A valid retrenchment may only be exercised after the employer has proved compliance with the procedural and substantive requisites of valid retrenchment. Absent any of these, then the dismissal is illegal.

Thus, for a valid retrenchment, the employer must show that: (a) retrenchment was a necessary measure to prevent substantial and serious business losses; (b) it was done in good faith and not to defeat employees’ rights; and (c) the employer was fair and reasonable in selecting the employees who will be retrenched.

For the first requirement, the employer must prove the “existence or imminence of substantial losses” that would warrant the retrenchment. In Lopez Sugar Corporation vs. Federation of Free Workers:

Firstly, the losses expected should be substantial and not merely de minimis in extent. If the loss purportedly sought to be forestalled by retrenchment is clearly shown to be insubstantial and inconsequential in character, the bonafide nature of the retrenchment would appear to be seriously in question. Secondly, the substantial loss apprehended must be reasonably imminent, as such imminence can be perceived objectively and in good faith by the employer. There should, in other words, be a certain degree of urgency for the retrenchment, which is after all a drastic recourse with serious consequences for the livelihood of the employees retired or otherwise laid-off. Because of the

consequential nature of retrenchment, it must, thirdly, be reasonably necessary and likely to effectively prevent the expected losses. The employer should have taken other measures prior or parallel to retrenchment to forestall losses, i.e., cut other costs than labor costs. An employer who, for instance, lays off substantial numbers of workers while continuing to dispense fat executive bonuses and perquisites or so-called “golden parachutes,” can scarcely claim to be retrenching in good faith to avoid losses. To impart operational meaning to the constitutional policy of providing “full protection” to labor, the employer’s prerogative to bring down labor costs by retrenching must be exercised essentially as a measure of last resort, after less drastic means — e.g., reduction of both management and rank-and-file bonuses and salaries, going on reduced time, improving manufacturing efficiencies, trimming of marketing and advertising costs, etc. — have been tried and found wanting.

Lastly, but certainly not the least important, alleged losses if already realized, and the expected imminent losses sought to be forestalled, must be proved by sufficient and convincing evidence. The reason for requiring this quantum of proof is readily apparent: any less exacting standard of proof would render too easy the abuse of this ground for termination of services of employees.

In the case of Team Pacific Corporation vs. Parente, the Labor Arbiter based its ruling only on the documents that the employee submitted, after the employer had refused to receive summons, attend hearings, or file pleadings. Nonetheless, the Labor Arbiter found that the retrenchment was valid because the Termination Letter, citing the global economic crisis as its reason, was served one month prior to dismissal. The Labor Arbiter also declared that the employee was bound by her acceptance of separation pay and her execution of a waiver and quitclaim.

The National Labor Relations Commission merely affirmed this ruling, saying that the said employee was estopped from questioning her dismissal.

The labor tribunals’ factual findings are not sufficient to rule that the retrenchment is valid. The company did not prove in any way that it incurred or is about to incur substantial business losses that would warrant retrenchment.

Independently audited financial statements are of high evidentiary value in terms of proving the employer’s serious business losses. In Manatad vs. Philippine Telegraph and Telephone Corporation.

The financial statements audited by independent external auditors constitute the normal method of proving the profit and loss performance of a company as enunciated in San Miguel Corporation vs. Abella:

Normally, the condition of business losses is shown by audited financial documents like yearly balance sheets, profit and loss statements and annual income tax returns. The financial statements must be prepared and signed by independent auditors failing which they can be assailed as self-serving documents.

No evidence can best attest to a company’s economic status other than its financial statement. The SC defined the evidentiary weight accorded to audited financial statements in Asian Alcohol Corporation v. National Labor Relations Commission.

The condition of business losses is normally shown by audited financial documents like yearly balance sheets and profit and loss statements as well as annual income tax returns. It is our ruling that financial statements must be prepared and signed by independent auditors. Unless duly audited, they can be assailed as self-serving documents.

But it is not enough that only the financial statements for the year during which retrenchment was undertaken, are presented in evidence. For it may happen that while the company has indeed been losing, its losses may be on a downward trend, indicating that business is picking up and retrenchment, being a drastic move, should no longer be resorted to.

Thus, the failure of the employer to show its income or loss for the immediately preceding year or to prove that it expected no abatement of such losses in the coming years, may bespeak the weakness of its cause. It is necessary that the employer also show that its losses increased through a period of time and that the condition of the company is not likely to improve in the near future.

That the financial statements are audited by independent auditors safeguards the same from the manipulation of the figures therein to suit the company’s needs. The auditing of financial reports by independent external auditors are strictly governed by national and international standards and regulations for the accounting profession.

In addition, the fact that the financial statements were audited by independent auditors settles any doubt on the authenticity of these documents for lack of signature of the person who prepared it.

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(1) That the retrenchment is reasonably necessary and likely to prevent business losses which, if already incurred, are not merely de minimis, but substantial, serious, actual and real, or if only expected, are reasonably imminent as perceived objectively and in good faith by the employer;

(2) That the employer served written notice both to the employees and to the Department of Labor and Employment at least one month prior to the intended date of retrenchment;

(3) That the employer pays the retrenched employ- ees separation pay equivalent to one month pay or at least 1⁄2 month pay for every year of service, whichever is higher;

(4) That the employer exercises its prerogative to retrench employees in good faith for the advancement of its interest and not to defeat or circumvent the employees’ right to security of tenure; and

(5) That the employer used fair and reasonable criteria in ascertaining who would be dismissed and who would be retained among the employees, such as status (i.e., whether they are temporary, casual,

regular or managerial employees), efficiency, seniority, physical fitness, age,

To justify retrenchment, the employer must prove serious business losses. To justify the employees’ termination of service, the losses must be serious, actual and real, and they must be supported by sufficient and convincing evidence.

Moreover, the employer must prove the requirements for a valid retrenchment by clear and convincing evidence; otherwise, said ground for termination would be susceptible to abuse by scheming employers who might be merely feigning losses or reverses in their business ventures in order to ease out employees.

Sliding incomes or decreasing gross revenues are not necessarily losses, much less serious business losses within the meaning of the law. The bare fact that an employer may have sustained a net loss, such loss, per se, absent any other evidence on its impact on the business, nor on expected losses that would have been incurred had operations been continued, may not amount to serious business losses mentioned in the law.

Clarion Printing House, Inc. v. NLRC teaches that sliding incomes or decreasing gross revenues alone do not necessarily indicate business losses within the meaning of Article 298, for, in the nature of things, the possibility of incurring losses is constantly present in business operations.

The employer must also show that its losses in- creased through a period of time and that the condition of the company will not likely improve in the near future.

The burden clearly falls upon the employer to prove economic or business losses with sufficient supporting evidence. Its failure to prove these reverses or losses necessarily means that the employee’s dismissal was not justified. Any claim of actual or potential business losses must satisfy certain established standards, all of which must concur, before any reduction of personnel becomes legal.

Any less exacting standard of proof would render too easy the abuse of this ground for termination of services of employees.

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However, there are limitations to the exercise of such right. In general, the only limitations to the exercise of this prerogative are those imposed by labor laws and the principles of equity and substantial justice.

In the case of Lopez Sugar Corporation v. Federation the Supreme Court itemized the limitations as follows:

Firstly, the losses expected should be substantial and not merely de minimis in extent. If the loss purportedly sought to be forestalled by retrenchment is clearly shown to be insubstantial and inconsequential in character, the bona fide nature of the retrenchment would appear to be seriously in question.

Secondly, the substantial loss apprehended must be reasonably imminent, as such imminence can be perceived objectively and in good faith by the employer. There should, in other words, be a certain degree of urgency for the retrenchment, which is after all a drastic recourse with serious consequences for the livelihood of the employees retired or otherwise laid-off.

Because of the consequential nature of retrenchment, it must, thirdly, be reasonably necessary and likely to effectively prevent the expected losses. The employer should have taken other measures prior or parallel to retrenchment to forestall losses, i.e., cut other costs than labor costs. An employer who, for instance, lays off substantial numbers of workers while continuing to dispense fat executive bonuses and perquisites or so- called “golden parachutes,” can scarcely claim to be retrenching in good faith to avoid losses.

To impart operational meaning to the constitutional policy of providing “full protection” to labor, the employer’s prerogative to bring down labor costs by retrenching must be exercised essentially as a measure of last resort, after less drastic means – e.g., reduction of both management and rank-and-file bonuses and salaries, going on reduced time, improving manufacturing efficiencies, trimming of marketing and advertising costs, etc. – have been tried and found wanting.

Lastly, but certainly not the least important, alleged losses if already realized, and the expected imminent losses sought to be forestalled, must be proved by sufficient and convincing evidence.

The right of an employer to dismiss an employee differs from and should not be confused with the manner in which such right is exercised. It must not be oppressive and abusive since it affects one’s person and property.

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Retrenchment is the reduction of personnel for the purpose of cutting down on costs of operations in terms of salaries and wages resorted to by an employer because of losses in operation of a business occasioned by lack of work and considerable reduction in the volume of business.

Stated in another way, retrenchment is defined as the termination of employment initiated by the employer through no fault of the employee and without prejudice to the latter, resorted by management during periods of business recession, industrial depression or seasonal fluctuations or during lulls over shortage of materials. It is a reduction in manpower, a measure utilized by an employer to minimize business losses incurred in the operation of its business.

The law recognizes the right of every business entity to reduce its work force if the same is made necessary by compelling economic factors which would endanger its existence or stability. Where appropriate and where conditions are in accord with law and jurisprudence, the Court has authorized valid reductions in the work force to forestall business losses, the hemorrhaging of capital, or even to recognize an obvious reduction in the volume of business which has rendered certain employees redundant.

Retrenchment is used interchangeably with the term “lay-off.”

Simply put, it is an act of the employer of dismissing employees because of losses in the operation of a business, lack of work, and considerable reduction on the volume of his business, a right consistently recognized and affirmed by the courts.

Retrenchment is a management prerogative consistently recognized by the Court.

Nevertheless, while it is true that the exercise of this right is a prerogative of management, there must be faithful compliance with substantive and procedural requirements of the law and jurisprudence, for retrenchment strikes at the very heart of the worker’s employment, the lifeblood upon which he and his family owe their survival.

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The establishment and implementation of criteria are important feature of redundancy to give respect to the employee’s constitutionally enshrined security of tenure.

In one case, the Supreme Court has refused to give credence to the redundancy invoked by the employer inasmuch as the company adopted no criterion in dismissing the employee.

Verily, the absence of criteria and the erroneous implementation of the criterion selected, both render invalid the redundancy because both have the ultimate effect of

In a case, studies for the redundancy program showed to eliminate the “undesirables,” “abusers,” and “worst performers.” It was challenged for being indicia of bad faith. The Supreme Court disagreed and did not put significance to the allusions. It may be argued that the elimination of the so-called “undesirables” was merely incidental to the redundancy program or that past transgressions could have been part of the criteria in determining who among the redundant employees is to be dismissed.

That no other person was holding the same position prior to the termination of one’s services, does not show that his position had not become redundant. Indeed, in any well-organized business enterprise, it would be surprising to find duplication of work and two (2) or more people doing the work of one person.

The fact that the employer hired contractual employees after implementing its redundancy program does not necessarily negate the existence of redundancy. Especially if there is showing that such hiring was intended solely for winding up operations using the old system.

The employer has the recognized right and prerogative to select the persons to be hired and to designate the work as well as the employee or employees to perform it.

This includes the right of the company to determine the employees to be retained or discharged and who among the applicants are qualified and competent for a vacant position. The rationale for this principle is that the employer is in the best position to ascertain what is proper for the advancement of its interest.

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In Wiltshire File Co., Inc. vs. NLRC, the position of Sales Manager was abolished on the ground of redundancy as the duties previously discharged by the Sales Manager simply added to the duties of the General Manager to whom the Sales Manager used to report. In adjudging said termination as legal, this Court said that redundancy, for purposes of our Labor Code, exists where the services of an employee are in excess of what is reasonably demanded by the actual requirements of the enterprise.

The characterization of an employee’s services as no longer necessary or sustainable, and therefore, properly terminable, was an exercise of business judgment on the part of the employer. According to the Court, the wisdom or soundness of such characterization or decision was not subject to discretionary review on the part of the Labor Arbiter nor of the NLRC so long, of course, as violation of law or merely arbitrary and malicious action is not shown.

In the case of International Macleod, Inc. v. Intermediate Appellate Court, the Supreme Court also

considered the position of Government Relations Officer to have become redundant in view of the appointment of the International Heavy Equipment Corporation as the company’s dealer with the government. It held therein that the determination of the need for the phasing out of a department as a labor and cost saving device because it was no longer economical to retain said services is a management prerogative and the courts will not interfere with the exercise thereof as long as no abuse of discretion or merely arbitrary or malicious action on the part of management is shown.

The Court also held in Bondoc v. People’s Bank and Trust Co., that the bank’s board of directors possessed the power to remove a department manager whose position depended on the retention of the trust and confidence of management and whether there was need for his services. Although some vindictive motivation might have impelled the abolition of his position, this Court expounded that it is undeniable that the bank’s board of directors possessed the power to remove him and to determine whether the interest of the bank justified the existence of his department.

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Article 298. Closure of Establishment and Reduction of Personnel. – The employer may also terminate the employment of any employee due to the installation of labor-saving devices, redundancy, retrenchment to prevent losses or the closing or cessation of operation of the establishment or undertaking unless the closing is for the purpose of circumventing the provisions of this Title, by serving a written notice on the workers and the Ministry of Labor and Employment at least one (1) month before the intended date thereof. In case of termination due to the installation of labor-saving devices or redundancy, the worker affected thereby shall be entitled to a separation pay equivalent to at least his one (1) month pay or to at least one (1) month pay for every year of service, whichever is higher. In case of retrenchment to prevent losses and in cases of closures or cessation of operations of establishment or undertaking not due to serious business losses or financial reverses, the separation pay shall be equivalent to one (1) month pay or at least one-half (1/2) month pay for every year of service, whichever is higher. A fraction of at least six (6) months shall be considered one (1) whole year.

Redundancy exists when the service capability of the workforce is in excess of what is reasonably needed

to meet the demands of the business enterprise. A position is redundant where it had become superfluous. Superfluity of a position or positions may be the outcome of a number of factors such as over-hiring of workers, decrease in volume of business, or dropping a particular product line or service activity previously manufactured or undertaken by the enterprise.

A valid redundancy program must comply with the following requisites: (a) written notice served on both the employees and the DOLE at least one (1) month prior to the intended date of termination of employment; (b) payment of separation pay equivalent to at least one (1) month pay for every year of service; (c) good faith in abolishing the redundant positions; and (d) fair and reasonable criteria in ascertaining what positions are to be declared redundant and accordingly abolished, taking into consideration such factors as (i) preferred status; (ii) efficiency; and (iii) seniority, among others.

Reorganization as a cost-saving device is acknowledged by jurisprudence.

An employer is not precluded from adopting a new policy conducive to a more economical and effective  management, and the law does not require that the

employer should be suffering financial losses before he can terminate the services of the employee on the ground of redundancy. (DOLE Philippines, Inc. vs. NLRC, G.R. No. 120009, September 13, 2001.)

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An interesting follow-up inquiry is if that is the case, it seems that saving on labor cost cannot be the basis for redundancy.

Adopting that line of inquiry in an actual case, redundancy was challenged on the ground that the true desire for the program is to save labor costs. The Court held that the law does not prevent employers from saving on labor costs.

The Court has recognized such right. The determination of the need for the phasing out of a department as a labor and cost saving device because it was no longer economical to retain said department is a management prerogative, with which the courts will not interfere.

The phasing out of a department and the consequent redundancy of the position held by the employee is a valid act of the company to save cost in its operations. The company may transfer the function of the

department to another.

So long as the undertaking to save on labor costs is not attended by malice, arbitrariness, or intent on the part of the employer to circumvent the law, courts should not interfere with such endeavor.

Indeed, the management of a company cannot be denied faculty of promoting efficiency and attaining economy by a study of what units are essential for its operation. To it belongs the ultimate determination of whether services should be performed by its personnel or contracted to outside agencies. While there should be mutual consultation, eventually deference is to be made to what management decides.

The employer’s utilization of high technology equipment in its operation such as computers and digital switches necessarily resulted in the reduction of the demand for the services of a Switchman since computers and digital switches can aptly perform the function of several Switchmen. Indubitably, the position of Switchman has become redundant.

In one case, the company phased-out its security section and hired an independent security agency. It was a valid act constituting a legitimate business decision. Consequently, absent proof that management acted in a malicious or arbitrary manner, courts should not interfere with the exercise of judgment by the employer.

When the employer terminated its Water Pump Tenders because of engagement with independent contractors, the employer’s good faith in implementing a redundancy program is not necessarily put in doubt by the availment of the services of an independent contractor.

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In a case, the company brought in its plant high- speed machines to be used in the manufacture of its beer.

affected by the introduction of such machines. Disgruntled employees challenged their dismissal. But the Supreme Court ruled that the installation of labor-saving devices by the company at its plant was a proper ground for terminating employment.

The termination of employment of the affected employees due to the introduction of machinery in the manufacture of its products for purposes of effecting more economy and efficiency was declared valid.

Companies may yield to faster production system and higher efficiency methods. Unfortunately, the usual effect of new technology is the displacement of employees. Yet, our laws recognize this situation as long as there is not bad faith on the part of the employer.

In fact, the law authorizes an employer to terminate the employment of any employee due to the installation of labor saving devices. The installation of these devices is a management prerogative, and the courts will not interfere with its exercise in the absence of abuse of discretion, arbitrariness, or maliciousness on the part of management.

While the law acknowledges the management prerogative of closing the business, it does not, however, allow the business establishment to disregard the requirements of the law.

Thus, to validly invoke installation of labor-saving devices as ground for termination, the following requisites must concur:

1. The introduction of the machinery, equipment or other devices must be done in good faith;
2. The purpose for such introduction must be valid, such as to save on cost, enhance efficiency and other justifiable economic reasons;
3. There is no other option available to the employer but the introduction of the machinery, equipment or device and the consequent termination of employment of those affected thereby;
4. The one (1) month prior written notice requirement under Article 283 should be complied with;
5. There should be reasonable and fair standards or criteria in selecting who to terminate such as nature of work, status of the employees (whether casual, temporary or regular), experience, efficiency rating and seniority, among other considerations; and
6. Separation pay must be paid to the affected employees in such amount equivalent to at least his one (1) month pay or to at least one (1) month pay for every year of service, whichever is high- er, a fraction of at least six (6) months shall be considered as one (1) whole year. In case the CBA or company policy provides for a higher separation pay, the same must be followed in- stead of the one provided in Article 283 (now Art. 298).

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It is a reduction in manpower, a measure utilized by an employer to minimize business losses incurred in the operation of its business. (Philippine Carpet Employees Association [PHILCEA] vs. Hon. Sto. Tomas, G.R. No. 168719, February 22, 2006)

Retrenchment is normally resorted to by management during periods of business reverses and economic difficulties occasioned by such events as recession, industrial depression, or seasonal fluctuations. (Edge Apparel, Inc. vs. NLRC, G.R. No. 121314 February 12, 1998)

Related topic: Constructive Dismissal Definition and Concept

It is sometimes also referred to as down-sizing. Retrenchment is an authorized cause for termination of employment which the law accords an employer who is not making good in its operations in order to cut back on expenses for salaries and wages by laying off some employees. The purpose of retrenchment is to save a financially ailing business establishment from eventually collapsing. (Sanoh Fulton Philippines, Inc. vs. Bernardo, G.R. No. 187214, August 14, 2013.)

Article 298 of the Labor Code, as amended, provides, that:

“Article 298. Closure of Establishment and Reduction of Personnel.—The employer may also terminate the employment of any employee due to the installation of labor-saving devices, redundancy, retrenchment to prevent losses or the closing or cessation of operation of the establishment or undertaking unless the closing is for the purpose of circumventing the provisions of this Title, by serving a written notice on the workers and the Ministry of Labor and Employment at least one (1) month before the intended date thereof. In case of termination due to the installation of labor-saving devices or redundancy, the worker affected thereby shall be entitled to a separation pay equivalent to at least his one (1) month pay or to at least one (1) month pay for every year of service, whichever is higher. In case of retrenchment to prevent losses and in cases of closures or cessation of operations of establishment or undertaking not due to serious business losses or financial reverses, the separation pay shall be equivalent to one (1) month pay or at least one-half (1/2) month pay for every year of service, whichever is higher. A fraction of at least six (6) months shall be considered one (1) whole year.”

The requirements of a valid retrenchment program are: (International Management Services vs. Logarta, G.R. 163657, 18 April 2012)

(1) That the retrenchment is reasonably necessary and likely to prevent business losses which, if already incurred, are not merely de minimis, but substantial, serious, actual and real, or if only expected, are reasonably imminent as perceived objectively and in good faith by the employer;

(2) That the employer served written notice both to the employees and to the Department of Labor and Employment at least one month prior to the intended date of retrenchment;

(3) That the employer pays the retrenched employees separation pay equivalent to one month pay or at least ½ month pay for every year of service, whichever is higher;

(4) That the employer exercises its prerogative to retrench employees in good faith for the advancement of its interest and not to defeat or circumvent the employees’ right to security of tenure; and

(5) That the employer used fair and reasonable criteria in ascertaining who would be dismissed and who would be retained among the employees, such as status, efficiency, seniority, physical fitness, age and financial hardship for certain workers.

Based on the above, there can be substantial basis for the planned retrenchment if the company can prove that it suffers significant financial losses over significant period of time. If the company alleges financial losses as ground for retrenchment it must be ready to provide proof of such financial losses. The losses must be demonstrated by the Audited Financial Statements (AFS) for the periods covered by the said losses.

The law states that to justify retrenchment, the employer must prove serious business losses. To justify the employees’ termination of service, the losses must be serious, actual and real, and they must be supported by sufficient and convincing evidence. (Mobilia Product, Inc. vs. Demecillo, G.R. No. 170669, February 4, 2009 citing Guerrero vs. National Labor Relations Commission, G.R. No. 119842, August 30, 1996, 261 SCRA 301, 305.)

Moreover, the employer must prove the requirements for a valid retrenchment by clear and convincing evidence.

In establishing a unilateral claim of actual or potential losses, financial statements (FS) audited by independent external auditors constitute the normal method of proof of profit and loss performance of a company. (TPI Philippines Cement Corporation vs. Cajucom VII, G.R. No. 149138, February 28, 2006, 483 SCRA 494, 503.)

The condition of business losses justifying retrenchment is normally shown by audited financial documents like yearly balance sheets and profit and loss statements as well as annual income tax returns. Financial statements must be prepared and signed by independent auditors, otherwise, they may be assailed as self-serving. (Danzas Intercontinental, Inc. vs. Daguman, G.R. No. 154368, April 15, 2005, 456 SCRA 382.)

The Supreme Court laid down the reasonable criteria in effecting retrenchment, such as, but not limited to: (See Flight Attendants and Stewards Association of the Philip- pines v. Philippines Airlines, Inc., G.R. No. 178083, July 23, 2008, 559 SCRA 252 citing Fernandez, P.V., The Law of Employee Dismissal, pp. 130-131, 1976 Ed.; Asiaworld Publishing House, Inc. v. Ople, G.R. No. L-56398, July 23, 1987, 152 SCRA 219, 225; Asufrin, Jr. v. San Miguel Corporation, G.R. No. 156658, March 10, 2004, 425 SCRA 270, 275.)

(a) Less preferred status (e.g., temporary employee);

(b) Efficiency;

(c) Seniority;

(d) Work skill required and qualities of workers to be retained; and

(e) Work experience.

The most important item in these criteria is the seniority.

As held by the Supreme Court, retrenchment scheme without taking seniority into account renders the retrenchment invalid. (Emcor vs. Sienes, citing Philippine Tuberculosis Society Inc. vs. NLRC, 356 Phil. 63, 72 (1998).)

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