Severance Agreement Defined
Severance agreements are arrangements between employers and employees who have decided to part ways voluntarily or via termination. Although the agreement benefits both parties, the employer generally drafts the agreement. The employer’s motivation is usually for the employee to release any claims against the company in exchange for financial compensation. Severance agreements can vary in the amounts and conditions of benefits provided, as well as the type of employment relationship between the parties. For example , a stated reason for the separation may be a reduction in work force or elimination of the position.
In the general employment context, severance agreements typically offer employees payments or benefits for a certain period after their employment ends. The intent is to assist the employee in seeking new employment, and often times include financial incentives for the employee to leave. The amount of compensation depends on a number of factors such as the employee’s tenure with the company and eligibility for any type of unemployment benefits or retirement funds.
California Law and Severance Agreements
While severance agreements are generally not required by law, there are several legal requirements that must be followed in California. Severance agreements are contracts, subject to California contract law rules, but the law triggers additional requirements in certain situations.
In addition, employers who offer severance to employees are required to comply with certain statutory and common-law rights. For example, severance plans fall within the definition of an "employee pension benefit plan" under ERISA. As a result, employers subject to ERISA must comply with the heightened documentation and disclosure requirements it imposes. And when an employer lays off over 50 employees at one time or over a six-month period, the employer must comply with the WARN Act.
Employers should also pay special attention to the tax consequences of providing severance. The IRS has generally held that severance payments to employees are to be considered wages and should be reported on Form W-2, unless they fall within one of the following exceptions:
Employers should be mindful of the amount of severance offering as compared to the employee’s regular pay to avoid an argument that the funds are actually for, in lieu of or as a replacement for, regular wages.
Severance Agreements Generally Include the Following Provisions
The first thing to do when you receive a severance agreement is to read it carefully. As stated above, there are several objectives of a severance agreement that you should consider. Once you know what you want from your severance agreement, you can decide whether the following standard components of a severance agreement are acceptable, negotiable or non-negotiable.
A severance agreement may contain all or some of the following clauses:
(1) Money. The most common reason for severance agreements is money. Frequently an employee will be entitled to a lump sum payment consisting of two weeks of pay for each year of service with the company. The amount of the payment can vary depending on the company policies and practices, employee’s position, and how long the employee has worked for the company. When calculating the amount of pay due under the agreement, you must also determine whether the payment is subject to income taxes or other withholdings and whether bonuses and/or commissions are included.
(2) Release. A release is a waiver of the employee’s right to bring any claims against the employer. A typical release contains a list of events or practices that could give rise to a claim, and states that employee waives his or her right to bring a claim against the employer regarding those events or practices. Common prohibitions include age, gender or race discrimination, breach of contract, wrongful termination, and violations of the California Labor Code.
In many cases, especially when you are given a termination notice, the company may agree to pay you extra money in exchange for you signing a liability release and a general waiver of claims. In rare cases, the company may offer you a choice between receiving a sum of money and receiving what you believe to be a right or entitlement, such as your accrued vacation and sick leave. It is generally advisable to not give up something you believe you may have an entitlement to unless you are getting extra money in exchange. The extra money should be enough to make giving up that right or entitlement worth your while.
- (3) Confidentiality. Many severance agreements contain confidentiality provisions stating that the employee agrees not to disclose the terms of the agreement. Keep in mind that California’s Labor Code does not allow an employer to restrict an employee’s right to make wage and benefit claims, so an employer can’t prevent you from reporting unpaid wages or unused vacation time to the Labor Commissioner’s Office.
- (4) Non-compete. Some severance agreements also contain non-compete language preventing the employee from working for a competitor for a period of time after termination. California courts consider non-compete clauses to be against public policy, and therefore California courts do not enforce them. That said, employees who violate their non-competition clauses may still face lawsuits and non-monetary injunctions from former employers.
- (5) Payment Terms. The final aspect of a severance agreement contains details about payment, including when the payment will be made, and whether the payment will be made as a lump sum or in installments. It will also describe whether the payment will be subject to income or payroll taxes, and if so, how this affects the amount. Employees should also consider whether they will be paid anything at the end of the term of their employment. Many employers provide pay in lieu of notice and severance pay for employees who are terminated without cause (i.e. fired or laid off).
Rights of Employees under California Law
While severance pay is not required by California law, employees have the right to receive certain payments even if they have not been expressly promised to them in a written contract. For example, employees have a right to receive payment for all earned and accrued wages, including any accrued but unused vacation time, upon termination of employment. Payment for any unused PTO time must be paid at the employee’s regular pay rates; which includes overtime rates if different from the employee’s standard pay rate. If an employee is paid on a piece rate basis (e.g. the more sales an employee generates, the higher his commission rate is paid), then any earned, accrued and unused PTO time must be paid at the employee’s average hourly pay rate for the year prior to termination.
Moreover, if a plaintiff brings a potential claim under California law to challenge the validity of an employment agreement or release, the employer is not allowed to withhold otherwise owed wages or PTO time until the claim dispute is resolved as is generally provided by the "pay and plead no contest" provision of California Labor Code Section 206.5. A plaintiff may be entitled to recover attorneys’ fees in connection with his/her lawsuit to recover such wages or PTO time.
Thus, severance agreements that purport to release claims against employers may not be enforceable if an employer improperly withholds pay earned under the guise of enforcing a release.
Negotiating the Best Severance Package
As previously mentioned, severance agreements are negotiable. It is therefore important for terminated employees to understand their bargaining power when negotiating a severance package with their employer. This is particularly critical in California, where even at-will employees have the right to bring a number of legal claims against their employer, such as wrongful termination and discrimination. Knowing about your bargaining power can guide you in making the right requests to your employer. Some severance packages will take care of employers’ potential liability by including a general release of all claims against the employer by the employee, in exchange for payments to the employee. The amount of money you could be giving up in such a release may be cause to negotiate the terms of the agreement.
A good starting point for negotiating a severance agreement is to understand the full extent of your employer’s obligations to you, and the potential claims you may have against the employer. For example, if you were terminated without the proper notice under your employment agreement or California law, you may be able to demand a certain amount of compensation from your employer to satisfy those notice obligations. Even if you do not have an employment agreement , you may be entitled to a certain amount of wages under California Labor Code and the Industrial Welfare Commission Orders. It is also important to continue to protect yourself after termination. For example, if you worked for your employer during a time period in which you would have been entitled to a commission if you had remained employed, and you are not provided with evidence that you received pay that satisfies that right, you should consider demanding additional commission pay as part of a severance agreement. In addition, you should verify that the intellectual property created by you while working for your employer has been accounted for in your severance agreement.
Moreover, employees whose severance agreements include extended payments over weeks or months after dismissal may be entitled to additional compensation based on the number of days they continued to work for their employer after the termination of employment, and the date the severance payment is made. It is important for those payments to be as soon as possible after your termination. Severance payments made over many weeks or months after employment is terminated may require more strategy to prevent any adverse tax impacts. Consult with an attorney and a tax advisor to determine the best strategy for your compliance with California system of taxation.
When to Seek Help from an Employment Lawyer
Situations that Suggest Consulting an Employment Lawyer
The first guidance I can offer is to remind the employee that this is a business transaction. The employer’s next best option may be to hire another employee to perform your job. It also may be considering the risk, merit, and cost of bringing a lawsuit based on the employee’s departure. Some employers choose to treat an employee well upon termination because it helps with their brand. However, as I tell my clients, companies cannot operate at a loss because they need to uphold their "brand" or be "nice." A company’s prices and profits are what allows them to be "nice."
These are some examples of situations where it would likely benefit an employee to retain an employment lawyer:
- if the severance package is substantially less than the employment relationship would have been worth;
- if the employee has information about the employer that constitutes prosecutable claims (including material wage and hour violations that suggest that other employees’ wages and hours have not been properly treated);
- if the employee is not proficient in English and there are strong incentives for an employer to take advantage of the language barrier;
- the employee is in a position of weakness compared to the employer and needs thoughtful insight into the transaction in order to ensure that it is fair and favorable;
- the employee does not understand the employment relationship and the companies legal rights and obligations and perceives the employer’s treatment of him or her as unjust or highly unfair because the employee does not have an objective understanding of how the law applies in the situation – I have seen this many many times and could write a book about it and likely will.
- the offer has unreasonably short time limits to accept or has a condition to it that is not readily understood.
- the release is very broad and the employees’ rights under the law could easily be violated.
- any provision that is waived by the employee may be that the employee does not know and understand all legal rights and remedies that are a result of such violation. For example, employees waive claims for claims filed with government agencies or any court of law. But, the employee does not waive claims that have not occurred. So, in some cases, if the employer has a history of false representation of the working conditions or other misrepresentations to employees, then it is possible that a subsequent claim may be based on those misstatements. If that is the case, the employee would not want to waive those possible future claims.
This is by no means an exhaustive list. I am simply trying to add some perspective into the situation. It is important to note that employees are entitled to obtain attorney’s fees if an attorney is retained to draft a Separation Agreement and/or General Release.
Commonly Asked Questions about California Severance Agreements
As with any area of the law, severance agreements in California can be fraught with complexity and nuance. Below are answers to some of the most common questions I receive from individuals regarding severance agreements in California:
Is my employer required to give me severance pay?
No. It is common for California employees to believe that they will receive severance pay if they leave their job involuntarily. That is not necessarily the case. Unless your employment contract, severance policy, or employment practices manual explicitly state that an employee will receive a severance package under required circumstances, the law does not require your employer to provide you with severance pay. However, many employers will voluntarily provide departing employees with severance packages in order to avoid the risk that the employee might bring a lawsuit against the company later.
Is my employer required to negotiate the terms of my severance agreement?
No. Unfortunately, if your employer requires you to sign a severance agreement in order to receive benefits, it is up to your employer to decide whether to negotiate the terms of that agreement with you.
How can I negotiate the terms of a severance agreement with my employer?
If you are fortunate enough to have the opportunity to negotiate an employer’s severance package, it is important to be realistic in determining which terms you would like to discuss, and what you may be willing to give up in exchange for those terms . An employer will likely only be willing to consider your preferred terms if you can offer the company something of value in return. For example, if you want more time to review a separation agreement before you sign, the company may agree to that as long as you can promise to sign the agreement and return it by a set deadline.
When can I safely sign my severance agreement after the company presented it to me?
You only have to sign your severance agreement when you have completely finished negotiating its terms, or if you have decided that you will not be negotiating the terms of your agreement any further. Otherwise, you should not sign the agreement until an attorney has had a chance to review the agreement and advise you not to worry about signing it. Otherwise, you may be giving up important rights before you even know they exist.
What should I do if my employer presents a severance agreement for me to sign shortly after my termination?
I receive numerous calls every month from clients who are offered a severance agreement only days after they terminate or are laid off. These clients are understandably concerned; can a company really expect them to fully read and understand the severance agreement in so short a timeframe? The short answer is, yes, often enough for "standard" separations. However, if a layoff is particularly large, or if it appears that the layoff may have been retaliatory in nature, you may have an argument that your reviewing and understanding the language in the agreement was not practical in such a short timeframe.