Employer's Guide to Severance Pay: Legal Requirements and Best Practices

Employers often offer a severance package in exchange for an employee signing a release of claims, which protects the business from potential lawsuits. This article reviews your legal obligations, the strategic benefits of offering severance, and what to include in a package. An experienced employment lawyer can provide guidance tailored to your specific situation.

When Severance Pay Is Legally Required

In most cases, at-will employment means you don’t have to offer severance. However, an employer must offer a severance package when the employment contract or company policy states that terminated employees will get one. Situations where you may have to provide a severance payment include:

• An employment contract or collective bargaining agreement that mentions a severance package
• A statement in your employee handbook or company policy that mentions severance benefits
• A company history of giving severance packages to similarly situated employees
• A verbal promise to an employee that they would get severance pay

Although employers are not required to offer severance in the event of a company shutdown or plant closing, they must comply with the WARN Act. Under the Worker Adjustment and Retraining Notification Act (WARN), employers with over 100 employees must give workers at least 60 days’ notice of an impending shutdown.

About 20 states have similar laws called “mini-WARN Acts.” These state laws apply to businesses with fewer employees than the federal standard. For example, New York law extends the notice requirement to 90 days. In New Jersey, employers must provide one week of severance pay per year of service for all affected workers. Check your state laws for notice requirements and when employers must submit final paychecks to employees.

Strategic Reasons To Offer Severance (When Not Legally Required)

Although you don’t have to provide a severance package, HR professionals suggest it may be a good idea in certain circumstances. These can include:

• Obtaining a release of claims: The primary reason to provide a severance package is to have an employee sign an agreement not to sue the company for wrongful termination, discrimination, or other reasons. Employers may add non-disparagement or non-compete clauses in their severance agreements.
• Protecting your business from lawsuits: You may consider giving a severance package to high-risk employees or those covered under the Age Discrimination in Employment Act (ADEA). These are workers you want to fire but who pose a potential legal risk.
• Maintaining morale and reputation: Large corporations often offer severance pay to executives and employees who have worked for the company for a significant amount of time. The ensuing boost in public perception can easily outweigh the financial outlay.
• Helping ease company restructuring: Companies may also offer voluntary “retirement bonuses” that are severance packages when the company is downsizing or merging with another company. Rather than lay off employees by seniority, companies offer older workers extra money and perks for leaving early. These early retirement bonuses are a form of severance pay.

When terminating an employee aged 40 or over, a severance agreement is a critical tool for mitigating legal risk. The Age Discrimination in Employment Act (ADEA) protects these employees and allows them to sue if they believe their termination was due to their age. In exchange for severance benefits, the agreement requires the employee to sign a waiver that releases the company from any potential ADEA claims related to the termination.

For this waiver to be legally binding, it must meet the Older Workers Benefit Protection Act (OWBPA) requirements, including giving the employee adequate time to review the agreement and consult an attorney. To ensure the waiver protects the company, consider drafting it with the aid of an employment law attorney.

The Fair Labor Standards Act (FLSA) doesn’t require severance pay or severance packages, as they’re optional under federal law. To avoid discrimination claims, consider offering similar compensation packages to employees with comparable roles, seniority, and pay levels.

What To Include in a Severance Package

When an employee leaves your company, you must provide certain items. Employees must get their final paycheck, retirement benefits, and the right to continue their health insurance. A severance package should be something more than what’s legally required. Options include:

• Bonus pay: Extra pay can be a benefit if employees are laid off or asked to retire early. The usual figure is a week’s pay for every year of service, usually as a lump sum. Employees also generally receive pay for unused vacation time.
• Health insurance: The Consolidated Omnibus Budget Reconciliation Act (COBRA) lets terminated employees keep their group health insurance coverage, even if they were fired for cause. Severance bonuses sometimes cover COBRA premiums for a short period. Confirm this with your insurance carrier, as COBRA payments can be over 100% of the employer’s cost.
• Unemployment benefits: The WARN Act and state mini-WARN laws exist to give employees time to file for unemployment compensation. Benefits can take several weeks to kick in. Employers can speed the process by responding quickly when they receive the worker’s claim.

Unless your employment agreement specified particular items, consider some of the following:

• Outgoing employment services: If your company has a human resources department, outplacement services can help workers find new jobs. Large corporations with high turnover often have these services to help workers during mass layoffs. Small business owners could consider referrals or recommendations.
• Letters of recommendation: Approach these cautiously. Letters of recommendation can strongly incentivize departing workers and protect you from possible legal action, but they can also expose you to other forms of liability. If you’re dubious about writing a recommendation for a terminated employee, it’s a good idea to confer with an employment law attorney.
• Financial perks: Allowing a departing employee to retain or exercise stock options can be a valuable, non-cash part of a severance package. Again, weigh the cost against the possibility of lawsuits or bad publicity.

Other options may exist.

Get Legal Help With Your Severance Agreements

Terminating employees is a difficult process fraught with legal risk. A severance agreement is a binding legal contract designed to protect your business. Before offering any severance package, consult an experienced employment law attorney. They can help you draft an enforceable agreement, ensure WARN Act compliance, and navigate high-risk terminations to reduce the risk of future litigation. Find a qualified employment law attorney near you to help protect your business.