When Mass Resignations Can Push a Company into Insolvency

Today’s End of Service Benefit (EOSB) gratuity system has been the standard in the UAE for decades, and everybody knows it very well. It is about to change - but more about that later.

First, let's remind ourselves how the old (current) system works:

1. Employees who have completed between 1 and 5 years of service are entitled to a gratuity of 21 days' basic salary per year of service

2. Those with more than five years of service are entitled to 30 days of basic salary as gratuity for each year of service

3. Once an employee leaves, all his entitlements are added up and multiplied with his latest basic salary.

It’s a straightforward calculation that's been around for a long time.

Many CFOs and HR Officers are asking: What happens if many employees leave the company in one go?

The first point that needs to be raised is that the current system is unfunded. What does that mean? It means that a company simply needs to recognize the liability of future EOSB payouts on its balance sheet, however, companies are not required to provide physical ring-fenced cash against those liabilities. Usually that is not a problem at all, as most companies are used to pay their employees their gratuity from ongoing operating cash flows.

So far so good, but what in the case of unforeseen events, when many employees resign in one go?

This is where things get complicated. Let us remind ourselves that such a scenario may not be far-fetched at all. Several circumstances may arise where companies need to make mass lay-offs, or many employees all decide to leave a company at the same time. For instance, plausible scenarios may include:

• Company facing a crisis of its own making (e.g., poor product quality, wrong strategic decisions, pervasive staff discontent, etc)

• Company facing an industry-wide downturn (e.g., a certain industry is particularly hard hit by a new technical revolution, e.g. Artificial Intelligence)

• The whole country facing an economic downturn (e.g., a regional or world-wide recession)

• Other external shocks, such as natural catastrophes, instability, war, terrorism and other significant events.

In all these instances companies may be forced to let employees go en masse - or maybe it’s the employees themselves that suddenly decide to leave.

Which employees leave? This matters greatly

Before we look at an actual example, let’s remind ourselves that averages – e.g. average EOSB liability, average tenure, average salaries – are only a rough guide. In fact, it matters greatly which employees leave. For instance, the accrued liability is much higher for:

• Senior and highly skilled employees, as they have a higher salary

• Long-tenured employees, as they have a high accumulated entitlement.

  
  

Vice-versa, gratuity is relatively smaller for:

• Junior employees and unskilled labour, as their salary is low

• Employees with a short tenure

  
  

Hence, if we are looking at “external shocks” hitting a company, it is worth carefully considering which segments of employees are most likely to depart.

An Example Case

Let’s consider an example case. Say, a company has the following workforce structure:

• Total employees: 50 FTE

• Average basic monthly salary: AED 12,000 (ie, AED600,000 total monthly payroll)

• Average years of service (tenure) of employees: 6 years

In case of a shock event, let’s say 20% of the workforce (10 senior/highly skilled staff) resign simultaneously, or are forced to go.

Such a company is likely to face a EOSB gratuity pay-out of perhaps around AED600,000 - 1,200,000 (depending on the employees' individual data points). That is more than the monthly payroll of the company, no small sum indeed!

And – let’s not forget - according to the Ministry of Human Resources & Emiratisation (MOHRE) rules, this sum must to be paid promptly, in cash, within 14 days, or the company will face MOHRE penalties.

Hence it is not inconceivable that such a “shock” event might push a company into insolvency, which also means that the departing employees may not receive their full gratuity entitlement.

What to do?

Firstly, we are happy to note that help is on the way: with the introduction of Cabinet Resolution 96/2023, the UAE has introduced an alternative EOSB system, which is funded, and which prevents companies from facing such stress scenarios. (If you are new to the topic, please read more here how the new system works).

With the new system, gratuity is paid on a monthly basis and invested in regulated funds, and held with secure custodian banks in the UAE. Without a doubt, employees are much better protected than before. And – companies are better protected too, as the random “lump sum” nature of the old EOSB payouts is replaced by a predictable, regular and budgetted “pay-as-you-go” mechanism.

Secondly, we recommend that CFO’s run stress-test-scenarios to test whether their liquidity can withstand such adverse events. And take action accordingly, e.g. by

• Putting money aside for potential cash crunch scenarios. In particular, start putting actual real assets (e.g., deposits) against the EOSB liabilities

• Enrolling (at least part of) the employee base into the new EOSB saving scheme, to start transitioning to the new funded EOSB model.

  
  

Such scenario planning and recommendations are often cumbersome – we recommend that companies take appropriate advice from a licensed professional financial adviser.

PS: GratuityAdviser will release an EOSB Cash-Flow simulator soon. Please subscribe to GratuityAdviser to be informed of the release of this tool, and all other news related to UAE’s EOSB System!