Termination Laws and Severance Obligations in Malaysia

Malaysia’s employment framework seeks to balance investor flexibility with statutory protection for employees. For foreign investors, mastering termination and severance obligations is central to effective governance, cost control, and dispute prevention. The country’s legal structure is built around the Employment Act 1955, the Industrial Relations Act 1967, and the Employment (Termination and Lay-Off Benefits) Regulations 1980, which together define how notice, inquiry, and severance must be handled.

Compliance is enforced through administrative oversight and Industrial Court proceedings, ensuring that both substance and procedure carry equal weight in any termination decision.

Employee classification and legal coverage

The Employment Act 1955 now governs all employees in Peninsular Malaysia and Labuan, creating a unified framework for employment regulation. Certain entitlements, including overtime and selected benefits, remain limited to employees earning RM4,000 (US$840) or less per month and to specific categories such as manual workers. In Sabah and Sarawak, employment matters continue to fall under separate Labor Ordinances.

Foreign nationals are covered by the same employment laws as local staff. When an employment relationship ends, employers must also notify the Immigration Department to cancel work passes and ensure full regulatory compliance.

Amendments to the Employment Act that took effect on January 1, 2023, broadened worker protection and increased employer responsibility. The reforms raised the salary threshold from RM2,000 (US$420) to RM4,000 (US$840), reduced the maximum weekly working hours from 48 to 45, granted 7 days of paternity leave, introduced flexible work arrangements, and prohibited workplace discrimination. These updates extended statutory coverage to a wider segment of the workforce and expanded the scope of compliance for employers operating in Malaysia.

Legal grounds for termination

Employment in Malaysia can only be ended for legitimate and defensible reasons. The law requires both a valid basis and a fair procedure, known collectively as “just cause and excuse.” If either element is missing, a dismissal can be ruled unlawful, regardless of the employer’s intent.

There are four main situations where termination is generally accepted. The first is misconduct, which includes dishonesty, theft, harassment, absenteeism, or insubordination. The second is poor performance, where the employee fails to meet reasonable expectations despite warnings, counseling, and time to improve. The third is redundancy or retrenchment, which applies when a position becomes unnecessary because of restructuring, automation, or cost control.

The fourth is expiry of a fixed-term contract, valid when the role was genuinely temporary and not extended repeatedly to avoid permanent status.

Employers may also offer mutual or voluntary separation arrangements during reorganization. These are lawful when both sides agree freely, and the terms are clearly documented.

Certain reasons are prohibited. Termination due to pregnancy, union activity, discrimination, or filing a complaint with authorities is unlawful and can result in reinstatement or compensation orders.

Even when the reason for termination is valid, the procedure must still be fair. The employer must notify the employee of the issue in writing, conduct an internal review or inquiry, and allow the employee to respond before any decision is made. Failing to follow these steps can make an otherwise legitimate termination invalid in law.

For foreign investors, understanding how reason and procedure work together is key to managing workforce risk. Clear policies, proper documentation, and consistent application of process protect both the company and its reputation when employment must be brought to an end.

Notice period and payment in lieu

The Employment Act sets clear minimum notice periods before an employment contract can be ended. Employees with less than 2 years of service are entitled to 4 weeks of notice.

Those with 2 to 5 years must receive 6 weeks, and those with more than 5 years are entitled to 8 weeks. Companies may offer longer notice in their contracts, but cannot set a shorter period than the law allows.

Employers who need to end employment immediately can make payment in lieu of notice instead of waiting for the period to pass. The payment must equal the salary the employee would have earned during the notice period, and the employee should confirm receipt in writing. Observing this step is important because even a legitimate termination can be challenged if notice obligations are not properly met.

Severance pay and termination benefits

Employees who have completed at least 12 months of continuous service are entitled to termination benefits under the Employment (Termination and Lay-Off Benefits) Regulations 1980, unless they are dismissed for misconduct or choose to resign. The amount depends on the length of service. Employees with less than 2 years receive 10 days’ wages for every year worked.

Those with 2 to 5 years receive 15 days’ wages per year, and those with more than 5 years receive 20 days’ wages per year.

For example, an employee earning RM4,000 (US$840) per month with 6 years of service would be entitled to around RM18,462 (US$3,877). The calculation is based on the daily wage of RM4,000 divided by 26, multiplied by 20 days, and by 6 years of service.

Compensation for loss of employment is generally exempt from income tax up to RM10,000 (US$2,100) for each completed year of service, with full exemption available in cases of ill health, according to Inland Revenue Board guidelines.

To put the cost in perspective, a company retrenching 10 employees earning RM6,000 (US$1,260) per month, each with 5 years of service, would incur roughly RM173,000 (US$36,400) in severance payments before accounting for notice and accrued leave. This illustrates how severance planning directly affects workforce budgeting and cash flow.

Redundancy and retrenchment

Redundancy is permitted in Malaysia when it arises from genuine business reasons such as restructuring, automation, or financial constraints. Before proceeding, employers must file Form PK, known as the Employment Retrenchment Notification, with the Department of Labor. This form notifies the government of the planned layoffs, explaining the reason, number of employees affected, and expected implementation date. It must be submitted before the retrenchment takes place and again after completion to confirm the outcome.

Selection for retrenchment should be based on fair and objective criteria. Many companies apply the “last in, first out” principle, but adjustments can be made when certain roles or skills are critical to operations. If the decision is well-documented and supported by clear business justification, redundancy is generally recognized as a lawful ground for termination.

Dispute resolution and industrial court process

If an employee believes they were unfairly dismissed, they can file a claim with the Industrial Relations Department within 60 days of termination. The process starts with a conciliation meeting led by the Director General of Industrial Relations, aimed at helping both parties reach a settlement. If no agreement is reached, the case moves to the Industrial Court for a formal hearing.

The court can order reinstatement, award compensation in place of reinstatement, or grant back pay for up to 24 months. On average, about 35 percent of dismissal cases are decided in favor of employees. Hearings usually take 9 to 12 months to conclude, and defending a case typically costs employers between RM30,000 (US$6,300) and RM50,000 (US$10,500).

For foreign investors, these figures highlight a simple reality: maintaining compliance and clear records is far less costly than facing litigation. A well-documented termination process remains the best protection against disputes.

Building confidence in employment governance

Managing terminations in Malaysia requires structure and consistency. The 2022 amendments expanded employee protection and placed greater responsibility on employers to follow proper procedures and keep clear records. For foreign investors, strong HR governance signals reliability to both regulators and staff.

When companies maintain accurate employee classifications, apply procedures consistently, and review practices regularly, they reduce legal exposure and strengthen trust within the organization. A transparent and well-managed termination process not only protects compliance but also reinforces long-term investor confidence in Malaysia’s labor environment.

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