The Indian Employer’s Guide to Termination under the New Labour Codes and Rules: Blue-Collar, White-Collar, and PIP Compliance

In India, employee termination is a critical administrative action with significant legal implications. Historically, HR leaders and business owners navigated a fragmented landscape of legacy central acts and inconsistent state regulations, where minor procedural errors often resulted in protracted industrial disputes.

The legal environment has fundamentally shifted with the implementation of the Four New Labour Codes: (1) the Industrial Relations Code, 2020 ("IR Code"); (ii) the Code on Wages, 2019; (iii) the Code on Social Security, 2020; and (iv) the Occupational Safety, Health and Working Conditions Code, 2019.

Together with the Central Rules, 2026, this framework consolidates 29 archaic laws into a unified statutory system. While the new system remains robust in its protection of worker rights, it provides employers with an objective compliance roadmap through defined procedures and strict statutory timelines—such as the requirement to pay all final wages within two working days of separation.

By strictly adhering to mandated processes, maintaining meticulous documentation, and upholding the Principles of Natural Justice in all disciplinary matters, businesses can manage separations legally and mitigate the risk of Unfair Labour Practices. This guide is designed to eliminate ambiguity and provide certainty in modern exit management.

1. The Critical Divide: "Worker" vs. "Employee"

Before initiating any separation process, an employer must determine the precise legal classification of the individual. The new framework has replaced the legacy term "workman" with a more nuanced definition of "Worker," while maintaining a broader category for "Employee" that encompasses managerial personnel.

The "Worker" (The Highly Protected Category)

Under Section 2(zr) of the IR Code, a "worker" is anyone (except an apprentice) employed in any industry to do manual, unskilled, skilled, technical, operational, clerical, or supervisory work. It explicitly includes working journalists and sales promotion employees. The law also states that any individual employed in a supervisory capacity earning more than INR 18,000 per month (or an amount notified by the Government) is automatically excluded from the "Worker" category and treated as a white-collar employee under Section 2(zr)(iv) of the IR Code.

This category is entitled to the most stringent statutory protections against termination namely:

• Retrenchment Compensation: Must be paid fifteen days' average pay for every year of service (Section 70, IR Code).

• Mass Layoff Rules: Establishments with 300+ workers require prior Government permission for retrenchment or closure (Section 77, IR Code).

• Dispute Reference: Individual termination disputes are automatically deemed "industrial disputes," allowing for direct application to a Tribunal for reinstatement (Section 2(q) and Section 50, IR Code).

  
  

The "Employee" (The Managerial & Administrative Category)

This is the most inclusive category, defined under Section 2(l) of the IR Code and Section 2(k) of the Code on Wages, 2019 as it includes any person employed for wages to do skilled, manual, supervisory, managerial, or administrative work.

Their separation is governed primarily by their Employment Contract and state-specific Shops and Establishments Acts. They generally do not enjoy the retrenchment compensation or "Works Committee" protections of the IR Code. Despite their managerial status, they are strictly protected by the Code on Wages, 2019.

• The Two-Day Rule: Under Section 17(2), all final wages must be paid within two working days of removal, dismissal, or resignation.

• Burden of Proof: Under Section 59, if an employee claims non-payment of dues, the burden to prove payment is on the employer.

2. Structural & Regional Nuances: State Rules vs. Standing Orders

The implementation of the Codes requires navigating specific workforce thresholds and jurisdictional boundaries that determine an employer's administrative burden and liability during separations.

A. The 300-Worker Threshold (IR Code)

As per the Section 28(1) of the IR Code, industrial establishments (factories, mines, plantations) with 300 or more workers must adopt formalised Model Standing Orders. Furthermore, these larger establishments must obtain prior permission from the appropriate government authority before executing any lay-off, retrenchment (downsizing), or closure. For establishments with fewer than 300 workers, prior permission is waived, though statutory notice and severance obligations remain intact.

B. Establishments with Fewer than 300 Workers (Chapter IX)

For smaller establishments, the process is less administratively burdensome but remains strictly regulated. For example, the prior government permission is waived (as explained above); however, employers must still follow the "Conditions Precedent" under Section 70 of the IR Code wherein (i) Workers with one year of continuous service are entitled to one month’s notice in writing (stating reasons) or wages in lieu of notice; and (ii) Employers must pay retrenchment compensation equivalent to fifteen days’ average pay for every completed year of service.

C. The "Appropriate Government" and State Nuances

Because Labour is on the Concurrent List of the Constitution, jurisdiction is split whereby the Central Government governs railways, mines, and major ports. For commercial offices and retail, the State Government holds authority through its specific Shops and Establishments Act.

Therefore, for white-collar "Employees" (managerial/administrative), the terms of separation are primarily governed by their Employment Contract and the rules notified under state-specific Shops and Establishments Acts, which define what constitutes a "shop" in that specific state (Section 2(76), Social Security Code).

It is important to highlight that regardless of state rules, provisions for Gratuity and Maternity Benefit apply to every shop or establishment employing ten or more employees (First Schedule, Social Security Code).

D. The Worker Re-skilling Fund (The New Statutory Cost)

A critical new structural nuance is the Worker Re-skilling Fund under Section 83 of the IR Code wherein, in every instance of retrenching a worker, the employer must contribute an amount equal to fifteen days' wages (based on the last drawn salary) to this fund. Under Rule 37 of the IR (Central) Rules, 2026, this amount must be transferred electronically to the fund within ten days of the retrenchment. This fund is then used to credit the retrenched worker's account within 45 days for their re-skilling.

3. Performance-Based Terminations: Step by Step Process for PIP based Exit

Terminating any staff member, whether a "Worker" or a white-collar "Employee", for low performance without robust documentation is a high-risk action. Under the new codes, arbitrary performance-based exits are often successfully challenged as Unfair Labour Practices (ULP) or "masked retrenchment."

The IR Code, under Section 84 and the Second Schedule (Part I, Item 5), strictly prohibits an employer from discharging or dismissing workers:

• "Not in good faith, but in the colourable exercise of the employer's rights".

• "In utter disregard of the principles of natural justice" or with "undue haste".

  
  

Without a documented PIP, a Tribunal may find that the employer acted in bad faith to circumvent statutory obligations like retrenchment compensation.

4 Steps Employers must follow for Legally Defensible PIP based exit

1. Maintain Clear Evidences: You must maintain documented proof of consistent underperformance over multiple review cycles. This is critical because under Section 59 of the Code on Wages, 2019, if a dispute arises over final dues or the legality of the exit, the burden to prove compliance and justification rests squarely on the employer.

   
   

2. Clear Communication (The "Natural Justice" Requirement): Placing an employee on a formal PIP for a reasonable period (typically 30 to 90 days) fulfills the legal requirement to provide a "reasonable opportunity of being heard". The PIP must explicitly state the performance gaps, the objective metrics required for a "pass," and that termination is the defined consequence of failure.

   
   

3. Active Support & Enablement: Documentation must show that the employer provided guidance, mentorship, or training. If a PIP is designed for failure without support, it is legally viewed as mala fide (bad faith) and a violation of natural justice.

   
   

4. Evaluation & The "Two-Day" Settlement Rule: If performance remains below the threshold at the end of the timeline, compile a final evaluation report. When issuing the termination notice, you must comply with the strict payment timelines of the Code on Wages (Section 17): all final wages must be paid within two working days of the removal or dismissal.

   
   

Critical Distinction: Retrenchment vs. Misconduct

• Retrenchment: If low performance is treated as a non-disciplinary separation, it is classified as "Retrenchment" under Section 2(zh) of the IR Code. For "workers" with one year of service, you must pay retrenchment compensation (15 days' average pay per year of service).

  
  

• Disciplinary Action: If the underperformance is so severe it constitutes "wilful neglect of duty" (as defined in your Standing Orders), you must follow the domestic enquiry process outlined in Section 38.

4. Disciplinary Termination for Breach of Policy or Misconduct: Step by Step Process

If an employee commits an act of gross misconduct (e.g., theft, fraud, physical violence, sexual harassment, or unauthorised absence exceeding 10 consecutive days), you cannot fire them on the spot—even if their contract explicitly states you can. The law explicitly overrides arbitrary contract clauses.

The IR Code classifies dismissing a worker in "utter disregard of the principles of natural justice" or with "undue haste" as a prohibited Unfair Labour Practice (ULP) under Section 84, exposing the company to heavy fines and mandatory reinstatement orders.

To execute a disciplinary exit, you must strictly follow this statutory procedural route:

1. Issue a Formal Show Cause Notice or Notice of Accusation: Serve a detailed written notice to the employee outlining the precise allegations of misconduct. State the specific company policies or statutory clauses breached and grant them a reasonable window (typically 48 to 72 hours) to submit a written explanation.

   
   

2. Evaluate Response & Initiate Domestic Enquiry: If the employee's response is missing, unsatisfactory, or fails to clear them, appoint an independent Enquiry Officer to conduct an internal "Domestic Enquiry." This behaves like a mini-courtroom inside the company to evaluate evidence and witness testimonies objectively.

   
   

3. Manage Suspension & Subsistence Allowance: If the employee is suspended pending the investigation, the enquiry must ordinarily be completed within 90 days. During this suspension, you must pay a mandatory statutory subsistence allowance: 50% of regular wages for the first 90 days, and 75% of wages thereafter if the delay is not caused by the worker.

   
   

4. Final Order Execution & Proportionate Punishment.: The Enquiry Officer must compile a balanced report proving or disproving the guilt based entirely on the evidence. If proven guilty, the management can issue a termination order. The punishment must be proportionate; firing an employee for a minor or technical first-time offence is a prohibited ULP.

5. Post-Exit Financial Compliance: The Mandatory Checklist

1. The "Two-Day" Final Wage Rule

Under Section 17(2) of the Code on Wages, 2019, all wages payable to an employee who is removed, dismissed, retrenched, or who resigns must be paid within two working days of the cessation of employment. This 48-hour deadline applies to all components defined as "wages" under Section 2(y), including earned salary and any remuneration payable under an award or settlement.

2. Mandatory Leave Encashment

According to Section 32 of the OSHW Code, 2019, if a worker is discharged, dismissed, or quits, they are entitled to wages in lieu of their earned leave. Similar to salary, this payment must be completed before the expiry of the second working day from the date of separation.

3. Gratuity Settlements

Under Section 56(3) of the Code on Social Security, 2020, the employer must arrange to pay the gratuity amount within thirty days from the date it becomes payable to the eligible person.

Fixed-Term Eligibility: A significant change in the law is that Fixed-Term Employees are now entitled to statutory gratuity if they render service under a contract for just one year, and this must be paid proportionately.

It is important to highlight that Gratuity can only be forfeited if the employee is terminated for riotous conduct, violence, or an offence involving moral turpitude, and only to the extent of damage caused to employer property.

4. Retrenchment Compensation and Re-skilling Fund

If the termination is classified as "Retrenchment" under Section 2(zh) of the IR Code, Employers must pay compensation equivalent to fifteen days' average pay for every completed year of continuous service at the time of retrenchment.

Also, as per the Section 83 of the IR Code, the employer must contribute an additional fifteen days' wages (based on the last drawn salary) to a government-notified Worker Re-skilling Fund within ten days of the retrenchment.

5. Mandatory Experience Certification

Under Section 56 of the OSHW Code, every contractor or principal employer is legally bound to issue an experience certificate to contract labour giving details of the work performed.

6. Permissible Deductions and the 50% Cap

Under Section 18 of the Code on Wages, employers may deduct for the recovery of advances, loans, or damage/loss of goods expressly entrusted to the employee. However, the Employer cannot deduct for damages automatically; you must give the employee a reasonable opportunity to show cause why the deduction should not be made. Also, the total deductions from the final settlement generally cannot exceed 50% of the worker's wages for that period.

7. The Burden of Proof and Record Retention

Under Section 59 of the Code on Wages, in any claim regarding non-payment of dues, the burden to prove that the dues have been paid is entirely on the employer. Therefore, it is advisable that all registers, wage slips, and records of final payment must be preserved in original for at least five calendar years from the date of the last entry.

Conclusion

The key question is no longer whether an employer can terminate an employee, but whether the termination process can withstand legal scrutiny.

As India's Labour Codes reshape the employment landscape, employers must ensure that every termination decision is supported by proper documentation, fair procedure, and statutory compliance. Investing in robust employment practices today can help prevent costly disputes and regulatory challenges tomorrow.

How Aristo Legal Can Help

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If your organisation requires legal support in navigating growth, compliance, workforce management, or strategic transactions, our team would be happy to assist.

Related Reading

• Performance Improvement Plans (PIP) in India: Employee Rights & Legal Precedents 

• The 4-Year 190-Day Rule: Is “5 Years” a Gratuity Myth in 2026? 

• Are ESOPs "Wages"? Decoding Section 2(y) of the New Labour Code 2026

• The Death of the "Black Box": Why AI Terminations are a Legal Minefield for Indian Employers

• Supreme Court's judgement that wage disputes & termination orders are Non-Arbitrable

FAQs

Q: Does having a "Manager" designation automatically exclude an employee from being classified as a "Worker"?

A: No. Under the new framework, the legal classification of a staff member is determined by a functional test rather than their official job title. According to Section 2(zr) of the Industrial Relations Code, 2020, the definition of a "worker" explicitly excludes those who are employed mainly in a managerial or administrative capacity. If an individual's primary duties are clerical, technical, manual, or operational rather than truly managerial, they remain classified as a "worker" under the law, regardless of whether their designation is "Manager" or "Senior Executive".

Q: What happens if an individual in a supervisory role earns more than INR 18,000 per month?

A: If an individual is employed in a supervisory capacity and their monthly wages exceed INR 18,000 (or an amount notified by the Central Government), they are automatically excluded from the "worker" category under Section 2(zr)(iv) of the IR Code. In this scenario, the individual is classified as a white-collar "Employee".

Q: Does my corporate IT office need government permission to terminate a group of employees? 

A: Generally, no. The requirement for "prior government permission" for retrenchment applies only to industrial establishments (factories, mines, plantations) with 300 or more workers. Corporate offices are typically governed by state-specific Shops and Establishments Acts, which require adherence to notice periods and final settlement timelines but do not require pre-approval for downsizing.

Q: Which law applies in case of termination if my company has branches in multiple states? 

A: For white-collar employees, the Shops and Establishments Act of the specific state where the branch is located will govern notice periods and service conditions. However, for "workers" (blue-collar/clerical), as per the IR Code, the State Government of the branch's location is considered the "Appropriate Government." Therefore, if a termination is challenged, the dispute must be processed through the internal Grievance Redressal Committee (GRC), conciliation officers, and labor tribunals of that specific state. Operating across multiple states does not centralise your termination liabilities.

Q: Is a PIP mandatory before firing an employee for poor performance? 

A: While the Labour Codes do not use the term "PIP," they do prohibit termination in "utter disregard of the principles of natural justice" and "colourable exercise of rights" (IR Code, Second Schedule). A PIP is the standard legal safeguard used to demonstrate that the employer acted in good faith, provided a fair hearing, and had objective justification for the termination.

Q: If an employee fails a PIP, can I terminate them immediately without notice pay? 

A: No. Statutory notice requirements still apply. If the individual is a "Worker" with at least one year of service, they are entitled to one month's notice (or wages in lieu) and statutory retrenchment compensation (Section 70, IR Code). For white-collar "Employees," you must follow the notice period specified in their Employment Contract, ensuring it also meets the minimums in the state-specific Shops and Establishments Act.

Q: If an employee fails a PIP, can I terminate them immediately without notice? 

A: No. Statutory notice requirements still apply. If they are a "Worker" (including supervisors earning < INR 18,000/month), you must provide one month’s notice (or wages in lieu) and pay statutory retrenchment compensation. For white-collar "Employees," you must follow the notice period in their Employment Contract, ensuring it meets the minimums in the state-specific Shops and Establishments Act.

Q: Can I terminate a worker for "minor" performance issues? 

A: No. The Second Schedule of the IR Code prohibits dismissal for misconduct of a "minor or technical character" where the punishment is disproportionate to the offense. Documentation must prove that the performance gap was substantial and impacted business operations.

Q: What are the penalties for missing the 48-hour payment deadline?

A:  Missing the mandatory 48-hour (two-working-day) window to settle all final dues—including salary and leave encashment—exposes employers to severe risks under two separate legal frameworks. Employers face distinct penalties under the Code on Wages (up to INR 50,000 for first-time underpayment) and the OSHW Code, 2019 (a general penalty of INR 2 lakh to INR 3 lakh for contraventions). Moreover, Under the Code on Wages, 2019, authorities can order the employer to pay the outstanding amount plus compensation up to ten times the value of the claim.

For repeat offenders who violate these payment provisions within five years, the law mandates imprisonment for up to three months, in addition to increased fines.

Q: Can an employer deduct the cost of unreturned company assets?

A: Yes, an employer can deduct the cost of unreturned company assets, but this process is strictly regulated by the new Labour Codes to prevent arbitrary or excessive financial penalties.