Philippine labor law balances the employer's management prerogative to conduct business with the employee's constitutional right to security of tenure. Separation pay serves as financial assistance for employees terminated due to authorized causes beyond their control, such as company closure. The interplay between closure and transfer to a new principal—whether through change of ownership, management, asset sale, or shift in contracting arrangements—raises critical questions about when employees remain entitled to separation pay.

Legal Basis for Separation Pay in Company Closure

The primary legal foundation is Article 298 (formerly Article 283) of the Labor Code of the Philippines, which authorizes termination due to closure or cessation of business operations, provided it is not intended to circumvent employee rights. The provision states that the employer may terminate employment for reasons including the closing or cessation of operations, with prior notice requirements.

Separation pay is mandatory in closures unless specific exceptions apply. For closures or cessation of operations not due to serious business losses or financial reverses, affected employees receive separation pay equivalent to one (1) month pay or at least one-half (1/2) month pay for every year of service, whichever is higher. A fraction of at least six (6) months counts as one full year.

In contrast, terminations due to redundancy or installation of labor-saving devices carry a higher rate: one (1) month pay or one (1) month pay per year of service, whichever is higher. Retrenchment to prevent losses and qualifying closures follow the one-month or one-half-month-per-year formula.

The law explicitly ties the standard separation pay rate to closures "not due to serious business losses or financial reverses." When closure stems from serious and proven business losses, employers are generally not obliged to pay separation pay, provided the closure is bona fide and the employer substantiates the financial reverses with clear evidence, such as audited financial statements. The burden of proving the legitimacy of the closure and the existence of serious losses rests squarely on the employer.

Requirements for a Valid Closure Entitling Employees to Separation Pay

For separation pay to become due, the closure must meet these conditions:

Bona Fide Closure — The shutdown must be genuine, permanent, and not a subterfuge to dismiss employees or evade obligations. Courts scrutinize whether the decision stems from legitimate business considerations rather than anti-union animus or bad faith.
Procedural Due Process — The employer must serve written notice to the affected employees and the Department of Labor and Employment (DOLE) at least thirty (30) days before the intended termination date. Failure to comply does not invalidate the closure if substantive grounds exist, but it may result in nominal damages.
Payment of Separation Pay and Other Benefits — Where required, separation pay must be tendered together with final wages, 13th-month pay, accrued leaves, and other due benefits.

Project employees or those hired for a specific undertaking whose term naturally expires are generally not entitled to separation pay upon completion, as their employment ends by agreement rather than employer-initiated closure.

The Concept of Transfer to a New Principal and Its Impact on Separation Pay

The phrase "transfer to a new principal" commonly arises in two contexts: (1) change of ownership or management of the business, and (2) job contracting or subcontracting arrangements where the client (principal) engages a new service provider (contractor).

Change of Ownership, Management, or Business Transfer

A mere change in ownership, corporate name, or management does not automatically terminate employment or trigger separation pay. The new owner or entity steps into the shoes of the predecessor, and the employment relationship continues uninterrupted. Employees retain their tenure, benefits, and collective bargaining agreements. No separation pay is due because no dismissal occurs.

This principle stems from the successor-employer doctrine: when the business or undertaking transfers and operations continue substantially unchanged, the successor assumes the predecessor's labor obligations. Courts pierce through formal changes if they appear designed to evade liabilities.

Distinctions matter:

Stock sale or merger — The corporate entity persists; employment continues seamlessly.
Asset sale — The seller may close operations and pay separation pay under Article 298 if terminating employees. The buyer has no automatic duty to absorb the workforce unless contractually agreed or bad faith is shown.
Complete cessation followed by new entity — If the old employer genuinely closes and a new, unrelated entity starts operations, the old employer owes separation pay (subject to the serious-loss exception). Rehiring by the new entity creates fresh employment without carrying over prior obligations, unless facts indicate continuity or circumvention.

If the transfer involves redundancy or restructuring, the new or surviving entity may invoke authorized causes and pay separation pay after proper notice and justification.

Job Contracting and Subcontracting Arrangements

In legitimate job contracting under Department Order No. 174-17 (DO 174), the contractor (not the principal/client) serves as the direct employer. When the service agreement with the principal ends or the principal engages a new contractor, the following rules apply:

The contractor must exert reasonable efforts to reassign employees to other principals or projects.
Employees may opt to wait for re-employment within a reasonable period (often referenced as three months in related guidelines) or resign and transfer.
If the contractor cannot provide new assignments and effectively ceases operations for those employees, separation pay becomes due from the contractor, computed under Article 298. Employees generally cannot claim separation pay directly from the principal in legitimate contracting.

In labor-only contracting (prohibited and treated as direct employment by the principal), the principal bears employer responsibilities, including separation pay obligations.

Security agencies and manpower providers frequently encounter "transfer to new principal" scenarios. When a client switches agencies, the old agency must pay separation pay if it terminates employees without re-assignment. Absorption by the new contractor does not automatically relieve the old contractor of obligations unless employees voluntarily resign or transfer without claiming benefits from the prior employer. Voluntary resignation to join the new contractor typically waives separation pay claims against the old employer.

Courts examine substance over form: if employees continue the same work at the same site under a new contractor without significant interruption, the arrangement may be scrutinized for circumvention of tenure rights.

Computation of Separation Pay

Separation pay is calculated using the employee's latest basic salary (including regular allowances integrated into the pay). The formula follows the applicable rate under Article 298:

Standard rate (most closures and retrenchment): One month or ½ month per year of service, whichever higher.
Redundancy rate: One month or one month per year, whichever higher.

Example: An employee with 5 years and 7 months of service earning P20,000 monthly basic pay would receive at least P20,000 × 5.5 (treating the fraction as a full year in some computations, but precisely applying the rule) or the higher of the two options depending on the cause.

Additional considerations include:

Inclusion of other benefits in final pay.
Tax treatment: Separation pay due to authorized causes like closure is often subject to withholding tax, though specific exemptions may apply under the National Internal Revenue Code for causes beyond the employee's control.
CBA or company policy may provide more generous terms, which prevail if more beneficial.

Employee Rights and Remedies

Entitled employees may demand separation pay through demand letters or direct negotiation. If unpaid, they can file a complaint with the NLRC within three (3) years from the date the cause of action accrues. Illegal dismissal claims (e.g., where closure is found not bona fide or procedural requirements ignored) may yield reinstatement, full backwages, moral and exemplary damages, and attorney's fees in addition to or in lieu of separation pay.

In transfer scenarios, employees may challenge non-absorption or unfavorable new terms as constructive dismissal if they result in demotion, reduced benefits, or unreasonable conditions.

Employer Obligations and Defenses

Employers must:

Prove the closure's legitimacy and, where claimed, serious business losses.
Comply strictly with notice requirements.
Pay all due amounts promptly to avoid liability for interest and damages.

Defenses include voluntary resignation, expiration of fixed-term contracts, or valid successor arrangements where no termination occurred.

In contracting, principals bear limited liability (primarily wage payment solidarity in certain cases), while contractors shoulder separation obligations.

Philippine jurisprudence consistently emphasizes that while employers enjoy business judgment, this prerogative yields to constitutional protections for labor. Closures and transfers are valid exercises of management rights only when exercised in good faith and with full compliance to due process and separation pay rules where applicable. Employees facing closure coupled with transfer to a new principal should carefully evaluate whether their employment truly ended or merely continued under a successor, as this determination directly governs entitlement to separation pay.