Severance Agreements in California: Understanding the Whats, Whens & Hows
As employment law attorneys we focus on the employment relationship from start to finish, but we spend much of our time dealing with the termination of that relationship. We advise clients on the lawfulness of terminations and the best ways for employees and employers to reduce risk in terminating the relationship, and we litigate cases based on terminations. So we generally find ourselves in familiar territory when addressing a matter involving firings, layoffs, and resignations.
The same does not always hold true for an individual who loses his or her job, or a company faced with the need to terminate an employee or conduct layoffs. The professional and personal impact on an individual can prove stressful and raise a wide range of emotions, even if he or she has gone through it before. For small and early stage companies, terminating an employee can disrupt the business, affect employee morale, and present a personal challenge as much as an unfamiliar personnel action. Even large and well-established companies experienced in terminating the employment relationship approach each situation with an awareness of the need for careful consideration and handling.
One of the first questions to come up involves severance. A person who just lost her job asks whether she has a right to severance; a question motivated not only by the sudden loss of income but often by a sense of unfairness in the decision. An employer terminating an employee asks whether it must provide a severance and, if not, whether it should provide one.
The following provides an overview of severance from the perspective of the employee and the employer.
Does an employer have to provide severance when terminating an employee?
For most private sector employees, an employer has no obligation to provide an employee severance. Some employers have policies providing severance agreements under certain circumstances. The question of entitlement for employees of these companies depends entirely on the policy. Some employees may have an individual right to severance based on a provision of their employment agreement, typically providing a right to severance in the event of a termination without “cause” or a resignation for “good reason” (the definitions of which the agreement will detail). Generally limited to executive contracts and agreements with higher-level employees, the severance provision defines the circumstances under which the person receives severance and the components of the severance package.
Absent a policy or individual agreement guaranteeing severance, an individual generally has no right to severance regardless of the reason for the termination, the person’s performance, or the length of employment. But the fact that an employer may have no legal or contractual obligation to provide severance does not mean that it has no reason to do so.
If an employer has no severance policy and the individual has no contract with a severance provision, why would an employer offer severance to a person whose employment has ended?
Employers frequently offer severance even where they have no legal obligation. They may do so for any number of reasons, including the desire to thank the person for their contributions and service and to soften the financial impact and ease the person’s transition into his/her next job. But perhaps the most compelling reason for an employer to offer severance in such circumstances has to do with the promises and protections that the employer gets in return for the severance paid (discussed below).
If an employer provides severance, does it have to provide a certain amount based on years of service or some other criteria?
If an employer has a binding policy or contract obligating it to pay severance, it must pay to the terminated employee the specified severance benefits. Absent a policy or an individual agreement, however, the decision about how much to offer rests entirely with the employer just like the initial decision about whether to offer any severance at all. In deciding how much severance to offer, employers have so frequently used two rules of thumb that people often mistakenly assume there exists some legal requirement. First, employers often base the amount of severance on the length of employment; awarding, for example, one or two weeks per year of service. Second, employers commonly use round numbers tied to a person’s compensation at the time of termination; for example, one, two, three, etc. months of pay.
But an employer having no legal obligation to provide severance can apply any formula it chooses or no formula at all. An employer need not provide severance according to formulas used in the past and need not even apply the same formula for multiple employees offered severance at the same time (in a layoff, for example). Just as with any employment decision, however, the employer cannot base the decision about whether to award severance or the amount of severance offered on certain unlawful criteria such as race, gender, or other protected statuses. In addition to the administrative simplicity and the avoidance of unfairness, the consistent use of criteria determining whether to award severance and a formula for calculating severance enables reduces the risk in this regard.
How much severance should an employer offer a terminated employee?
In some cases, an employer can easily determine how much severance to offer. It need only offer the amount specified in the policy or agreement, or an amount consistent with what it has or will offer others. But if a policy or contract does not require a certain amount, setting the amount will depend on how much it will take to persuade the person to sign a severance agreement and the value that the employer places on getting an agreement signed. That, in turn, depends on the value of the claims that the individual would release in a typical severance agreement, the risk that he or she would pursue those claims, and the importance to the employer in securing the additional protections a severance agreement provides. The stronger the individual’s claims and the greater the risk of litigation, the greater the value of the release and the more it may cost to purchase that release (and the greater the employer’s willingness to pay).
Can an employer provide severance other than money?
Many people equate severance with the payment of money, and this certainly qualifies as the most common form of severance. But a severance can consist of anything of value to which the terminated employee has no entitlement other than the employer’s offer to provide it and usually conditioned on the employee signing a severance agreement. Severance can include payment or reimbursement of COBRA premiums, payment of all or part of a bonus that the employee would not otherwise receive given the date of termination, acceleration of vesting in equity, the career counseling services, or any number of other payments or benefits. Of course, a severance package can include a combination of two or more payments/benefits.
Does an employee have to sign a severance agreement to receive severance?
The law does not require that an employee sign a severance agreement as a condition of receiving severance, and employers sometimes offer severance without requiring the execution of an agreement (usually because they have offered only a small severance, they want to keep it simple, or they do not fully understand the value of a severance agreement). But in most cases, an employer will require an agreement. In severance policies and individual agreements providing for severance, the employer generally conditions the person’s right to the specified severance on his/her executing a severance agreement with a release of claims. For an employer hoping to avoid potential disputes with the terminated employee by offering a parting payment, execution of a comprehensive and enforceable agreement can prove essential.
Does a severance agreement have to include certain provisions?
With some limitations, employers have wide latitude in conditioning severance on the execution of an agreement that includes a number of standard provisions and provides the broad protection that employers seek. Although the scope varies from company to company, and even from person to person within a company (dependent on factors including the circumstances leading to the termination and terminated employee’s position), severance agreements typically include the following provisions. First and foremost, the agreement includes a release of claims pursuant to which the terminated employee releases nearly all – but not all – claims that he or she may have against the company and perhaps others, and it includes a provision obligating the employer to give the employee certain things of value. These provisions comprise the heart of a severance agreement. The agreement might include a provision characterizing the employee’s termination as a voluntary resignation. It might also include a provision limiting what the employer will say to those calling to get a reference for the terminated employee. For the employer’s benefit or protection, a severance agreement might also include a confidentiality provision limiting the person’s right to disclose certain information, a non-disparagement provision restricting the person from saying bad things about the company, and certain restrictive covenants limiting the person in his or her next positions of employment (provisions for which the enforceability will vary from state to state and on which California law imposes substantial limitation).
Along with the many optional provisions, the parties can include, some provisions are required to ensure enforceability. For example, federal law requires specific provisions if the agreement includes a release of claims for age discrimination and may require that the employer provide certain statistical information to the terminated individual. Employers hoping to avoid challenges to the enforceability of severance agreements based on provisions that some federal agencies and courts have recently deemed unlawful must exercise caution in using the standard form agreements that they may have used for years without revision and must include specific provisions to avoid these recently identified problem areas.
In short, severance agreements simply embody a contractual agreement between the company and a terminated employee. In exchange for the employee’s release of claims and adherence to certain other obligations, the employer gives the person something of value. Both the employer and the employee have to decide whether the value of what they receive equals or exceeds the value of what they will give. As with any contract, however, the devil is in the details. Each party needs to fully understand the value of the give and the get and what they can and cannot accomplish in a severance agreement. Perhaps most important, they need to ensure the deal set out in the written agreement matches the deal they think they struck.