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You Demote Me and I'll Sue You

July 1, 1996
Related Topics: Staffing and the Law, Wrongful Discharge, Featured Article
You know how difficult it is any more to terminate an employee? It just got that hard to demote an employee. For years, courts have recognized "implied contracts" in wrongful termination charges. This meant even employers who used no employment contracts were subject to lawsuits if their policies or procedures somehow implied a contract for job security.

In November 1995, the California Supreme Court—for the first time in history—applied the same theory to demotions. Two Pacific Gas & Electric Company (PG&E) employees were discovered to have misrepresented their ownership of an outside consulting firm. The employees allegedly used their managerial positions in PG&E to recruit employees for work in their outside firm, rewarding them in return with pay increases. The two men also used PG&E property and equipment for operating their own enterprise, as well as committing other violations of PG&E policies.

After its investigation, PG&E demoted the men to nonmanagement positions, with a 25% cut in pay and benefits. The two men sued. In the ruling for Scott v. Pacific Gas & Electric Company, the Court found that PG&E's official and unofficial policies, practices and communications created an implied promise not to demote employees without good cause.

PG&E lost $1.325 million in damages to the two plaintiffs for lost wages and benefits, and emotional distress. Employers nationwide lost peace of mind. Although it's the first ruling of its kind, California courts often lead the way nationally. If the ruling starts a trend, as expected, not only does it mean employees can now sue for wrongful demotion, it means they can use an implied contract claim to challenge any employment decision—wrongful discipline, change in benefits, failure to promote, the list goes on.

Michael Loeb, partner at the labor and employment practice group of Oakland, California-based law firm Crosby, Heafey, Roach & May, offers advice on safeguarding against a wrongful demotion lawsuit.

Can you explain how this case germinated at PG&E?
The company, as is typical for large employers, had detailed personnel policies. The personnel policies spoke of progressive discipline, which means that in most cases the employer has committed itself to going through various procedures before taking serious discipline—for instance, oral warnings, then written warnings—before there would be a demotion or termination.

PG&E didn't do this?
The company prepared a report outlining the employees' [misdeeds]. Then a few days after it had given the report to the employees, the company demoted them. It took away their managerial responsibilities and reduced their rate of pay. The employees claimed it was a breach of their implied contractual rights.

Why "implied" contractual rights?
Because they didn't have an express written employment agreement. Instead what constituted their employment contract were [less-specific] things, such as the company's personnel policies and promises. The two plaintiffs claimed their implied contract consisted of the promise of progressive discipline, that they wouldn't be demoted unless there had been warnings.

What's the connection between wrongful demotion and wrongful discharge here?
This case concerned wrongful demotion and whether there could be an implied contractual right—not an express agreement, but implied promises that could protect employees from demotion without certain safeguards and procedural steps before the demotion. The court was saying basically the rules of contract that apply to termination also can apply to other employment practices.

Why are so many employers worried over this ruling?
The fear of employers is that if you permit this implied contract doctrine in situations other than termination, you'll open up virtually all employment decisions to potential legal challenge. It's one thing to challenge a termination. It's another thing to challenge a demotion or suspension or warning or failure to promote. I, as a former employee, [could] claim there was an oral understanding between [myself and my employer], an implied contract, that the company would promote me if I performed satisfactorily and was a long-term employee. What you're talking about is potential legal challenges to many, many different kinds of employment decisions.

So employers worry they now might be vulnerable to lawsuits over even basic employment decisions. How likely is that?
Nobody knows how far this is going to go. The court said that as a practical matter, employees aren't going to be able to file breach of contract claims for suspensions or warnings because there's no economic damage in it. I think one of the things the court was missing is that these claims often are going to be attached to an existing claim for wrongful termination. What we're dealing with here in many cases is going to be additional claims that are part of an existing lawsuit.

What can companies do to protect themselves?
Basically the court suggested an employer can protect itself by maintaining its discretion to make discipline decisions in any order or without going through any previous sets. PG&E didn't have such a statement. Typically if you have an at-will clause, you could expand it to [say] the employee has no right to progressive disciplines.

What's the biggest problem for employers in dealing with this?
What's troublesome for employers is they're not dealing with express written contracts in which [employees] have a document that has been negotiated with their employer that says "employment contract." These implied contracts are really the problem, because they're just not clear. A [verbal] promise I make to you in the hallway or sitting in my office [may later be subject to] dispute. It's much easier to create an implied contractual right. Now these outside the area of termination are actionable.

What should employers look for or be careful of?
One of the ironies of the last 15 years is many employers have tried to get as far as possible from having an express employment contract with their employees. What this court may be telling us is that if you want to avoid misunderstandings, then you should have something that's expressed and in writing.

So maybe the best thing an employer should do with its employees, particularly new employees, is to bite the bullet and have express written agreements so there can be no question about what the rights and obligations are.

What kind of form should this be in?
It can be a two-page letter that sets forth the basic terms: what can lead to termination, basic job duties, an [item] retaining the employer's right to terminate at will and to apply discipline in any order it deems appropriate. [It can state] that raises are based on performance only and aren't guaranteed every year. That way you're keeping your discretion. You can have an alternative dispute resolution (ADR) clause, arbitration or mediation clause. And you need what we call an integration clause, something that says, "This is our understanding and there are no promises on these subjects outside of this written agreement."

What about employers who want to remain contract-free?
If you don't want to have a contract, then you're going to open yourself up to claims based on oral understandings or implied contractual rights.

One of the things that employers [who don't want contracts] frequently do is [put policies in a handbook] and then say their handbook isn't a contract. When you say that manual isn't a contract, you're creating the possibility of an implied contract being created.

Since managerial promises are often the basis for implied contracts, what education should managers receive?
Be careful managers don't make promises that are inconsistent with company policy. Many employers today have policies that say one thing—for instance, "We can terminate you at will." On the other hand, managers are promising something different: "We believe in due process. We believe in giving you a fair chance." To some extent we've created this problem by being schizophrenic, by saying one thing and doing something else. You have this tension between written policies and what's verbally represented. I think there needs to be more consistency. You just can't say your practices are at odds with something you've written or vice versa.

Any final suggestions?
Audit your handbooks and manuals to make sure you've retained your discretion in making disciplinary decisions. Ensure you're not inconsistent in your dated, written policies and practices. Stick to written formal agreements. All these are good ways of avoiding misunderstandings or inconsistencies.

Personnel Journal, July 1996, Vol. 75, No. 7, pp. 83-87.

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