What Are Severance Pay Agreements?
A severance pay agreement is a mutually beneficial document entered into by an employer and a former or soon-to-be former employee. Both parties must sign the agreement for it to be valid, and for it to be incorporated into the severance package issued to the departing employee.
Look similar to a waiver and release agreement, a severance pay agreement specifies the amount the employer will be providing to the terminated or laid off employee. This financial payment is often referred to as severance pay.
According to Harris & Ruble, a California law firm , a severance pay agreement also includes a release of all legal claims the employee has against the employer. This allows employers to protect themselves from future lawsuits filed by terminated employees by having those employees acknowledge in the severance pay agreement that they will not sue.
While it is in the best interest of the employer to make sure their severance pay agreement is written accurately and to their benefit, it should also be written to benefit the employee. While the severance pay agreement will likely not be written in the same way as a contract, it serves the same purpose: to provide certain benefits to each of the parties involved.
Severance Pay Agreements Under California Law
Although federal law does not require employers to provide severance pay to employees, many employers choose to do so as a way to reward long service, build goodwill and/or avoid exposure to costly litigation. Severance agreements that follow the requirements mandated by California law give employers a way to protect their interests as well as provide for the employee’s smooth transition from employment.
California Labor Code Section 2802 requires that an employer indemnify an employee for "all necessary expenditures . . . incurred by the employee in direct consequence of the discharge, dismissal or involuntary resignation of employment." Employees often claim that separation packages include unearned wages (for accrued but unused vacation or PTO) and other unprovided-for compensation, and that by not paying all wages owed to employees at the time of termination the employer has breached the severance agreement, thus excusing the employee’s return of the consideration given under the agreement. An employee who says an employer has breached a severance agreement also is asserting a claim for breach of contract.
California courts recognize that an employee can waive statutory rights and claims so long as the waiver is knowing and voluntary, and the employee receives consideration in exchange for the waiver. Case law establishes that because severance pay is earned compensation, an employee may waive claims to that compensation in return for the severance pay. Severance pay also is earned compensation to which an employee would be entitled to even in the absence of a severance agreement, provided that the employee gives the requisite notice of intent to quit. Because employees are entitled to severance pay under the terms of the severance agreement and applicable law, coercive conduct of the employer that taints the employee’s voluntary departure and diminishes the value of consideration to the employee may result in non-enforcement of the waiver. Consequently, it is critical that California employers refrain from artillery blasts when employees inform the employer of their intention to leave.
What Are the Key Things to Look for in a Severance Agreement?
While the names and addresses of the parties, as well as the date of the agreement, are somewhat of a formality, the critical elements of the agreement fall into three categories: (i) the payment; (ii) the release of claims; and (iii) confidentiality. The payment should include a statement that the severance check will be paid and mailed to "alternate payee" as the payee’s attorney. Even though that seems a little funny, it serves an important purpose and protects the employee’s rights to claim attorneys’ fees and costs, if the employer fails to comply with the terms of the agreement. Then again, the agreement should also specifically state that the check must be received by the employee no later than the "xx day of xx 2007", or whatever year it is. In other words, it is not enough that the check must be mailed by the last day of the month; it must actually be received by the employee by the last day of the month. Of course, the severance pay should be paid at the most tax-advantageous method, i.e. as severance pay taxable under Section 404 of the Internal Revenue Code where no withholding is required or, if severance benefits cannot qualify as severance pay, under Section 3121 of the Internal Revenue Code where the employer is required to withhold taxes but, still, 0% is withheld for unemployment purposes. The release of claims almost always includes a general waiver, a release of unknown claims and a representation that the employee has no pending legal claim against the employer. If the employer has pending unfair competition or trade secrets claims against the employee or has made an investment in real property or is owed money in another work-related business venture with the employee, those claims may be released in the agreement. The confidentiality provision usually is a very broad general provision precluding the discussion of any information concerning the employer’s business and/or precluding the employee from talking about the agreement itself, except to his or her spouse, or attorneys, and sometimes accountants, counselors or therapists. Of course, the agreement must not include a non-disparagement clause, which probably will never pass the "is it reasonable under the circumstances" standard.
How to Discuss a Severance Pay Agreement
If you are specifically targeted for severance, what should you negotiate? The first step is to read the severance offer letter carefully. A severance agreement request may be a general request in which all eligible employees are asked to sign an agreement and receive a severance package. However, it is not uncommon that some form of negotiation is involved in the severance process. Employees should look for negotiation options with respect to details of the overall severance package or exclusion from the severance package. One strategy is to ask the employer for additional severance terms and provide reasons for those requests. The following are strategies and tips for negotiating the terms of a severance pay agreement in California:
• It is a best practice to read the severance offer letter and analyze the legal violations and risks with the agreement. In some cases, the agreement contains blatantly illegal terms that could void the "severance."
• If your specific position has been eliminated, offer to sign a severance agreement in exchange for non-mutually offered terms (in other words, ask the employer if you can negotiate for terms not included in the agreement). For example, ask the employer for an increased severance payment, a neutral reference, and increased healthcare benefits.
• In certain circumstances, you may want to negotiate out the post-employment restrictions in the California severance agreement. When seeking to avoid violating a non-competition agreement, the goal is for the employee to ensure that enough of the employee’s former duties are "under the belt" so the employer does not have a valuable trade secret to protect.
• If you believe the employer discriminated against you based on your age, a very useful tactic is to highlight the age of all the employees who are not receiving a severance pay agreement. This tactic aims to show the company that their reasoning for excluding you from the severance offer could lead to potential litigation.
• Above all else, start by consulting an attorney. In many cases, the agreement offered to the employee is already in violation of employment law and good attorneys can spot these issues early on.
What are Common Mistakes To Avoid?
I’ll start with the employers first. The biggest mistake I see employers make is waiting until there is a dispute to do a severance agreement. This is very common in long-term employment relationships where no severance agreement ever existed. By the time the employer (or the employer’s attorney) convinces the individual to do a severance agreement, the employer is not thinking as clearly about what to include. This often leads to exposure and unnecessary litigation when Court costs are considered versus the cost of including a waiver in the original document. Not to mention the employer does not have the protection of knowing that the individual has had the chance to think over the agreement with counsel before signing it. It often leads to the individual requesting outside counsel after the relationship ends because the parties were not on the same page and the requests being made are much more aggressive.
Now to the employees. The biggest mistake I see employees make is that they do not get a severance agreement reviewed by an attorney with experience in negotiating severance agreements. Unlike an employer , employees should not negotiate severance agreements themselves. There are always nuances that an employer may try to use against an employee. These nuances can often lead to unnecessary legal costs and rights being waived that were not supposed to be waived. Additionally, it is important for both sides to have understanding of the process for a claim disqualification through a severance pay agreement, so that issues of timeliness can be avoided.
When Is it Time to Get an Attorney?
Under certain circumstances, consultation and representation by an attorney experienced in employment law may be desirable or necessary. While many severance agreements are straightforward and presented to employees at low or no cost, severance agreements vary in language and scope. The specific facts of an individual situation are always key, and should be reviewed carefully with a knowledgeable attorney.
Parties with special needs or interests include: Companies may wish to consider engaging counsel to draft or assist in drafting the severance agreement itself. In addition to compliance with California law, there are many issues that can arise in context of a severance agreement. It is always advisable to consider any pending or potential claims against the company, the risk that the employee may pursue those claims notwithstanding execution of an agreement, and providing sufficient consideration to the employee in order to strengthen the validity of a general release.
Among the Changes in Recent Severance Agreements
Recent trends in the use of severance agreements have focused on two issues: (1) whether the severance agreement is a contract that must be supported by something of value given to the employee at the time of execution; and (2) the enforceability of certain clauses in the severance agreements, such as those which preclude an employee from making claims against the employer.
In Steinberg v. Arcturus Corp., Court of Appeal Case No. B248054 (published April 25, 2014), the employee signed a severance agreement in which she promised not to make any claims or institute any lawsuits against the employer. The employee later sued on the claim that she had not been paid wages due under California law. After the employer filed a summary judgment motion, the employee filed an amended complaint adding claims for breach of the severance agreement and declaratory relief. Although the trial court granted summary judgment for the employer, the appellate court reversed. With respect to the breach of contract claim, the appellate court stated that the jury could hold for the employee on her claim that the severance agreement was unenforceable because it lacked consideration. The court noted that the foregoing principles apply "regardless of whether the release agreement is part of a termination agreement, a layoff plan, a settlement agreement, a negotiation agreement, a non-disclosure agreement, a promise of future employment, a severance package, a stand-alone release agreement, or whatever." Steinberg is pending review by the California Supreme Court.
In Hesse v. Drew Indust., Inc., 12 C 6527, 2014 U.S. Dist. LEXIS 37076 (N.D. Ill. March 20, 2014), despite an Illinois federal court upholding an employer’s mandatory arbitration agreement in Hesse v. Drew Indust., Inc., 12 C 6527, 2013 U.S. Dist. LEXIS 140773 (N.D. Ill. Sept . 30, 2013), a Federal judge in California refused to do so in O’Hare v. MacMillan McClintock & Marshall, 5:13-CV-05744 EJD, 2014 U.S. Dist. LEXIS 59904 (N.D. Cal. Apr. 28, 2014). In O’Hare, the California judge struck the employer’s mandatory arbitration agreement in a severance agreement because the agreement also included a covenant not to sue and a RICO claim that was not arbitrable.
Mandatory arbitration clauses were also in the news in the highly publicized case of Martinez v. Compton Unified School District, 31 Cal.App.4th 1173 (1995). In Martinez, a long-held precedent in California was shattered when the California Supreme Court ruled that a mandatory arbitration provision in a severance agreement violates public policy under California Labor Code sections 229 and 2802, and therefore void and unenforceable.
Also in the realm of severance packages, an interesting trend during the last year has been for employers to offer employees options among several severance packages. For instance, an employee could choose between three months of salary continued and his or her accrued vacation time paid, or six months of salary continued with no accrued time paid, etc. Typical employer objectives with the "menu" approach to severance packages include (1) to save costs by requiring employees to give up accrued benefits for additional payment, (2) to avoid paying more than an employee would otherwise be entitled to, and (3) to ensure that the company is not better off agreeing to pay severance through litigation, which would require payment of attorneys’ fees and interest.
The trend in California law is to routinely invalidate some type or another of severance agreements provision. Employers are well advised to consult with counsel experienced in crafting severance agreements to ensure that the agreement will be enforceable.
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