Are We Headed for the “Fiscal Cliff” of Sequestration?

Like Thelma and Louise in the movie of the same name driving their convertible over the cliff, or even more analogous, like a bunch of lemmings blindly following their leaders over the precipice, as a nation we may be headed over the “fiscal cliff” of sequestration if Congress does not act to avert automatic tax increases and widespread government spending cuts before January 1.

If sequestration occurs, federal contractors face not only the fiscal crisis that would result from losing billions of dollars in federal contracts, but also they would face cut backs in available work and mass layoffs, along with other employment law problems. Even if sequestration is averted at the last minute, all of this still becomes a huge political problem for the administration and Congress if employers must issue advance notices under the Worker Adjustment and Retraining Notification (WARN) Act of impending mass layoffs to their workers, as required by law, on November 3, 60 days prior to the threatened sequestration and shortly before the fall elections on November 6. What a message to send to voters shortly before the election, to take effect just after the holidays, especially given the already reeling economy and high unemployment rates. Economists predict the threat of sequestration could even send the country into the tailspin of a double dip recession.

Exactly what is “sequestration” and why is it being contemplated?

According to the Politico staff in a July 19, 2012, article, “It’s a wonky term long used in congressional appropriations staff rooms but now it’s one of the hottest political issues in Washington. . . Simply put, [a sequester] is the formal term for mandatory cuts to federal programs—the process of cordoning off money that may have been authorized by Congress but is now prohibited from being spent. Literally, the money is being ‘sequestered’—taken away from the federal agencies affected.”

As the article continues:

“The process has been used over the years in other budgets, but now the federal government may be one of the biggest sequestrations of all time: $1.2 trillion in mandatory cuts—half from the military, half from domestic programs. The sequester was invented as part of the debt limit law last year and was meant to act as a punishment of sorts if the deficit supercommittee didn’t come up with a complete package to cut the deficit.

Since the supercommittee failed, the sequester will now go into effect starting next year—slashing more than $500 billion from the military alone…[.]”

So, it’s a plan to reduce the deficit by cutting the budget. Also, if Congress allows current tax deductions to expire at the end of the year without extending them, the result will be to raise taxes.

Sounds like the same old political food fight: increase taxes on the wealthy or cut government spending. Except, it’s not just about tax increases for the wealthy, but ending popular tax deductions used by many Americans including small businesses ,  and it’s not just about cutting wasteful government spending programs. “Sequestration” is indiscriminate—it would cut spending across the board, although a disproportionate amount would come from the military budget.

On July 25, 2012, Congress passed and sent to the President for signature the Sequestration Transparency Act of 2012, which would require the White House to outline what budget items would be cut under the sequester within 30 days of the law’s enactment. The House of Representatives has passed a spending bill that would avoid the sequester, although the Senate, which has not passed a budget in over three years, has not passed a companion bill. Thus, the problems posed by sequestration are unlikely to be resolved before Election Day.

But that’s not the only problem for federal contractors. Further complicating the issue is how and when to inform their employees of the consequences of “sequestration”—i.e., mass layoffs.

What’s an Employer to Do?

The federal law is fairly clear: firms expecting mass layoffs, plant closings, or certain other employment losses are required to inform their employees 60 days in advance pursuant to the federal WARN Act of 1988, and if they fail to do so the courts may award backpay and attorneys’ fees for each employee they fail to notify. Obviously, for large employers, the failure to provide timely WARN Act notices could result in tens of millions of dollars in court-imposed backpay and fees for violating the Act.

Now, however, without legal authority over the matter, the U.S. Department of Labor has informed employers that sequestration is too uncertain, and therefore, they need not worry about issuing WARN Act notices to their employees—the law is, in effect, waived. A July 30, 2012, guidance letter from Jane Oates, the Labor Department’s assistant secretary for employment and training, advised government contractors to forget about the warnings to employees. The letter states: “WARN Act notice to employees of Federal contractors, including in the defense industry, is not required 60 days in advance of January 2, 2013, and would be inappropriate, given the lack of certainty about how the budget cuts will be implemented and the possibility that the sequester will be avoided before January.”

That said, courts are not bound by what the Labor Department opines about the applicability of the WARN Act, especially when the Labor Department does so in this way without the formal process associated with issuing regulations. Courts still may impose stiff monetary backpay against employers that fail to provide WARN Act notices. And the Guidance certainly is no silver bullet for employers in defending against laid off workers suing their employers for failing to give the required 60-day notice. As to whether WARN Act notices would be “inappropriate” since sequestration is too uncertain, that’s not the intent of the law—many events requiring worker notification are even less certain.

Also, employers are required by the Securities and Exchange Commission (SEC) to inform it of pending losses through quarterly filings, and the Labor Department certainly has no authority to waive that requirement either.

Of course, this puts government contractors on the horns of a dilemma: break the law or disappoint their government client who is advising them that they do not need to inform their employees of a potential layoff. Quite simply, the administration wants to avoid compounding bad economic news shortly before an election, especially giving employees the bad news that they may be laid off in 60 days—not due to their own actions or anything their employer did, but solely due to the government’s (Congress’s and the White House’s) failure to reach an acceptable compromise to avert sequestration.

Will we leap off the “fiscal cliff” of sequestration? Let’s hope not. But in the process, well-counseled employers are advised to follow the law, not the politics.

Harold (Hal) P. Coxson is a shareholder in the Washington, D.C. office of Ogletree Deakins, and he chairs the firm’s Governmental Affairs Practice Group.