Discriminatory opportunism: why undertaking self-employment to mitigate damages creates unique challenges.

Author:McIntyre, Thomas J.

"The notion that starting one's own business cannot constitute comparable employment for mitigation purposes not only lacks support in the cases, but has a distinctly un-American ring.... [But] [t]he ADEA must not be used as a tool for insuring a plaintiff's fledgling business while it continues to sustain losses." (1)

  1. INTRODUCTION

    To sustain a backpay award following a wrongful termination, the terminated employee has a duty to mitigate damages by exercising reasonable diligence in seeking comparable employment. (2) The net damages award is then calculated by deducting the wages earned in the interim period from the wages the former employee would have continued to earn at the former employer's business but for the wrongful termination. (3) The preferred remedy to make claimants whole is backpay, which is "[t]he wages or salary that an employee should have received but did not because of an employer's unlawful action in setting or paying the wages or salary." (4) Although backpay is an equitable remedy used at the court's discretion, the Supreme Court has made backpay the presumptive remedy for unlawful employment discrimination. (5)

    Mitigation by self-employment, however, creates unique problems that are absent from the more traditional cases, in which the former employee simply searches for comparable work. (6) Some of the problems inherent in self-employment include the risk of the business failing and uncertainty in determining the mitigating value. (7) Thus, the critical question is whether the self-employment "is undertaken in good faith and is a reasonable alternative to seeking other comparable employment." (8)

    The statistically low success rates for new small businesses illustrate the problematic uncertainties inherent in mitigation by self-employment. (9) only seventy percent of new businesses survive at least two years, and only half last at least five years. (10) Thus, there is a reasonable likelihood that a claimant's self-employment venture will fail, leaving the former employer to pay the claimant's full wages through the backpay period without any offsetting mitigation value. (11) Another major issue concerns the valuation of the burgeoning business's profits in the mitigation context. (12) Some courts contend that the reasonable value of services provided by the self-employed should constitute the mitigating value. (13) others conclude that the new business's net profits should be deducted as the mitigating value. (14) Lastly, courts must consider whether employers are essentially insuring their former employee's self-employment venture. (15)

    This Note will explore the effects and ramifications when the former

  2. History

    The law of damages stemming from the employment relationship has evolved significantly over the last two centuries. (20) Developing out of common-law contract disputes, damages for wrongful termination have mostly fallen under the purview of congressional antidiscrimination statutes. (21)

    1. The Common Law and the Duty to Mitigate

      In Ford Motor Co. v. EEOC, (22) the Supreme Court noted that the employee's duty to mitigate is rooted in ancient common law, but the doctrine actually did not appear until the latter part of the nineteenth century. (23) In fact, one early English case, Gandell v. Pontigny, (24) held that a discharged employee may sue as salary becomes due, provided that the employee remains both unemployed and available to return work for the employer. (25) But the mitigation doctrine eventually prevailed: American courts began to impose a positive duty on former employees to mitigate damages, which necessitated a deduction of the interim earnings from the gross backpay award. (26) Ultimately, courts determined that discharged employees should not remain idle, because former employees have a moral duty to mitigate damages. (27) Although the mitigation principle may not be as ancient as the Supreme Court claimed, by the turn of the twentieth century, courts routinely required the discharged employee to seek reasonably comparable employment before collecting backpay. (28)

      Unsurprisingly, courts eventually faced the issue of applying the mitigation principle when the discharged employee mitigated via self-employment rather than by finding reasonably comparable employment. (29) As part of this inquiry, courts struggled to determine the best method for calculating the mitigating value in self-employment cases. (30)

      1. Determining the Reasonableness of Undertaking Self-Employment

        Initially, employers asserted that former employees who choose self-employment should not receive backpay because self-employment could not constitute reasonable mitigation. (31) Courts generally held, however, that self-employment is a reasonable method of mitigation because of the potential benefit to the employer--namely, the elimination of backpay altogether--if the former employee succeeds in the new venture. (32) Some courts required the former employee to exhaust his search for comparable employment before entertaining the idea of self-employment. (33) Generally, however, the former employee may freely choose self-employment in the immediate aftermath of a wrongful termination. (34)

      2. Calculating the Mitigating Value

        Turn-of-the-century courts next faced the challenging issue of how to calculate the mitigating value to be deducted from backpay in the self-employment context. (35) One method deducts the reasonable value of the labor and services--but not capital--that the employee provides to the new business. (36) Employers prefer this method because it guarantees the existence of a mitigating value, even in cases in which the self-employed's new venture operates at a loss. (37) The second method deducts the net profit actually realized by the self-employed's new business. (38) Former employees generally prefer this method because it preserves a greater backpay award due to the smaller--or even nonexistent--mitigating value. (39)

        A secondary problem under the net-profits-of-the-business method is determining whether the profits belong to the business or to the individual. (40) one court, adhering to a strict reading of corporate law, refused to deduct the profits of the former employee's wholly owned corporation, reasoning that those profits belonged exclusively to the corporation; they did not belong to the individual unless paid out in dividends or salary. (41) Most courts, however, have refrained from such a strict reading and instead have attempted to compute a fair mitigating value attributable to the former employee based on the net profits of the business. (42) Furthermore, most courts apply the collateral-source rule, whereby profits derived from passive capital investment in a new business do not count toward the mitigating value, but profits from the former employee's labor and services do. (43)

    2. Congressional Antidiscrimination Statutes

      Throughout the twentieth century, Congress passed statutes that prevented employer discrimination against employees, whether based on union activity, race, age, disability, or other protected conditions. (44) The National Labor Relations Act (NLRA), (45) Title VII of the 1964 Civil Rights Act (Title VII), (46) and the Age Discrimination in Employment Act (ADEA) (47) each provide redress procedures for employees terminated due to discriminatory conduct by the employer. (48)

      1. National Labor Relations Act

        In addition to providing certain employees the right to collectively bargain, the NLRA outlaws discrimination against employees' union activities. (49) To prevent unfair labor practices, Congress created a cause of action whereby employees who face discrimination can seek redress from the National Labor Relations Board (NLRB), which has authority to award backpay. (50)

        Although the NLRA does not contain an explicit mitigation provision within its text, the NLRB and courts read the mitigation duty into the language of the statute, likely due to early common-law decisions. (51) Accordingly, the NLRB and courts routinely hold that self-employment, if undertaken in bona fide good faith, complies with the obligation to mitigate damages. (52)

        Following a wrongful termination, the discharged employee must make reasonable efforts to obtain comparable employment, which may include self-employment. (53) The self-employed's endeavor does not require success, but it does require "an honest good faith effort." (54) Typically, the NLRB and courts find a good-faith effort when the discharged employee starts a new business in a field related to his former employment. (55)

        Furthermore, as long as the former employee does not engage in a willful loss of earnings, the NLRB and the courts generally deem the self-employment reasonable. (56) One notable exception occurred in the case of a discharged employee who operated a small ice-house business with his wife. (57) Though the discharged employee worked a full-time shift, the Fifth Circuit concluded that working at the ice-house business was not bona fide self-employment because the business was registered under his wife's name. (58) The dissent echoed the theme of cases upholding reasonableness of self-employment, claiming that the discharged employee made an honest, good-faith effort to mitigate his damages by working with his wife, and therefore there was no willful loss of earnings that would be detrimental to a backpay recovery. (59)

        Having determined that self-employment can constitute reasonable mitigation of damages, the NLRB and the courts next had to determine the best method for calculating the mitigating value. (60) Unlike the common-law courts, which struggled with determining the best method to calculate the mitigating amount, the NLRB settled on the method of "deducting his net profits from his gross back pay." (61) As an ancillary issue in Golden State Bottling Co. v. NLRB, the Supreme Court tacitly approved the NLRB's method of deducting the net profits of the self-employed's...

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