Severance Agreement Basics

Few things are more frustrating in life than the realization that an employment relationship has run its course and is coming to an unceremonious conclusion.

Photo by Vitaly Gariev on Unsplash

Sometimes, separation or severance agreements are offered by the employer as a way to get the employee to agree to set conditions in order to receive a benefit and forego any right to sue or seek re-employment with the company. The benefit to the employee is usually a certain amount of compensation to allow them to continue paying their bills and other life expenses until they can find other employment. When fair, these agreements can be a solid way for the parties to move on with life, giving everyone a bit of certainty on how the relationship will end (think post nuptial agreement but for work instead of marriage — we will get to prenuptial agreements (i.e. pre-employment contract) in a later post).

These agreements are usually somewhere in the 5–10 pages range and include a decent amount of legalese. While the entire agreement is important and needs to be reviewed word for word, there are seven (7) particular sections of these agreements that are usually ripe for dispute and negotiation before the agreement is signed by the parties. I will outline them below (in no particular order):

1. Voluntary or Involuntary separation. Will the person be considered terminated or to have resigned/retired? This is an important consideration, because sometimes these agreements — while normally confidential — may nevertheless be compelled to be disclosed (think unemployment compensation requests; the state’s decision process may involve a request to review the agreement). If it is posited as voluntary, on one hand it could hamper a later request for unemployment compensation, but on the other hand it will require the employer not to tell a future employer that you were fired since the contract stipulates the relationship ended in a voluntary resignation or retirement.

2. Lump Sum or Payments. How will the severance amount be paid out, via one lump sum check or in installment payments — perhaps through continued payroll cycles? Note that the bigger the check, the larger the amount of taxes will likely be deducted. Also, some employers only desire for it to be a lump sum, so that they can sever ties with the employee sooner rather than later.

3. Emotional Distress. Are there any claims of harassment or discrimination that also led to emotional distress? If yes, there might also be a need to discuss a separate payment for the intentional infliction of emotional distress. Even if the employer is uninterested in a separate payment, they may be willing to split up the lump sum payment into two parts: one part to be considered W2 wages and the other part 1099 nontaxed compensation for emotional distress. This helps the (ex)employee lower the tax burden but note that this does not guarantee that the IRS will not later conduct an audit and determine taxes should have been paid. Because of this, employers tend to require language in the agreement making it clear that any tax burden is the sole responsibility of the former employee.

4. Non-disparagement. This is a big one. It is important to both parties that no disparagement occurs. The employer does not want a social media warrior bashing them online or in other venues. The former employee does not want the employer bashing them to potential new employers. This clause attempts to keep everyone on their best behavior. While the employer is usually unwilling to consider a blanket non-disparagement clause that covers every employee that works for the employer (this would be hard to manage or enforce), they will typically agree to having it cover a narrow and important subset of employees such as the direct supervisor, HR representatives, senior leadership, and other supervisory people who may have been closely connected and in a position to be asked why the person left the company.

5. Confidentiality. Similar to non-disparagement, the parties also value confidentiality. This means the agreement will not be shared with anyone outside of the respective parties’ legal counsel and tax advisors, unless disclosure is compelled by law.

6. References. How will the employer respond when called by a potential future employer conducting a background or reference check? The agreement should provide clarity. Will the employer provide a positive recommendation/reference (rare), a neutral one (common), or a negative one (rare)? Or will the reference checker simply be forwarded to HR for a basic outline of dates of employment, last salary, etc.? This last option is also common. Of course, the former employee will certainly negotiate for a positive reference, especially if there exists evidence that the employment relationship was otherwise a good one — evidenced by good annual performance evaluations and consistently good merit pay increases.

7. Project Work. Sometimes it is in the best interests of both parties for the employee to continue working a bit longer before any severance payout occurs. An employee may desire this so they can still legitimately say they work at the company, making it easier to find new employment (since they do not appear to be unemployed and thus do not have to answer the “why” questions that are sure to follow). The employer may also desire this if it will take several months to re-fill the position and there are critical projects or other work duties looming. Of course, for this to work the employee needs to be on their best behavior and capable of being trusted to stick around without creating any turmoil.

While this is by no means an exhaustive list, it is incumbent upon the parties to consider these options when working on a severance agreement. If the relationship can end as amicably as possible, and with an air of mutual dignity and respect, everyone will be much better off!