Can a Japanese employer cut an employee’s pay unilaterally? When a pay cut is invalid, and how to proceed lawfully

Question

阿部国際法律事務所 · Accepted Answer

As a rule, no. A pay cut needs the employee’s consent or a reasonable change to the work rules; otherwise it is invalid and the shortfall can be claimed.

As a rule, a Japanese employer cannot cut an employee's pay unilaterally. Changing pay or other working conditions requires the employee's agreement (Labor Contract Act, Art. 8). Without agreement, pay can be reduced through a change to the work rules only if the revised rules are made known to employees and the change is reasonable (Arts. 9 and 10). A pay cut that has neither agreement nor reasonableness behind it has no effect, and the employee can claim the difference from their original pay.

When this becomes an issue

・Business has slowed and management wants to cut every employee's base salary across the board.
・The company wants to lower the pay of an employee who received a poor performance rating.
・An employee has signed a form agreeing to a pay cut, but the company is unsure whether it will hold up.
・A former employee has sent a letter claiming the pay they lost while employed.

1. Pay cuts come in four types, each with different rules

How the law treats a pay cut depends on how it is made. First identify which type the company has in mind.

・A change agreed with the individual employee (Labor Contract Act, Art. 8)
・A company-wide change made by revising the work rules, including wage regulations (Arts. 9 and 10)
・A demotion or a performance-based reduction under the work rules
・A disciplinary "pay reduction sanction" (Labor Standards Act, Art. 91)

Treating one type as another can mean overlooking the required procedure or limits, which invites challenges to the reduction. A common example is a reduction intended as a disciplinary sanction that exceeds the statutory cap.

2. Pay cuts agreed by the employee

An employer and employee may change working conditions by agreement (Labor Contract Act, Art. 8). But consent to lower something as important as pay needs more than a signature.

The Supreme Court has held that whether an employee consented to an adverse change in pay or retirement allowance set by the work rules is not judged only by whether they signed or sealed a document (Supreme Court, Second Petty Bench, 19 February 2016, Case No. 2013 (Ju) 2595, Minshu Vol. 70, No. 2, p. 123). The court also asks whether, objectively, there are reasonable grounds to find the consent was given of the employee's own free will, looking at the nature and extent of the disadvantage, how and why the employee came to agree, and what information and explanation they were given beforehand.

In practice, the following steps make consent easier to defend.

・Set out in writing the amount of the reduction, when it starts, how long it lasts and why.
・Give the employee time to ask questions and consider.
・Keep a record of what was explained and when.

The work rules also matter. An individual agreement that sets working conditions below the standards in the work rules is invalid to that extent, and the work rules apply instead (Labor Contract Act, Art. 12). If the wage regulations fix pay by grade, the employee cannot validly agree to less than that amount.

3. Pay cuts made by changing the work rules

As a rule, an employer cannot change working conditions to employees' disadvantage by revising the work rules without their agreement (Labor Contract Act, Art. 9). As an exception, the revised rules become the employees' working conditions when both of the following are met (Art. 10).

・The revised work rules have been made known to employees.
・The change is reasonable.

Reasonableness is judged in light of the extent of the disadvantage to employees, the need for the change, the appropriateness of the revised rules, the state of negotiations with a labour union or others, and other circumstances (Art. 10).

The Supreme Court upheld as reasonable a bank's revision of its work rules that raised the retirement age from 55 to 60 and reworked pay from age 55 (Supreme Court, Second Petty Bench, 28 February 1997, Case No. 1992 (O) 2122, Minshu Vol. 51, No. 2, p. 705). The court pointed to the strong social demand at the time for a retirement age of 60, the fact that the change followed negotiation and agreement with a union representing about 90 percent of the bank's staff and the signing of a collective agreement, and the fact that pay after the change remained considerably higher than at other banks and in society generally.

Put the other way round, a change with little explanation of why it is needed, a large disadvantage and no discussion with employees is much harder to justify. In practice the following preparation is essential.

・Be able to show, with financial figures, why the pay cut is needed.
・Calculate how much each employee's pay will fall.
・Consider transitional or compensating measures to soften the impact.
・Record the explanations given to, and negotiations with, the union or employees.

On procedure, a company that regularly employs ten or more workers must file revised work rules with the Labour Standards Inspection Office (Labor Standards Act, Art. 89). It must hear the opinion of a union representing a majority of the workers (or, if there is none, a person representing a majority) and attach a document stating that opinion (Art. 90).

4. Pay cuts through demotion or performance ratings

Where pay is linked to grades or positions, a demotion or a poor rating can lower pay. This presupposes that the work rules or wage regulations set out how grades map to pay, and the criteria and procedure for pay rises and reductions based on ratings.

Lowering base pay on the company's judgment alone, with no such provision, risks being challenged as a change to working conditions made without agreement. Even where the provisions exist, the company will be asked whether it can explain the basis for the rating and whether it followed the procedure in its rules.

5. Disciplinary pay reduction sanctions

Where the work rules provide for a pay reduction as a disciplinary sanction, the reduction is capped (Labor Standards Act, Art. 91).

・A single reduction must not exceed half of one day's average wage.
・The total must not exceed one tenth of the total wages for a single wage payment period.

The average wage is, in principle, the total wages paid in the three months before the event giving rise to the calculation, divided by the total number of days in that period (Labor Standards Act, Art. 12(1)). If the average wage is JPY 10,000 a day, a single reduction is capped at JPY 5,000. For an employee paid JPY 300,000 a month, even several sanctions cannot reduce that month's pay by more than JPY 30,000 in total.

To impose a sanction at all, its type and severity must be set out in the work rules (Labor Standards Act, Art. 89, item 9).

6. If a pay cut turns out to be invalid

A pay cut without agreement or reasonableness has no effect, and the employer must pay the difference from the proper wage. Wages must in principle be paid in full (Labor Standards Act, Art. 24(1)).

The statute sets the limitation period for wage claims at five years, but for the time being it is three years (Labor Standards Act, Arts. 115 and 143(3); five years for retirement allowances). An employer can therefore face a claim for up to three years of shortfall at once.

7. Consider other ways to reduce labour costs as well

Cutting base pay hits employees' livelihoods hard and tends to weigh heavily when reasonableness is assessed. When a company has to justify the change in court, it is also likely to be asked whether it tried other measures first.

A common order is to start with measures other than employees' wages, such as reducing directors' pay and cutting expenses. Next come options that avoid lowering wages already promised, such as deferring pay rises or reducing overtime. If that is still not enough, limiting the cut to a fixed period or phasing it in with transitional measures can reduce the disadvantage.

Recording which measures were chosen, and why others were not enough, gives the company material to explain its decision if a dispute arises later.

What you can do now

・Work out which of the four types the planned pay cut falls into.
・Check whether the work rules and wage regulations contain a basis for pay reductions, demotions or downward pay adjustments.
・If seeking the employee's consent, prepare a written explanation stating the amount, period and reason.
・If changing the work rules, assemble figures showing why the cut is needed and an estimate of its effect on each employee.
・For a disciplinary reduction, calculate the average wage and confirm the amount is within the cap in Article 91 of the Labor Standards Act.
・For past pay cuts, check whether consent forms and records of the explanation given still exist.

When to consult a lawyer

・When the company starts considering a company-wide pay cut because of poor results.
・When a union or employee representative objects to a pay cut.
・When an employee or former employee sends a letter or certified mail claiming the pay they lost.
・When the Labour Standards Inspection Office contacts the company or gives notice of an inspection about wage payments.

Frequently asked questions

Q. If business is bad, can the company cut pay on its own judgment?
Poor results alone do not allow a unilateral pay cut. The company needs the employee's consent, or a change to the work rules that is reasonable (Labor Contract Act, Arts. 8 to 10). A downturn is one of the circumstances considered as "the need for the change" when reasonableness is assessed.

Q. If the employee signs a consent form, is the pay cut always valid?
Not necessarily. The Supreme Court looks beyond the signature to the extent of the disadvantage and the explanation given beforehand, to decide whether consent was given freely (Supreme Court judgment of 19 February 2016). An agreement below the standards in the work rules is also invalid to that extent (Labor Contract Act, Art. 12).

Q. How large can a disciplinary pay reduction be?
A single reduction is capped at half of one day's average wage, and the total at one tenth of the total wages for a single wage payment period (Labor Standards Act, Art. 91). Anything beyond that is not allowed.

Q. If the company made an invalid pay cut, how far back will it have to pay?
For the time being, the limitation period for wage claims is three years (Labor Standards Act, Arts. 115 and 143(3)). The company may therefore be asked to pay up to three years of shortfall.

Q.Can a Japanese employer cut an employee’s pay unilaterally? When a pay cut is invalid, and how to proceed lawfully

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