducing individual employee hours can be a way for your company to save money without causing a massive decrease in morale. It also lets you keep employees on staff and have them remain productive. If you have nonexempt employees working 40 hours per week, you could reduce them to 32 or even 25, saving your company money. Just make sure you have enough employees on staff to meet customer demand.
Alternatively, you could reduce your entire company’s hours. At the beginning of the COVID-19 pandemic, for example, many companies reduced their operating hours to 32, closing on Fridays. While this could reduce productivity, it’s a way to keep employees on staff, keep customers happy, and give your company a reduction in overhead.
Compliance Note: A reduction in hours wouldn’t work for exempt employees. If they work just a single hour in a workweek, they must receive their full salary for the entire week. A reduction in company work hours and subsequent reduction in salary, however, could work for nonexempt employees.
Bottom Line
Deciding to reduce your workforce, whether temporarily or permanently, is never easy. But for small businesses, it’s important to understand all of your options, such as when to do a layoff vs furlough (or apply a reduction in hours), so that you can make the best decision for your business.
The choice you make will largely depend on your specific circumstances. If you’re confident that things will eventually pick back up and you’ll be able to bring your employees back on board, then a furlough might be the way to go. However, if you’re facing long-term financial challenges or don’t see things improving soon, layoffs might be necessary.
