04 Jan The Case For or Against Severance Agreements
I have been asked more times than I can remember whether entering into a severance agreement with an existing employee is a good or bad idea. Here are some legal and business reasons for entering, or not entering, into a severance agreement.
Release of Employee’s Claims: Carefully drafted severance agreements buy an employer some measure of insurance against the threat of a lawsuit from terminated employees. Severance agreements require that the terminated employee, in exchange for consideration (often monetary), release or withdraw certain claims he or she may have asserted against the employer. They also require that former employees agree not to bring those claims in the future. Severance agreements will often specifically identify all claims to be released and waived, such as those pursuant to federal or state anti-discrimination laws. Further, properly drafted severance agreements will specify that the employee is releasing and waiving all types of damages he or she may have incurred (i.e., lost wages, emotional distress, statutory penalties, attorneys’ fees, etc.) based on any alleged actions of the employer which predate the agreement. With this, however, beware as there are certain claims that cannot be waived without approval from a government agency such as the Department of Labor or a Court (i.e. claims under the Fair Labor Standards Act).
Confidentiality: Confidentially provisions in severance agreements can serve many purposes. First, such provisions can be used, and are often used, to keep the agreement itself confidential. Second, they can be used to keep any discussions/negotiations leading up to the agreement confidential. And finally, such provisions can be used to limit a terminated employee’s ability to disclose internal policies, trade secrets and/or confidential operating procedures to third parties.
Cooperation During Transition Period: On occasion, issues arise that only a terminated employee can answer, by virtue of his/her former position within the organization. It is not hard to understand, then, how discharging key employees can result in a disruption in business operations. To avoid this disruption, severance agreements are often used to secure a key employee’s cooperation in resolving outstanding issues for a specified amount of time after the employee’s discharge. This cooperation can range from answering outstanding questions from time to time to ensuring that the employee’s replacement has all the necessary tools and information to transition smoothly into the former employee’s old position.
Goodwill: Severance packages may often purchase a measure of goodwill from otherwise disgruntled employees. Such packages can soften the blow of being terminated and provide some income replacement and health care benefits to employees. A happier former employee makes for a less litigious former employee. This is especially important since severance agreements only release claims that were available to the employee on or before the date the agreement was signed. Accordingly (absent language in the agreement to the contrary), an employee is generally free to reapply for a position and, if not selected, bring a lawsuit against his/her former employer. In this scenario, even if the claim is meritless, the employer is faced with the expense and burden of defending the same. Creating some goodwill with the employee may go a long way in lessening the likelihood that this may occur. (A no-hire/no-future employment provision in the agreement — whereby an employee agrees not to seek further employment with the company — also lessens the likelihood of this happening).
Monetary Payout: The most obvious drawback of offering a severance package is the monetary payout often, but not always, necessitated by the severance. Depending on the circumstances, this amount can be significant. While there is no hardline rule for how much severance to pay out, many employers look at how long the affected employee has worked for the company in determining the severance amount (i.e. one week of severance pay for every year worked). Other employers conduct a cost-benefit analysis, which takes into account the amount of liability and expense the company could be exposed to should the employee file (or continue to litigate) a lawsuit.
Risk of Breach of Agreement: Typically, when severance agreements are breached, all bets are off the table. Severance agreements obligate both employees and employers alike to several terms and conditions. An employer, for example, may be required to give neutral references when third parties call or write in to inquire about the terminated employee’s employment history. If a supervisor inadvertently gives anything other than a neutral reference (which on occasion occurs, as supervisors are not always aware of the terms and conditions of the agreement), the agreement has been breached and the employee is generally free to file a claim against the employer. Conversely, if an employee breaches an agreement, the employer can either waive the breach or take steps to try to recoup its severance payout. Many times, employers waive small breaches in order to keep the agreement effective, as pursuing a former employee to recoup a severance payout is often timely, costly and uncertain.
Risk of Inconsistent Application: Many risks of offering severance to terminated employees are due to inconsistency. Inconsistent application on who gets severance payouts and how much is offered can be used to try to support claims of discrimination (e.g., allegations that employees of one race or gender are routinely treated more favorably than others). While the circumstances of each terminated employee can and should be analyzed on a case-by-case basis, consistency is imperative unless the employer can point to specific and easily articulated reasons for variances.
These are just a few, of many, considerations to take into account when deciding whether or not to enter into a severance agreement with an existing employee. If your circumstances are such that you are contemplating a severance agreement, consult with legal counsel if possible, and carefully assess and account for the unique legal and business issues your situation may present.