California Supreme Court Recognizes New Cause of Action for Wrongful Demotion

California employers are all too familiar with claims of wrongful discharge by terminated employees who allege that they were party to an implied contract with the employer, under which they could not be discharged without just cause. Recently, the California Supreme Court recognized a new cause of action for employees who are not discharged but merely demoted, without good cause. In Scott v. Pacific Gas & Electric Company, 11 Cal.4th 454, 46 Cal.Rptr.2d 427 (1995), a jury found that there had been an implied contractual agreement between P.G.&E. and the plaintiffs not to demote without good cause and that P.G.&E. had breached that agreement. A unanimous California Supreme Court, in an opinion by Justice Stanley Mosk, upheld the jury verdict of $1.4 million and became the first and only high court in the country to establish implied contractual liability for wrongful demotion.

The plaintiffs in the Scott case, C. Byron Scott and Al Johnson, had each been employed by P.G.&E. as engineers for over 20 years. In 1979, Scott and Johnson started an outside consulting business. Work for the consulting business was done only outside regular working hours. Several other P.G.&E. employees were also employed by Scott and Johnson, and these employees also worked only on their off hours. There was no company policy prohibiting P.G.&E. employees from engaging in outside businesses so long as such businesses did not create a conflict of interest with P.G.&E., nor was there a company policy against hiring P.G.&E. employees for outside businesses. Scott and Johnson’s outside business was well known throughout P.G.&E. management.

In 1988, P.G.&E. began an investigation into plaintiffs’ supervisory practices and outside business interests. The investigation resulted in charges that plaintiffs were negligent supervisors and that their outside business gave rise to a number of conflicts of interest in which P.G.&E. was disadvantaged.

Consequently, plaintiffs were suspended with only a brief explanation of the charges against them. Over a month later, they were finally permitted to read the report outlining the charges against them but were denied a copy of the report. They were given three days to respond to the charges, which they did at length and with extensive documentary support. Scott and Johnson were nevertheless demoted to positions they last held over a decade earlier, and they were relieved of all supervisory authority. Their salaries and benefits were reduced by approximately twenty–five percent.

Plaintiffs then sued, alleging, among other claims, that P.G.&E. had breached an implied contract not to demote employees without good cause. The plaintiffs’ contract theory was based largely on P.G.&E.’s detailed personnel policies, in particular P.G.&E.’s system of “positive discipline.” Set forth in a document entitled “Pacific Gas and Electric Company: Positive Discipline Guidelines,” P.G.&E.’s discipline system outlined progressively more serious, but constructively oriented, responses to employee misconduct.

The guidelines provide that, if an employee has a conduct, attendance, or work–performance problem, “disciplinary action may be necessary to correct the situation.” The guidelines detail a series of steps to be taken to remind the employee of performance expectations, including “coaching and counseling” by supervisors, followed by an oral reminder and a written reminder. The process is concluded with a “decision-making leave” in which an employee is given a paid one–day leave to consider whether or not he or she can comply with P.G.&E.’s standards. Demotion is discussed as a disciplinary step short of discharge, appropriate when the employee shows an “ability deficiency.”

Scott and Johnson argued that P.G.&E. had not followed these policies when it demoted them without cause. At trial, P.G.&E. managers were unable to point to any specific conflict of interest on the part of the plaintiffs, and little evidence was submitted to show that plaintiffs’ outside work interfered with their duties at P.G.&E. Consequently, a jury found that there had been an implied contract between P.G.&E. and plaintiffs not to demote without good cause and that P.G.&E. had breached that agreement.

In the Scott opinion, the California Supreme Court ruled that the evidence did indicate that P.G.&E. intended to bind itself to its disciplinary policies. The guidelines stated that it was P.G.&E.’s intention that the disciplinary process be uniformly applied to all employees, and one of P.G.&E.’s personnel managers testified that P.G.&E. expected employees to rely on company disciplinary policies. Finally, the Court found no evidence that the disciplinary policy was merely followed at the discretion of P.G.&E. management. Consequently, the Court affirmed that P.G.&E. had breached an implied contract not to demote without good cause.

In support of the establishment of the new wrongful demotion cause of action, Justice Mosk wrote that an employer’s policy that its employees will not be demoted except for good cause can become an implied term of an employee contract just as a policy restricting termination or providing severance pay. Although there is strong common–law presumption that an employee may be demoted at–will, that right is not absolute, and the trier of fact (i.e., the jury) may look to the employer’s policies, practices, and communications in order to infer a policy limiting demotion to situations where good cause is present.

Justice Mosk also stated that once the trier of fact determines that an implied agreement not to demote without good cause exists, its inquiry into whether there was “good cause” for the demotion is identical to the inquiry made in the wrongful discharge context. The Court defined “good cause” as essentially a “fair and honest cause or reason, regulated by good faith on the part of the party exercising the power” as opposed to one that is “trivial, capricious, unrelated to business needs or goals, or pretextual.”

The Court’s opinion does concede that many employers will view the Scott decision with great concern that they will become embroiled in numerous lawsuits over trivial employment matters. Consequently, Justice Mosk provided an outline of how employers, through traditional principles of contract law, can prevent excessive intrusion by the courts into the employment relationship.

First, employers have the ability to alter their policies and practices to avoid unwanted contractual obligations. Employers seeking to avoid implied contract causes of action such as wrongful demotion or wrongful termination should undertake audits of their inventory of personnel forms, recruitment practices, offer letters, applications forms, employee handbooks, and benefit plans, to ensure that they contain no express or implied promises of just cause protection. By taking these actions, a company can significantly limit its exposure to wrongful discharge and wrongful demotion claims.

The Court also observed that vague promises about the terms and conditions of employment that provide no definable standards will not support enforceable contract claims. By way of example, Justice Mosk cited as unenforceably vague promises “reasonable salary increases,” “reasonable annual bonuses” and the right to “actively and meaningfully participate.”

At a practical level, the most troubling aspect of the Scott decision may be the inherent uncertainty as to what constitutes a “demotion.” There is little California case law defining the term demotion, but the Scott case is likely to give rise to litigation over whether and when a reduction in rank, salary, or responsibility is serious enough to constitute a demotion and therefore to form the basis for a claim of wrongful demotion.

In summary, the Scott v. P.G.&E. decision is a troubling development for California employers. At the same time, there is a silver lining. Employers should accept the Court’s invitation that they limit their exposure to so-called wrongful demotion claims (and perhaps all other implied contractual claims including wrongful termination) by “consistently articulat[ing] and implement[ing] policies designed to preserve their traditional prerogatives.” This can be accomplished by undertaking a thorough audit of existing forms, policies, and procedures to ensure that all communications with employees make it clear that there is no requirement of good cause as a prerequisite to either demotion or termination.