Severance agreements are legal contracts between an employer and a former (or soon-to-be former) employee that provide benefits to the employee in exchange for certain promises and obligations, usually including a release of the employee’s potential claims against the employer.
Despite the fact that severance agreements are commonly used in organizations of all types, employers frequently make mistakes in preparing them. Errors can cause an employee’s release of claims to be unenforceable, leaving the employee with severance benefits in hand and the employer without protection against a potential legal action.
From a big picture standpoint, the most common mistake employers make is treating severance agreements like generic, “one-size-fits-all” form documents that can be used with any employee in any circumstance, ignoring differences in state laws, changes in the law that may make previously used documents obsolete, and the unique circumstances of each employee. While some language is suitable for use in most severance agreements, employers should treat each agreement with care and thoughtfully consider the terms they include in it.
Some of the specific errors that occur frequently and can render a severance agreement wholly or partially unenforceable include:
- Failing to provide adequate consideration- In order to create an enforceable contract, each party must receive some form of “consideration,” or value it was not otherwise entitled to receive. Employers sometimes ask departing employees to sign a release of claims without receiving any consideration in exchange. In other cases, an employer may promise in a severance agreement only to pay the employee’s final wages (which it is already legally obligated to pay) in exchange for a release of claims. In these scenarios the employee does not receive valid consideration, making the employee’s release of claims unenforceable in both scenarios.
- Ignoring, or misapplying, the rules applicable to employees aged 40 and older– As mentioned above, employers often treat severance agreements as “one-size-fits-all” documents, ignoring the special rules that apply to agreements with employees who are 40 or older when an employer is covered by the Age Discrimination in Employment Act (ADEA). The ADEA requires employers to allow employees to consider a release agreement for 21 days (45 days if the employee is terminated in connection with a group separation program like a reduction in force), and employees 40 or older are also entitled to rescind severance agreements for seven days after signing them. Employers often fail to include language required by the ADEA (or Older Workers Benefit Protection Act for a group reduction) when creating severance agreements for employees 40 and older, and they sometimes include a right to rescind the agreement when creating agreements for employees under age 40 when that may not be required. Employers should also recall potential unique state law requirements – such as the California law that requires an employer to allow employees under age 40 to consider a severance proposal for at least five business days.
- Including illegal terms- Some provisions that employers commonly include in severance agreements, such as covenants not to compete and broad non-disparagement clauses, may be illegal and unenforceable under the laws of certain states. Employers must be alert to restrictions that may exist, such as California’s general prohibition of covenants not to compete and potential restrictions or limits on confidentiality and non-disparagement clauses under both state and federal law. Although severance agreements can create enforceable releases of most claims, they generally cannot operate to release claims for workers’ compensation benefits or unemployment insurance benefits.
- Other Unique State Law Issues- Some states have special requirements for release agreements. While not exhaustive, some examples include: the inclusion of unique language for a release of unknown claims, express references to certain state laws in the release; and unique review and/or revocation periods.
- Overlooking the impact of the agreement on other contracts- Like most contracts, severance agreements typically include a clause stating that the agreement supersedes all prior agreements between the parties. If an employee has executed a confidential information, valid noncompetition or nonsolicitation, invention or intellectual property, or arbitration agreement, for example, the employer may want those agreements to remain in effect following the execution of the severance agreement. In such circumstances, the severance agreement should specifically identify any agreements that are intended to remain in effect.
As is true with all legal contracts, prudent employers should consult with an experienced employment attorney when preparing severance agreements in order to assure that they are enforceable and provide the employer with all of the benefits and protections available under the law. If you have any questions, please contact the author listed above or your regular Lathrop GPM attorney.