Creating Equitable Severance Packages

In today's state of economic uncertainty, most people are not losing their jobs through any fault of their own; rather, layoffs are predominantly based on business decisions to maintain profitability and competitiveness. As a result of the current economic climate, it is important for employers (and employees) to be informed of the components of an equitable severance package.

Severance Practices

There is no legal requirement in the US to provide severance pay, unless the employee has a contract with the employer that provides for severance. If an employer does provide severance pay, employees are usually only eligible if they are laid off or downsized due to a merger, acquisition, or other business decision not if they leave voluntarily or are fired for cause.

Some employers offer severance plans contingent on an employee's agreement not to compete with the organization or make slanderous remarks about the former employer. Typically, the employer provides the employee with some form of severance benefit and, in exchange, the employee agrees to release the employer from any potential litigation.

While severance is voluntary, employers are required to give notice to employees about a plant closing or mass layoff, so that employees have a chance to find another job and adjust to the loss of employment. The Worker Adjustment and Retraining Notification Act (WARN) offers protection to workers, their families and communities by requiring employers to provide notice 60 days in advance of plant closings and mass layoffs, which are covered under WARN. (For more information about the WARN Act, please visit the US Department of Labor Employment and Training Administration).

Virtually everywhere in the world, laws and customs regulate the ability of employers to lay off workers. From an organization's standpoint, the decision to terminate a group of employees is fraught with potential legal, financial, and public relations consequences. An employee who feels he/she was wrongfully terminated may want to pursue a lawsuit against the company. Whether or not the employee wins, this will most likely negatively affect the organization's financial situation and public image.

While layoffs can be necessary at times, they can also negatively impact an organizations productivity levels as well as the ability to retain and attract top talent in the future.

Creating Equitable Severance Packages

Severance is intended to bridge the gap between one job and the next. The two most significant factors in the length of time this takes are the age of the individual and his/her salary level, not the length of service, which most organizations use to create a severance policy. Including age and pay level in the overall formula creates a more equitable policy. Nevertheless, on average, organizations provide between one and two weeks' pay for each year of service unless the employee has a negotiated employment contract or is at a senior level.

A good rule of thumb, for employees, is not to sign a severance agreement, until they've had ample time to think it over and do some research to be sure the package is reasonable. A severance package that provides a bridge to another endeavor in the form of continued pay, suitable benefit coverage (especially health insurance), and career transition services should be structured to compensate for reasonable estimates on how long it will take to find another position.

There are six typical components in a severance agreement:

  1. Severance Pay: Although not legally bound to do so (unless by an employment contract or union agreement), most organizations will provide severance pay to help bridge the gap between jobs. Organizations have a choice to pay severance either in a lump sum or as salary continuation, but the latter is recommended in order to maintain financial discipline. (It can be disastrous when displaced employees have misused lump sum payments and gotten into financial difficulty.)
  2. Outplacement: Approximately 80% of employers in the US provide outplacement services to employees, who have been laid off. In most cases, the length of the programs provided is tied to the departing employees' seniority levels within the organizations. However, it is also necessary to assess each individual's needs based on his/her marketability and career goals.
  3. Medical Insurance: Continuation of health care provisions were enacted as part of the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA). Employers must, according to law, offer employees COBRA coverage for 18 months after they have left the organization. There is a period of time before COBRA coverage becomes available to employees; however, many employers continue coverage through the period of severance before it becomes available. (For more information on COBRA laws and guidelines, visit the US Department of Labor.)
  4. Vacation Pay: Sometimes an organization will allow its employees to accrue vacation time from one year to the next. Departing employees in organizations that follow this practice should remember to account for their unused and accrued vacation time.
  5. Bridging to Retirement: Organizations are often willing to grant time for bridging to retirement if an employee is within a few years of eligibility for either early or normal (full) retirement. This is usually in the form of adding years to age and service, e.g. 3 + 3 (three years added to age, three years to service). If the organization's pension plan is funded, this costs little for them to give.
  6. Stock Options: Generally, departing employees have 90 days after they've been laid off to exercise vested stock options before they are lost. Please note, however, that employees can negotiate to have this period extended and even have unvested options become exercisable. (Employees usually have to wait a certain amount of time designated by the employer for their options to "vest", before they are eligible to use, or "exercise", them.)

In addition to a severance package, departing employees may be asked to sign a Waiver and Release and Covenant Not to Compete. Non-compete clauses that are broadly written (e.g. industry-wide) have proven unenforceable in the courts, so most organizations write these provisions as specifically as possible. These agreements can get very sticky, as they are narrowly construed in law. They must be very reasonably drafted in terms of duration, geographic coverage, and extent. If this type of agreement is to be used, it is recommended that both the employee and the employer seek expert legal opinion, so that the terms of the agreement are fair and legal to both parties.