Severance Agreement: Definition, Terms, Considerations

What Is a Severance Agreement?

A severance agreement is a contract between an employer and an employee detailing the compensation package an employee would get in exchange for the termination of the latter's employment. This document outlines the rights and responsibilities of both the employee and the employer if an employee loses their job due to layoffs or other circumstances. It summarizes the benefits the employee could receive and explains what steps they must follow to be eligible for those benefits.

Please note, severance agreements and this area of the law is widely based on jurisdiction, specific company policies, and case specific circumstances. It is recommended to consult a local employment lawyer if you have any further questions.

Components of a Severance Agreement

A severance agreement is a complex legal document that has many standard parts explaining what the employee will receive in exchange for agreeing to their employer's terms of separation. Because the severance agreement finalizes an employee's termination and can influence employee behavior after they leave, the consequences of each clause need to be carefully considered. Talk with a contract lawyer for help deciding what elements you should include in a separation agreement document for your business.

• Reason for Separation Many severance agreements start by listing the reason the employee is being fired or asked to resign. The severance agreement explains that both the employer and the employee want to reach a satisfying agreement to officially settle their differences and part ways professionally.
• Timeline The agreement should explain when the employee was hired, the date of termination, and information on how long the employee has to accept or reject the severance agreement.
• Pay Severance pay is usually the most significant employee benefit of accepting a severance agreement. This can be a percentage of the employee's salary for a certain amount of time made in regular payments or a large lump sum.
• Paid Time Off Compensation for unused vacation benefits and paid time off can also be part of a severance package. Companies may allow the employee to take their paid vacation and sick days before leaving or pay out the amount they would have earned from taking those benefits while they were still eligible.
• Health Insurance Agreeing to continue health coverage is another key benefit and can help provide stability for employees while they look for a new employer to sponsor their medical benefits. According to the Consolidated Omnibus Budget Reconciliation Act (COBRA), employees are legally entitled to continue receiving medical benefits for up to a year and a half after their termination, but the length may vary depending on qualifying events.
• Stock Options If your company gives stock options as a benefit, changing the vesting schedule so that the employee can cash out could be a valuable severance benefit.
• Career Placement Businesses provide outplacement assistance and career coaching to help employees find a new job after they are laid off or let go for another reason. This benefit gives employees reassurance that they will have some career stability and shows that you care about their wellness outside of their role at your company.
• Liability Release After explaining what the employee will receive in exchange for signing the severance agreement, the document explains the stipulations for getting those benefits. This usually starts with a general liability waiver, where the employee agrees not to make or pursue any legal claims against the company. The release of liability agreement is designed to protect:
  • Other employees
  • Shareholders
  • Company directors
  • Subsidiaries
  • Affiliated companies

  The general liability release usually specifies a few key instances to protect the company from litigation from:

  • Wrongful termination
  • Civil rights violations
  • FMLA violations
  • Discrimination

  Once the employee agrees to this section, they waive their former right to take legal action against the company. It is worth noting that this would include nearly all claims, and not just the ones listed above.

• Return of Company Equipment If the employee has company property in their possession, the severance agreement can go over how and when they are expected to return it. This helps ensure a peaceful transition and ties up the loose ends of terminating an employee.
• Reference Check Procedure Just as a non-disparagement clause keeps the employee from defaming your company, a reference check clause can prevent the company from giving a negative reference to future employers. Some employers agree to give a positive reference as part of the agreement, and may even provide the employee with a reference letter for them to approve.
• ADEA Information Any severance agreement for employees over the age of 40 must refer to the Age Discrimination in Employment Act to inform the employee of their legal rights.
• Confidentiality Details Part of the severance agreement is an explanation of what the employee is allowed to disclose to others after signing. Some companies make the agreement itself confidential, meaning that the employee cannot tell anyone the terms of the severance agreement they signed. It can also include other company information such as customer data and internal processes.
• Non-Compete Clause Employers include a non-compete clause to ensure the employee will not enter into competition with their company using company resources. Non-compete clauses can have an expiration date and apply to a certain geographical area.
• Non-Disparagement Clause A non-disparagement clause explains that the employee cannot spread negative information about the company for a certain period of time.

Having a strong severance agreement can protect both you and your employees during a staff transition. Negotiating each clause with employees to come to a mutually beneficial agreement helps ease the tensions associated with terminating an employee and sets both parties up for future success.

What's Included in a Typical Severance Package?

Even without a legal necessity, many employers offer severance to reduce the chance of facing wrongful termination lawsuits. This strategy can work for a wide range of companies. However, you should always speak with a business lawyer if you’re wondering how severance packages will legally impact your company.

• Wages Financial compensation based on wages is a prevalent type of severance pay. Employers typically offer terminated employees up to two weeks’ pay for each year of service. For example, an employee working for the company for two years could severance pay equal to four weeks of wages.
• COBRA The Consolidated Omnibus Budget Reconciliation Act (COBRA) affords eligible employees and their dependents to continue receiving health benefits if they are laid off or have a reduction in their work hours. Private sector employers with 20 or more employees are generally subject to COBRA provisions – meaning they must provide the option for continued coverage. The length at which an employee can remain on COBRA can vary but can generally be up to a year and a half.
• Unemployment Upon termination, employees can apply for some severance benefits which will vary by state. If the employer has signed a severance agreement with the terminated employee, they must follow through with the agreement.
• Transition Help Employers can offer employees transition services to assist departing employees in finding new employment. These options are particularly beneficial for employees out of work for an extended period. Employers also usually write recommendation letters or serve as references for terminated employees.

Unless a severance agreement is made in advance to provide specific post-employment compensation, severance packages are typically designed at the employer’s discretion. There is no obligatory severance pay, and employers are free to offer whatever benefits they deem appropriate for a terminated employee.

Common Terms to Negotiate in a Severance Agreement

While many businesses and employees correlate severance packages with severance pay, a severance package can include various components. This element is advantageous for the former employee because it provides multiple bargaining points, and it reduces the chances of wrongful termination lawsuits for the employer since severance agreements require the employee to sign a waiver.

Here are a few standard terms to know in a severance package negotiation :

• Termination Compensation Severance pay refers to the monetary compensation offered by a company following an employee’s termination. Standard pay is typically between six and twelve months’ pay at the employee’s previous salary.
• Paid Vacation Time Accrued paid time off (PTO), such as sick and vacation days, is negotiable for severance when it goes unused at the time of the possible termination. Numerous employers offer a PTO policy in their employee handbooks and may be negotiable when receiving a proposed severance agreement.
• Benefits Full-time employees can continue receiving healthcare insurance and other employer-sponsored benefits. If employees pay a monthly premium, they may negotiate with their employer to cover this cost while looking for new employment opportunities.
• Stocks If employees have non-vested stock options with their employer, the severance package may specify when they can exercise your stock options.
• Transition Services Certain employers provide access to outplacement resources that can assist employees in developing professional skills and locating a new job.
• Liability Waivers Along with compensation and benefits, severance agreements may include a clause disclaiming liability for any complaints.
• Non-Disclosure Certain severance agreements compensate employees in exchange for signing a non-disclosure agreement. Non-disclosure agreements can include anything from an employee agreeing not to share information with competitors or speaking negatively about the former employer.
• References Severance agreements may specify whether or not the employer may use this employer as a reference. Incorporating a reference clause into the severance package can aid in the employee’s new job search.

Why Should I Have a Severance Agreement in Place?

The main purpose of a severance agreement is to prevent your employees from filing for a wrongful termination lawsuit against your company, but there are several reasons a company could opt to provide a severance package. Some businesses give severance packages as part of standard company procedure and describe their severance policy in the employee handbook well in advance of actually letting an employee go. Others draft severance packages to cut a deal with a specific high-level employee. Severance agreement terms are highly customizable to bring different benefits to your business.

Some of the positive results of providing a severance agreement to your employees are:

• Fostering goodwill with terminated employees
• Protecting private company details, processes and data
• Showing respect to remaining employees

Circumstances for Offering Severance

You don't have to draw up a severance agreement every time someone leaves your business. For example, when you fire someone for severe misconduct, giving them a severance agreement may be seen as inappropriate and awarding bad behavior. If you have a clear justification for letting someone go and they do not pose a risk to the company, a severance agreement may not be appropriate. However, severance agreements are more popular when the employee in question has access to sensitive company information or is terminated due to circumstances beyond their control.

Common situations for offering severance pay include:

• Layoffs
• Company restructuring
• Eliminating a position or department
• Bad fit for a role or company culture

One example of an appropriate situation for severance pay is the termination of a top company manager. Their employer might provide a severance agreement with the condition that the manager could not work for a direct competitor for the next six months. In this case, the severance agreement helps protect company operations during a transition period. Severance agreements are also common when the employer is concerned about a discrimination or harassment lawsuit and is willing to pay benefits in exchange for an agreement not to sue.

Image via Unsplash by Scott Graham

Can Employees Reject a Severance Agreement?

Just as your company is not legally obligated to offer a severance package to employees, the employees are not required to accept a severance package from your company. If the severance package does not benefit the employee and only helps your company, they may reject it and feel insulted by being offered a low-value deal.

Is an Employer Required to Provide Severance Pay?

No, an employer isn’t required to provide severance pay, and the Fair Labor Standards Act (FLSA) doesn’t require you to provide severance pay when employees leave your company. However, if the relevant employee’s contract includes a severance package, this contract provision is valid and must be paid.

Certain states demand severance pay for workers laid off when a factory closes or an employer massively reduces its workforce. Additionally, employers may be required to provide severance pay if specified in company communications. Always speak with an employment lawyer if you have questions about how severance pay applies to your specific situation.

Lastly, in some circumstances you can offer a severance package instead of the 60-day notification requirement under the Worker Adjustment and Retraining Notification (WARN) Act for mass layoffs and site closures. You must provide a WARN notice if you are an organization with at least 100 full-time employees eliminating at least 50 from a single location. This is a complex area of labor law, and consulting legal counsel to make sure you comply is recommended.

Can an Employee File for Unemployment if they receive Severance Pay?

An employee could file for unemployment if they get a lump-sum severance payment. Severance pay in installments, on the other hand, may jeopardize their ability to collect those benefits, as they continue to receive a steady income stream. However, state laws vary, and in some parts of the country, severance doesn’t fall under earned wages for unemployment purposes, meaning it will not prevent them from collecting benefits.

If the employee is receiving continuation pay, they may be ineligible for unemployment. Continuation pay is compensation paid until a specified date, during which they don’t perform job duties. For instance, you can lay an employee off for one month without work and still pay them, making them ineligible for unemployment benefits until the continuation pay period expires. Note, continuation pay is not common and the more common practice is to offer a lump sum or structured payout severance package.