Ready for departure
Severance agreements can be worthwhile when cutting ties to a team member, but employers need to be careful with the terms and cognizant of applicable laws.
Have you ever terminated an employee? Whether the act was related to performance, a practice reorganization or another issue, navigating the process can be challenging. In these situations, a severance agreement can be a helpful tool for employers, but many don’t understand how or when to use them.
Here are answers to eight commonly asked questions about severance agreements.
1. What is a severance agreement?
It’s a contract between an employer and a departing employee. A severance agreement contains the following:
- A promise by the employer to provide some sort of compensation, typically monetary, to the employee.
- A release of claims by the employee. The employee agrees not to sue for discrimination or other employment-related claims.
Other provisions that are commonly, but not always, included in a severance agreement include:
- An obligation by the parties to keep confidential the terms of the agreement.
- An obligation by the employee, and sometimes the employer, to not disparage the other.
- An acknowledgment by the employee that he or she has received all owed wages and other compensation.
- An obligation by the employee to comply with any legal or contractual requirements to protect the confidential and proprietary information of the employer.
- An obligation by the employee to return all of the employer’s property and equipment.
- Certain restrictive covenants by the employee, such as a non-compete agreement or an obligation not to solicit remaining employees to leave the employer.
2. Are employers required to provide employees with severance?
Generally speaking, employers have no obligation to make any type of severance payment to a departing employee. One exception, though, is if the employer has promised the employee through an employment agreement, benefit plan or other policy to pay some amount of severance at the time employment ends.
3. How common are severance agreements?
In the United States, the use of severance agreements for departing employees is the exception and not the rule. Of course, this varies by industry and employer. Some companies adopt severance plans as a benefits program that promises employees they will be eligible for severance if their employment ends under certain circumstances. Some companies offer severance packages when a layoff occurs, meaning the layoff was not the employee’s fault. Other companies offer severance when they believe the decision to terminate an employee carries a legal risk.
4. What is a typical severance payment amount and when is it paid?
Severance pay can vary from a few hundred dollars up to a year or more of wages, depending on a number of factors. Employers might make the payment in a lump sum or in installments that coincide with the employer’s pay schedule.
5. Are severance payments taxed?
Yes. They are treated as wages, so they are subject to withholding and employment taxes.
6. Can employers provide something other than money as severance?
Severance does not always, or exclusively, consist of a monetary payment. Employers can provide anything that would be of value to the employee. For example, an employer might release an employee from a non-compete agreement or an employer might allow an employee to keep certain equipment rather than return it.
7. When are severance agreements useful?
Severance agreements are most useful when the employer wants to secure a release of claims from the employee. This can be due to unusual circumstances, such as a risk that the employee might sue the employer. The best practice is for an employer to secure a release of claims anytime a monetary benefit is given at termination.
8. What are the pitfalls of a severance agreement?
- Employers cannot get a valid age-discrimination waiver from an individual over 40 unless certain, very specific provisions are in the agreement. For example, the employee must get 21 days (or 45 days when a group of employees is terminated) to consider the agreement terms and seven days to revoke the agreement after signing it. Additionally, the waiver of an age-discrimination claim must contain certain wording to make it “knowing and voluntary,” and the individual must be advised of the right to consult with an attorney.
- Employers might want to include a non-compete agreement in the severance package, but such a clause is not always permissible under state law.
- Employers cannot require employees to waive their right to cooperate with law enforcement, a governmental entity or in an administrative proceeding. The agreement can state that the employee waives rights to a compensation award in any such proceeding.
- Employers cannot require employees to waive a wage claim. Employees are entitled to be paid for any work they performed.
- In a risky termination — when an employee has a strong claim against an employer — presenting the employee with a severance agreement can backfire in some cases. If the employee doesn’t sign it and instead sues for discrimination or another claim, the employee might assert that the severance offer was evidence that the employer knew it did something wrong.
Overall, severance agreements can be valuable tools when used carefully and when they comply with all relevant laws and legal procedures. Consulting with an attorney when drafting a severance agreement is important.
Legal Lingo columnist Nicole Snyder is a partner at Holland and Hart, where she advises clients on mergers, acquisitions and complex employment matters. She is a member of the American Veterinary Medical Law Association and co-chairs Holland and Hart’s Animal Health and Pet Products Industry Group.