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Calculation of the End of Service Gratuity after a Termination Agreement

Guiding Principle

The UAE Labour law (Federal Labour Law No. 8/1980) determines that the calculation of gratuity differs for an employee, who has resigned and an employee, whose employment contract has been terminated by the employer. Therefore, while calculating gratuity for employees relocating within the company’s group, the question emerges: should they be considered as employees who have resigned or employees whose contract has been terminated. And consequently: is a formal termination letter necessary in both of the above mentioned cases?

A. Scenario

Once a company has decided to expand its footprint in the Middle East and African Region and sets up offices and/or different legal entities in different countries in the region it is during this process, where considerations are made to relocate some employees to different countries in order to take up new assignments/positions.

Sometimes the wish for such relocation is driven by the employee (he looks for a different opportunity in the company group). Sometimes, the change is based on supervision and advice from the management (and thus driven by the management offering a better position in a new entity in the region, where he/she can take charge of the particular market. These different offices may be under the same regional management or might be legally independent entities within the company/s group.

B. Termination of the Employment Contract

With the enactment of the Labour Law the UAE implemented a so-called “End of Service Gratuity”-System. The law requires the employer in compliance of certain conditions to pay an employee a specific amount of money after termination/ending of the employment relationship.

Referring to Article 113 of the UAE-Labour Law (“UAE-LL”) an employment contract will be terminated under one of the following cases:

(a) Both parties agree to the termination of the contract under the provision that the employee consents to this in writing.

(b) If the contracted period expires, unless the contract has been explicitly or implicitly extended according to the rules of the Law. – Limited employment contract.

(c) If a contract with an indefinite term was terminated by one of the parties under the conditions set out by the Law regarding notice and the acceptable reasons to cancel the contract without arbitrariness. – Unlimited employment contract.

In any event the leading motivation is to avoid a period without planning security between the date of termination and a new contract is signed. It is also preferable for both parties to know the new conditions for the contract when the old contract is terminated. Based on these advantages, it is relevant if there are legal effects according the UAE-LL in particular for the calculation of the End of Service Gratuity.

C. End of Service Gratuity (“ESG”)

I. Duration of Employment and Calculation of the ESG

Employees, who at least served one year continuously, are entitled to the ESG. In the first five years of employment the employee’s severance pay amounts to 21 calendar days’ salary for each completed year of continuous service (Article 132 (1) UAE-LL). After five years of employment, the amount is calculated at 30 calendar days’ salary for each year of service (Article 132 (1) UAE-LL). The assessment of the ESG payment is based on a pro-rata basis. Under the requirement of 12 month continuous service an employee is also entitled to “severance pay for any fraction of a year he actually served” (Article 133 UAE-LL). However, the maximum ESG amount shall not exceed two years salary (Article 132 UAE-LL).

According to Article 134 UAE-LL, the amount will be assessed by the employee’s basic salary at the time of termination This does not include additional expenditures such as “housing allowance, transport allowance, travel allowance, overtime pay, representation allowance, cashier’s allowances, children education allowance, allowances for recreational and social facilities, and any other bonuses or allowances” (Article 134 UAE-LL).

II. Special provision regarding the amount

1. Reduction of the Amount

In the case of open debts, Article 135 UAE-LL provides that “an employer may deduct any amounts owed to him by a worker from the severance pay”.

According to Art. 137 UAE-LL, in case the employee terminates an unlimited contract on “his own initiative” after a minimum of one year and less than five years continuous service, the amount will be assessed as follows:

• 1-3 years of continuous service : 1/3 of the severance pay

• 3-5 years of continuous service : 2/3 of the severance pay

• after 5 years of continuous service : Full amount

In the event of termination of a limited term contract on his own initiative prior to the expiry of his contract period, Article 138 UAE-LL requires a minimum of five years employment to entitle the employee for the severance pay.

Exceptions from the reduction of the severance pay only apply for employees who are employed in the Jebel Ali Free Zone, the Dubai Airport Free Zone and the Dubai International Financial Centre.

a) The Change is driven by the Employee

In the case that the relocation is driven by the employee it is possible that Art 137 UAE-LL is relevant. Depending on the translation Art. 137 UAE-LL reads

“Where a worker under an indefinite term contract abandons his work at his own initiative after a continuous service of not less than one year and not more than three years, he shall be entitled to one-third of the severance pay provided for in the preceding article. Such a worker shall be entitled to two thirds of the said severance pay if his continuous service exceeds three years up to five years, and to the full severance pay if it exceeds five years.”

Whereas this translation refers to the fact who initiated the termination “on the employee’s initiative”; another translation reads “if the employee resigns the contract”. Both wordings relate to the fact whether the reason for termination is found in the employee’s free will. However, the main difference is that in the second translation, it seems that a formal termination by the employee is requested and it also not clear whether the amount will be reduced even though the contract has been terminated by a mutual agreement between the parties.

b) The Change is advised by the Management

If the relocation has been decided by the management and the employee agreed, there is no doubt that the employer has to pay the full gratuity. Art. 137 UAE-LL is not applicable in this case, because the termination of the contract was not based on the will of the employee. This complies with the position of the Ministry of Labour.

c) The Formal Procedure

The question at hand is if Art. 137 UAE-LL is only applicable if the employees terminated the contract by a formal termination, or also in the case that the parties agree to terminate the contract based on the explicit will of the employee to relocate.

(i) The Arabic Wording

It is advisable to have a look on the Arabic wording to evaluate whether the literal translation of the Arabic wording can answer the question. The literal translation of Art. 137 UAE-LL is “If the employee left the job on his own will” or “free willingly”. Even the Arabic wording does not clearly say that Art. 137 UAE-LL requires a formal termination by the employee and also the possibility of a reduction in case an agreement was initiated by the employee can not be answered from the wording.

It appears that there is a clear gap in the law because this case was not regulated. Fact is that the Arabic wording does not explicitly require a formal termination, but refers to the free will of the employee.

(ii) The Objective of the Provision

Looking at the objective of. Art 137 UAE-LL it appears to be the counterpart for the provision which adjudges a worker a compensation for arbitrarily dismissal (Art. 123 UAU-LL). The compensation is to indemnify the employee for the time he needs to find a new job caused by the termination by the employer. Art. 137 UAE-LL, however, intends to offer compensation for the decision of the employee in case he terminates the contract; the reason is that the employer possibly invested time and money for the initial training of an employee and it is assumed that this investment is made for at least a period of five years. In case of an early termination which was driven by the employee irrespective of the reason the employer has to be indemnified to compensate the initial investments.

Given the objectives of the provision Art. 137 UAE-LL should be applicable where the change is driven by the employee with the effect that the amount has to be reduced accordingly even if the contract was terminated by an agreement because the initial situation is exactly the same. The only difference is the way both parties handle the situation and how can the way the parties find a solution affect the calculation of the End of service Gratuity.

From the point of view of the employee it could be argued that in case the employee will continue the work for in the same group there is no need to punish him for the relocation from one entity to another from the same group because the initial expenses for the training did not become useless. But this might be the case in same cases but can not be the base of a general evaluation.

(iii) The Ministry of Labour

The view of Ministry of Labor regarding this subject is quite clear in case there is no termination by the employee but a mutual agreement no matter who initiated it, the employee is entitled to the full amount; Art. 137 UAE-LL is only applicable if the employee resigns.

2. Conclusion and Recommendation

The point of view explained by the Ministry of Labor is very formalistic. The result is that in case an employee wants to relocate the employer will wait for his resignation before agreeing with him on the new contract. The procedure will be more complicated. It can not easily be done in one step.

Therefore it appears to be preferable to lay down in a termination agreement the reason of the agreement; and explain that this is made to avoid the formal procedure of a termination and a new contract; based on that the agreement will consider Art. 137 UAE-LL as applicable and this consideration should be declared as fundamental for the agreement. If this way of proceeding will withstand a judicial examination is not clear, a judge could see a conflict with mandatory provisions as the effect is the deduction of the ESG by an agreement.

If a judge would declare the consideration of the application of Art 137 UAE-LL as invalid, the entire agreement will be invalid with the consequence that the old contract will revive. But this result would be the opposite of the leading motivation of the employee. It was his will to relocate and to have the new contract and the company followed his desire. Therefore we can almost exclude that it will come to a judicial examination because the employee will never file a claim.

D. Final Conclusion

  • In case the relocation is initiated by the employee and the employer aim to find a solution, a possible mutual agreement should contain that the situation corresponds to the described situation in Art. 137 UAE-LL and that this is the fundamental base of the agreement. The other option is that the employee should resign officially and then sign the new contract with the possible disadvantage regarding the planning security.
  • In case the management advised the relocation, the employer can simply make the termination agreement; the employee is entitled to the full amount.
  • In case the employee is entitled to other retirement pension, this should be considered as well in a termination agreement.
July, 2013 Francesco Jorno
Meyer-Reumann & Partners, Dubai Office
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