A severance agreement is a contract between an employer and an employee that outlines the terms of a severance package upon employee separation. It covers various aspects, including financial compensation, benefits, confidentiality clauses, and non-disparagement agreements. Severance packages are generally a company perk—unless there’s an employment agreement or collective bargaining agreement that requires one upon separation.
As a small business owner, understanding what a severance agreement is can be as crucial as knowing your company’s bottom line. These agreements can serve as a protective shield for your business during the turbulent times of employee departures. They set clear expectations, minimize legal risks, and can even help preserve your company’s reputation.
Key Takeaways:
- A severance package is more than just giving an employee a few extra paychecks upon termination
- Severance packages aren’t required in most cases
- Any time you offer a severance, make sure it includes a release
How Severance Agreements Work
A severance agreement and release entails that the departing employee waives their right to sue the company post-departure. This release can cover various claims, including wrongful termination, discrimination, or harassment. However, it’s crucial to note that certain claims, such as workers’ compensation or vested rights under retirement plans, cannot be waived even with a release.
Including a release in your severance agreement serves a dual purpose. First, it provides your business with an added layer of legal security. Second, it gives the departing employee clarity about their rights and obligations post-employment. Hence, a severance agreement and release is not just about parting ways; it’s about doing so amicably and legally.
Who Receives Severance Packages and Agreements
But who gets offered these severance agreements? Is it just for the executives lounging in corner offices, or does it extend to all levels? While there’s no one-size-fits-all answer, typically, a company’s decision to offer severance agreements depends on factors like the employee’s position, tenure, and circumstances of departure.
For example, senior-level executives are often offered severance packages because of the potential impact their departure could have on the company. Mid-level managers or long-standing employees may also receive severance packages, especially if their departure is due to company restructuring or layoffs.
However, it’s not uncommon for companies to extend severance agreements to all departing employees, regardless of their position. This can be part of an overall strategy to maintain positive relationships with former employees and uphold a good company reputation.
Core Elements of a Severance Agreement
1. Parties Involved: This is the starting point of any severance agreement. It clearly identifies the employer and the departing employee entering the contract.
2. Termination Details: This section outlines the specifics about the employment termination—when it’s effective, the reason behind it, and the final paycheck details.
3. Severance Compensation: The heart of any severance agreement, this part details the compensation package offered to the departing employee. It could include financial payouts, continuation of benefits, or other perks. Absent rare circumstances, severance pay isn’t a legal obligation, but a gesture of goodwill. Note: if an employer isn’t offering a severance package or isn’t contractually obligated to do so, a termination notice is sufficient.
4. Release of Claims: As discussed earlier, the release clause is where the employee waives their right to sue the company for issues like wrongful termination or discrimination. However, certain rights cannot be waived, so this section needs to be crafted carefully.
5. Confidentiality and Non-disparagement Clauses: These are the guardian angels of your company’s reputation. A confidentiality clause ensures the employee doesn’t disclose sensitive company information post-departure. The non-disparagement clause prevents them from bad-mouthing your business.
6. Noncompete and Non-Solicitation Clauses: These clauses prevent the departing employee from working with a competitor or soliciting your clients or employees for a specified period. However, enforceability varies by jurisdiction, so tread carefully here, especially with noncompete clauses.
7. Dispute Resolution: This section specifies the method of resolving any disputes arising from the agreement, often arbitration or mediation.
8. Legal Counsel: This clause indicates the employee has had the opportunity to seek legal advice before signing the agreement. It protects the employer from claims that the employee didn’t understand what they were signing.
9. Rehire Policy: Some agreements include a clause stating that the employee will not be rehired, which can protect against future legal issues.
10. Revocation Period: This is the answer to “how long do I have to sign a severance agreement?” The law often provides employees with a specific time frame to consider the agreement before signing, and possibly, a few days to revoke it after signing, depending on the state. Broadly speaking, you’ll need to provide reasonable time for your employee to consider the agreement, usually at least a few business days.
Determining Severance Packages
Now that we’ve peeled back the layers of a severance agreement, let’s address how severance packages are determined. This isn’t a one-size-fits-all scenario; several factors come into play. Let’s analyze these driving forces.
1. Employee Tenure: Typically, the longer an employee has served your company, the larger their severance package. Many businesses use a formula, often a week or two of pay for every year of service. It’s a simple and fair method, but remember, it’s not set in stone.
2. Position and Salary: Higher-ranking employees with larger salaries may receive more generous severance packages. Why? Their departure can have a significant impact on the company, and they may have more bargaining power.
3. Reason for Termination: If the employee is leaving due to layoffs or restructuring, you might offer a more substantial package. However, if they’re being let go because of performance issues, you might choose to be less generous or provide no severance at all.
4. Company Policy and Precedence: Consistency is key. If you’ve given severance packages in the past, it’s wise to follow a similar pattern unless circumstances dictate otherwise. Your company policy should provide guidelines, but remember, flexibility is also important.
5. Legal Considerations: Certain laws may influence the size of the severance package. For example, the Older Workers Benefit Protection Act may require employers to offer a higher severance to older employees in some cases. Always consult with legal counsel to ensure you’re compliant.
So, when might it not be beneficial for you, as a small business owner, to offer a severance agreement?
If the agreement poses more risks than rewards, it’s wise to reconsider. For instance, if you’re dealing with an employee who has violated company policies or engaged in illegal activities, offering a severance package might not be necessary or beneficial.
Also, if the cost of the severance package would significantly strain your business finances, it might be better to explore other options. While severance packages can provide many benefits, they are not legally mandatory.
Components of a Severance Package
So, you’ve considered all the factors. Now, what? It’s time to assemble the package. Here’s where the art of negotiation meets the science of fair compensation.
A severance package typically includes several components:
1. Financial Compensation: This is the mainstay of any severance package. As discussed, it’s often based on the employee’s tenure and salary.
2. Continued Benefits: This could include extending health insurance coverage, retirement benefits, or other perks for a certain period.
3. Outplacement Services: Some companies offer services to help the departing employee find a new job, such as resume writing assistance or career counseling.
4. Payment for Unused PTO: If the employee has unused vacation or sick days, you might choose to pay these out.
A severance package is not just about financial compensation. It’s a show of good faith, a way to part on good terms, and, let’s be honest, a method to avoid potential legal battles. So, while determining a severance package requires shrewd calculation, it also calls for a dash of empathy. After all, transitions are never easy. But with the right severance package, they can be handled with dignity and respect.
Benefits of Using a Severance Agreement
A severance agreement serves as a strategic tool, offering both legal protection and non-legal advantages to your business. Let’s dissect these benefits further.
Legal Protections
The primary function of a severance agreement is to provide legal security to your business. It’s a shield, protecting your business from potential lawsuits post-employee departure. The release clause in the agreement ensures that employees waive their rights to sue for issues like wrongful termination or discrimination. However, remember, not all claims can be waived, so it’s crucial to have your agreement reviewed by legal counsel.
Another key legal consideration is compliance with employment laws. For example, the Older Workers Benefit Protection Act stipulates certain conditions for severance agreements with employees over 40. A well-crafted severance agreement ensures adherence to such regulations, safeguarding your business from legal pitfalls.
Non-Legal Advantages
Beyond the courtroom, severance agreements offer several other benefits. They can help maintain a positive company image. Offering a severance package shows you value your employees, even when parting ways. This can enhance your reputation among current employees and make your company more attractive to prospective ones.
Severance agreements can pave the way for smoother transitions. When an employee leaves, especially a key player, it can create ripples in your organization. A severance package, particularly one that includes outplacement services, can help mitigate these effects and ensure a less disruptive changeover.
Severance agreements can serve as valuable negotiation tools. If an employee’s departure involves complex issues like intellectual property rights or noncompete clauses, you can use the severance package as a bargaining chip.
What to Avoid in Drafting Severance Agreements
It’s crucial to recognize that not all glittering packages are gold. Sometimes signing a severance agreement might not be in your best interest.
1. Vague or Incomplete Terms: If the terms of the agreement are unclear or incomplete, proceed with caution. Ambiguities can lead to misunderstandings and potential legal disputes down the line. Always ensure the agreement is comprehensive and explicit, leaving no room for doubt.
2. Unfair Compensation: The severance package offered should be fair and commensurate with the employee’s tenure, position, and contributions. If the compensation doesn’t seem adequate, it might be time to revisit the negotiation table.
3. Overreaching Restrictions: Noncompete and non-solicitation clauses are common in severance agreements. But if these restrictions are overly broad or long-lasting, they may unduly hamper the departing employee’s career prospects. Be reasonable in defining these terms and be sure you’re adhering to state regulations where these clauses may be forbidden.
4. Waiver of All Claims: The release clause in a severance agreement typically asks the employee to waive their right to sue. However, certain rights, like filing for workers’ compensation or reporting illegal activities, cannot be waived. If an agreement attempts to include such waivers, it’s a red flag.
5. No Legal Counsel: If the employee signs the agreement without having the opportunity to consult with a lawyer, it could be contested later. Make sure the agreement includes a clause indicating that the employee had the chance to seek legal advice.
Once you’ve determined that you’d like to pay an employee severance, the next step will be to include the payment in their last payroll. If you need help calculating payroll, check out our step by step guide that will walk you through everything you need to know.
Frequently Asked Questions (FAQs) About Severance Agreements
In line with the Older Workers Benefit Protection Act, employees aged 40 and above get 21 days to consider the agreement for individual terminations and 45 days for group terminations. However, for those under 40, there isn’t a legally mandated timeframe. It’s good practice, though, to allow a reasonable period—say, a week—for consideration.
A severance package is more than a parting gift. It’s a tool for risk management, helping companies avoid legal disputes. Plus, it’s a show of goodwill, aiding in maintaining a positive company image.
There’s no one-size-fits-all severance package. The contents vary based on factors like the employee’s tenure, job role, and the company’s financial standing. Typically, it includes financial compensation and may extend to benefits like health insurance coverage or outplacement services.
Termination refers to the end of an employment relationship. Severance, on the other hand, is the package offered to the employee upon termination. It’s not obligatory but is often used to smooth transitions.
While severance packages have their advantages, they’re not without potential pitfalls. They can strain a company’s finances if not managed well. Also, in some cases, offering severance might not be necessary or beneficial—for instance, when dealing with an employee who has violated company policies.
Bottom Line
A severance agreement is a tool that, when wielded correctly, can safeguard your business from legal disputes while expressing goodwill to departing employees.
However, these agreements come with their own set of caveats. They must offer something beyond what an employee is already entitled to, and they must respect an employee’s right to counsel. Overreaching restrictions or unfair terms can lead to contention, so tread carefully.
Offering and signing a severance agreement isn’t a decision to be taken lightly by either party. So take your time, review your options, and when in doubt, seek legal counsel.
