10.3 Severance agreements and releases
7 min read•august 20, 2024
Severance agreements are contracts between employers and departing employees that outline separation terms. They typically include severance pay, benefits continuation, and release of legal claims. These agreements help manage risks associated with terminations and can benefit both parties.
Key components include severance pay, benefits continuation, release of claims, , and . For employers, they mitigate legal risks and protect company interests. For employees, they provide financial support and maintain benefits during job transitions.
Severance agreements overview
- Severance agreements are contracts between employers and departing employees that outline the terms and conditions of the employee's separation from the company
- These agreements typically include provisions for severance pay, benefits continuation, and release of legal claims against the employer in exchange for the employee's agreement to certain terms and conditions
- Severance agreements are an important tool for managing the risks and liabilities associated with employee terminations and can provide benefits for both employers and employees
Key components of severance agreements
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- Severance pay provisions outlining the amount and timing of payments to the departing employee (lump sum or installments)
- Benefits continuation provisions specifying the duration and scope of continued health insurance, life insurance, or other employee benefits
- Release of claims provisions where the employee agrees to waive their right to sue the employer for any claims related to their employment or termination (wrongful termination, discrimination)
- Non-compete and non-solicitation clauses restricting the employee's ability to work for competitors or solicit clients or employees for a specified period
- Confidentiality and non-disparagement clauses prohibiting the employee from disclosing confidential information or making negative statements about the employer
- Return of company property provisions requiring the employee to return any company-owned equipment, documents, or materials
Benefits for employers
- Mitigate legal risks by obtaining a release of potential claims from the departing employee
- Protect confidential information and trade secrets by including non-disclosure provisions
- Maintain a positive reputation by including non-disparagement clauses
- Prevent departing employees from immediately joining competitors through non-compete agreements
Benefits for employees
- Receive financial support during the transition period between jobs through severance pay
- Maintain health insurance and other benefits for a specified period after termination
- Obtain a positive reference or agree to a neutral reference from the employer
- Negotiate favorable terms, such as an extended notice period or outplacement services
Negotiating severance agreements
- Severance agreements are often negotiable, and the terms can be customized to meet the needs and interests of both the employer and employee
- Negotiations typically involve the amount of severance pay, duration of benefits continuation, scope of release provisions, and any additional terms or conditions
Employee leverage in negotiations
- Length of employment and seniority within the company
- Circumstances surrounding the termination (layoff, performance issues, or voluntary resignation)
- Potential legal claims against the employer (discrimination, harassment, or retaliation)
- Specialized skills, knowledge, or relationships that are valuable to the employer
Employer considerations during negotiations
- Consistency with company policies and past practices regarding severance
- Budget constraints and financial impact of severance payments
- Potential legal risks and liabilities associated with the termination
- Reputational concerns and impact on employee morale and retention
Releases in severance agreements
- Releases are provisions in severance agreements where the employee agrees to waive their right to sue the employer for any claims related to their employment or termination
- Releases are a key benefit for employers, as they provide protection against potential legal claims and liabilities
General releases vs specific releases
- General releases are broad and cover all potential claims, whether known or unknown, that the employee may have against the employer
- Specific releases are limited to certain types of claims or specific incidents and do not waive the employee's right to sue for other claims
Scope of claims released
- Releases typically cover claims related to the employee's hiring, employment, and termination, such as wrongful termination, discrimination, harassment, and retaliation
- Releases may also cover claims related to wages, benefits, and other compensation issues
- Some claims, such as workers' compensation or unemployment benefits, may be excluded from the release
Non-disparagement clauses
- Non-disparagement clauses prohibit the employee from making negative or critical statements about the employer, its products, services, or employees
- These clauses are designed to protect the employer's reputation and prevent the employee from harming the company's business or relationships
- Non-disparagement clauses may be mutual, meaning the employer also agrees not to make negative statements about the employee
Confidentiality provisions
- Confidentiality provisions prohibit the employee from disclosing the terms of the severance agreement or any confidential information obtained during their employment
- These provisions are designed to protect the employer's confidential business information, trade secrets, and other sensitive data
- Confidentiality provisions may include exceptions for disclosures required by law or in response to a subpoena or court order
Enforceability of severance agreements
- Severance agreements are generally enforceable as long as they comply with applicable laws and are entered into knowingly and voluntarily by the employee
- However, there are certain legal requirements and limitations that employers must follow to ensure the enforceability of severance agreements
Compliance with age discrimination laws
- The Age Discrimination in Employment Act (ADEA) and Older Workers Benefit Protection Act (OWBPA) set specific requirements for severance agreements offered to employees aged 40 or older
- These requirements include providing the employee with at least 21 days to consider the agreement, a 7-day revocation period, and advising the employee to consult with an attorney
Knowing and voluntary waiver requirement
- For a release of claims to be enforceable, the employee must enter into the agreement knowingly and voluntarily
- This means the employee must have a clear understanding of the terms and consequences of the agreement and not be coerced or pressured into signing
- Employers should provide the employee with sufficient time to review the agreement and seek legal advice if desired
Revocation periods
- Under the OWBPA, employees aged 40 or older must be given a 7-day revocation period after signing a severance agreement
- During this period, the employee can revoke their acceptance of the agreement without penalty
- Employers should not provide any severance payments or benefits until after the revocation period has expired
Tax implications
- Severance payments are generally considered taxable income to the employee and subject to federal, state, and local income taxes, as well as Social Security and Medicare taxes
- Employers are required to withhold and remit these taxes from severance payments, just as they would with regular wages
Severance pay tax treatment
- Severance pay is typically treated as supplemental wages for tax purposes
- Employers can choose to withhold taxes at a flat rate of 22% for federal income tax or combine the severance pay with the employee's regular wages and withhold taxes based on the employee's Form W-4
- Severance pay is also subject to Social Security and Medicare taxes, which are withheld at the standard rates
Structuring payments for tax efficiency
- Employers and employees may negotiate the structure of severance payments to minimize tax liabilities or maximize tax benefits
- For example, spreading severance payments over multiple tax years may help the employee stay in a lower tax bracket and reduce their overall tax liability
- Employers may also offer to pay for outplacement services or other job-related expenses, which may be tax-deductible for the employee
Severance agreements best practices
- To ensure the enforceability and effectiveness of severance agreements, employers should follow best practices in drafting and administering these agreements
Clear and unambiguous language
- Severance agreements should be written in plain, easy-to-understand language to ensure that the employee fully comprehends the terms and conditions
- Avoid legal jargon or complex terminology that may confuse or mislead the employee
- Use specific and detailed language to clearly define the rights and obligations of both parties
Individualized terms based on circumstances
- Severance agreements should be tailored to the specific circumstances of each employee and termination
- Consider factors such as the employee's length of service, position, reason for termination, and potential legal claims when drafting the agreement
- Avoid using a one-size-fits-all approach, as this may not adequately address the unique needs and risks of each situation
Legal review and compliance
- Before offering a severance agreement, employers should have the agreement reviewed by legal counsel to ensure compliance with applicable laws and regulations
- Legal review can help identify potential issues or risks and ensure that the agreement is enforceable and protective of the employer's interests
- Employers should also ensure that the agreement complies with any internal policies or procedures regarding severance and termination
Alternatives to severance agreements
- While severance agreements are a common tool for managing employee terminations, there are alternative approaches that employers may consider depending on the circumstances
Voluntary resignation programs
- Employers may offer voluntary resignation or early retirement programs to encourage employees to leave the company willingly
- These programs typically offer enhanced severance benefits or other incentives to employees who agree to resign by a certain date
- Voluntary programs can help reduce the need for involuntary layoffs and minimize the risk of legal claims or negative publicity
Early retirement incentives
- Similar to voluntary resignation programs, early retirement incentives are designed to encourage older employees to retire earlier than they otherwise would
- These incentives may include enhanced pension benefits, retiree health insurance, or other financial rewards
- Early retirement programs can help employers manage workforce demographics and reduce labor costs while providing a positive exit for long-serving employees
Retention bonus agreements
- In some cases, employers may offer retention bonuses to key employees to encourage them to stay with the company during a transition period or after a merger or acquisition
- Retention bonus agreements typically provide a financial incentive for the employee to remain with the company for a specified period, such as 6 or 12 months
- These agreements can help maintain business continuity and retain critical talent during times of change or uncertainty
Key Terms to Review (17)
Confidentiality Provisions: Confidentiality provisions are clauses in legal agreements that restrict the sharing of sensitive information disclosed during the term of the agreement. These provisions are essential in protecting the interests of both parties, ensuring that confidential information remains private and is not disclosed to unauthorized third parties. In the context of severance agreements and releases, these provisions help maintain privacy regarding the circumstances of an employee's departure and any related negotiations.
Counteroffer: A counteroffer is a response to an initial offer in which the terms are modified or changed by the offeree. This term is crucial because it indicates a rejection of the original offer while simultaneously proposing new terms, thus initiating a negotiation process. A counteroffer alters the legal landscape of the negotiation, as it signifies that the original offer is no longer valid, and the parties must now consider the new terms presented.
Effective Date: The effective date refers to the specific date when a severance agreement or release becomes enforceable and legally binding. This date is crucial as it marks the transition point when the terms outlined in the agreement begin to take effect, including any obligations, rights, or waivers involved. Understanding the effective date helps both parties know when they can rely on the agreement and can affect the timing of any benefits or payments.
Executive severance package: An executive severance package is a financial compensation and benefits arrangement provided to high-level employees when they leave an organization, often due to termination or restructuring. These packages typically include cash payments, bonuses, stock options, health benefits, and other perks designed to ease the transition for executives leaving their roles. The specifics of such packages can vary significantly based on company policies, individual contracts, and the circumstances surrounding the departure.
Layoff circumstances: Layoff circumstances refer to the specific conditions and reasons under which an employer decides to temporarily or permanently terminate employees from their positions due to factors like economic downturns, restructuring, or changes in business needs. Understanding these circumstances is crucial as they often influence severance agreements and the legal implications that follow an employee's termination.
Legal counsel consultation: Legal counsel consultation refers to the process of seeking advice from a qualified attorney regarding legal rights, obligations, and potential strategies in legal matters. This consultation is crucial for understanding complex legal issues, particularly in employment law where agreements like severance agreements and releases come into play, ensuring that individuals are well-informed before making decisions that could impact their rights or financial security.
Negotiation tactics: Negotiation tactics are specific strategies and methods employed by parties during negotiations to achieve desired outcomes. These tactics can range from persuasive techniques to competitive strategies, influencing how agreements, such as severance agreements and releases, are reached. Effective negotiation tactics can create favorable terms for one party while ensuring the other party feels satisfied with the final agreement.
Non-compete clauses: Non-compete clauses are legal agreements that restrict an employee from entering into competition with their employer for a specified period after leaving the company. These clauses are designed to protect an employer's legitimate business interests, such as trade secrets and intellectual property, by preventing former employees from exploiting sensitive information or client relationships gained during their employment.
Notice requirements: Notice requirements refer to the legal obligations that must be fulfilled by employers when terminating an employee or when certain employment conditions change. These requirements ensure that employees are informed of their rights, the reasons for termination, and any severance packages available to them, fostering transparency in the employment relationship.
Payment Schedules: Payment schedules are structured timelines that outline the specific amounts and due dates for payments made in accordance with an agreement, particularly in severance agreements. They serve as a crucial tool to clarify when and how payments will be distributed, ensuring that both parties have a mutual understanding of the financial obligations involved. These schedules often include details such as lump-sum payments or installment plans, which can impact the tax implications for the recipient.
Release of Liability: A release of liability is a legal document that frees one party from any future claims or legal responsibilities that may arise from a specific event or action. This concept is commonly seen in severance agreements, where employees agree to relinquish their rights to sue the employer in exchange for certain benefits, such as severance pay. The release ensures that both parties can move forward without the burden of potential legal disputes.
Right to review: The right to review refers to the provision that allows employees a specified period to evaluate a severance agreement before they agree to its terms. This right is important as it ensures that employees have adequate time to understand and consider the implications of the agreement, which may include waiving certain legal rights or claims against the employer. This provision is particularly relevant in severance agreements, where employees are often asked to release their claims in exchange for compensation.
Signing Process: The signing process refers to the formal procedure of executing a legal document, such as a severance agreement or release, which typically involves the parties involved providing their signatures to indicate consent and understanding of the terms outlined. This process is crucial in employment law as it solidifies the agreement between an employer and an employee regarding severance terms, waivers of rights, and any related conditions.
Standard Severance Agreement: A standard severance agreement is a legal document that outlines the terms of compensation and benefits provided to an employee upon termination of employment. This agreement often includes a release of claims against the employer, ensuring that the employee waives their right to pursue legal action related to their employment or termination. Such agreements help to protect the employer from potential lawsuits while providing financial support to the departing employee.
Voluntary separation: Voluntary separation refers to the process where an employee chooses to leave their job of their own accord, rather than being terminated or laid off. This decision can be influenced by various factors such as personal circumstances, career advancement, or dissatisfaction with the current role. Understanding this concept is crucial when examining severance agreements and releases, as they often come into play when an employee resigns and negotiates terms for their departure.
Waiver of claims: A waiver of claims is a legal provision where an individual relinquishes their right to pursue any legal action or claim against another party, usually in exchange for a benefit such as severance pay or a settlement. This concept is particularly important in severance agreements and releases, as it helps protect employers from future litigation by ensuring that departing employees cannot later challenge the terms of their separation.
Worker Adjustment and Retraining Notification Act (WARN): The Worker Adjustment and Retraining Notification Act (WARN) is a federal law that requires employers with 100 or more employees to provide a 60-day notice before implementing mass layoffs or plant closings. This act aims to give workers and their families time to prepare for the loss of employment and seek new job opportunities or training. WARN is crucial for protecting employees' rights during layoffs and has implications on severance agreements, as it ensures that affected workers are informed and supported during transitions.