Consultant to this Program

In these uncertain economic times, many organizations are experiencing unprecedented levels of financial pressure. Reductions in force (RIFs) are becoming increasingly necessary and common. There are many risks to manage when reducing your workforce by one employee or by many. This article discusses the benefits of using severance packages as well as the pitfalls to avoid. 

A severance package usually consists of pay and benefits an employee receives when leaving an organization. Some of the benefits may include payment for unused, accrued vacation or sick leave time, insurance continuation, retirement benefits, job placement assistance, and/or a payment in exchange of a waiver of the right to sue the organization.

Some organizations have a policy for severance packages in their employee handbook, while others do not. In a recent study by Culpepper and Associates, Inc., sixty-eight percent of the companies they surveyed use some form of a formal severance policy. Most companies have a policy that impacts all job levels, while some restrict it to the executive level. Eighty-two percent of larger companies surveyed use a formal plan, while smaller companies are more likely to deal with the issue informally. Some calculate benefits based on a fixed amount, without regard to employee longevity, while others calculate based on weeks of service, or use both a fixed amount and a tenure calculation. 

A benefit of having a written policy is that it helps the organization manage severance more equitably, thus reducing the likelihood of a discrimination lawsuit. The downside of having a policy is that your organization may end up paying severance to someone who the organization would prefer not to pay.

Severance can engender good will with departing employees. It can be viewed as a reward for loyal service or as a way to nurture business connections if the departing employee is going to work for a customer. 

When an employee leaves for less than positive reasons, before a severance is paid out, according to the Culpepper study, ninety percent of companies require the employee to sign a waiver of the right to sue.  The enforceability of these waivers varies from state to state and can hinge on seemingly slight differences in wording. Always consult your legal counsel in preparing a severance agreement. In addition to the risks discussed here, there also can be IRS and COBRA regulations implications involved in severance agreements.

If the waiver portion of the severance agreement is to be used to prevent a lawsuit—discrimination or other grievances the employee may have—the waiver must outline with specificity the claims being waived. The severance package is given in exchange for the signed waiver or release of the right to sue for any reason relating to employment, including the termination process itself.  

If the employee responds by requesting a higher severance payment, the organization may consider that a rejection. The employer can then refuse to stand by the original offer or choose to change the terms.  

There is an important caveat that should not be overlooked in using severance agreements—the Older Workers’ Benefit Protection Act (OWBPA). Because workforce reductions tend to have a disproportionate impact on employees age 40 and older, Congress enacted the OWBPA to provide some protections to this group of workers. The OWBPA has specific requirements that any waiver of rights has to include for older employees or it will be unenforceable.

An OWBPA waiver must be knowing, voluntary, and written in simple English. It must specifically reference Age Discrimination in Employment Act rights, as well as all others being waived. It cannot purport to waive claims the terminated employee may someday have that arise after the waiver is signed, and it cannot be executed in consideration of something the employee is already entitled to, such as the final paycheck. The severance payment serves as the consideration necessary to make the severance agreement enforceable. 

OWBPA requires the waiver contain advice to the employee to seek legal counsel, and the employee must be given at least 21 days to consider the terms prior to signing. (If the waiver is drafted for a group of employees, they have 45 days to consider it and are entitled to additional information.) And, once the agreement is signed, the employee has seven days to revoke it.

Finally, it is important to note that a past common practice of employers was to include a term in the severance agreement that stated that if an employee breached the agreement and sued the organization anyway, the employee would have to return the severance payment to the organization. The courts have held that this practice is not legal. 

Bottom Line:

Liability risks run high with reductions in force. Only one affected employee can file a charge or lawsuit, but it could become a class action. A successful RIF usually requires an attractive severance package and a valid waiver, carefully crafted by the organization and its legal counsel, so that the benefits of a severance agreement are achieved by the organization and the pitfalls are avoided.