Severance Pay

Severance pay comes in five forms:

  1. None at all
  2. Unemployment compensation
  3. Severance Pay Plans
  4. Voluntary Severance Pay (rare today) and
  5. Bargained for Severance by Agreement.

At-will employees rarely receive severance pay upon their termination. They usually have no right to receive it. Unless fired for cause, though, eligible, terminated at-will employees should receive unemployment compensation benefits.

Employers can offer a Severance Pay Plan as an employee benefit, but most do not. Employers can voluntarily pay severance to employees, and some used to do it. If the employer demands a general release of rights (i.e., a promise not to sue) in exchange for severance, that converts an offer of severance into a negotiated severance payment by agreement. Severance pay agreements also include severance pay clauses in employment agreements negotiated at the beginning of employment.

Employers have No Obligation to pay Severance to At-will Employees

Unless the parties agree otherwise, the law presumes that their employment relationship is “at-will.” This means it lasts only as long as both parties want it to last. Either of them can end it at any time, for any lawful reason, or even for no reason at all. This tends to work out well mostly for employers.

Once either party ends the employment relationship and the employer pays the employee amounts earned, the employer’s obligation to pay an at-will employee ends . After that, employers have no further obligation to pay anything to at-will employees, including severance pay.

Unemployment Compensation Benefits

Unemployment compensation benefits pay workers who lost their job without fault a modest weekly payment until the worker finds a new job, up to a specified number of weeks. Each state administers its own unemployment compensation program.

Unemployment compensation benefits, which are also known as unemployment insurance, are not, technically, a form of severance pay. Rather, the federal government created unemployment compensation programs as a statutory benefit in 1935. Taxes on employers fund unemployment compensation benefits and each state administers. its own program. 

For at-will employees, unemployment compensation benefits fill a function similar to severance pay, providing cash when needed most. MEL has more information on unemployment compensation benefits here.

Severance Pay Plans

Employers can offer employees severance pay benefits in the event of certain job losses, like from a reduction in force. Severance plans typically compute benefits using a formula based on length of service, like a week or month of pay per year of service.

Once an employer offers a severance pay benefit, federal law treats it as a “welfare benefit plan” under the Employee Retirement Income Security Act of 1974 (ERISA). ERISA is the same law that covers employer group health insurance plans. ERISA requires employer who offer ERISA plans to put them in writing and to provide written summaries to covered employees. Importantly, if employers do not deliver a promised ERISA benefit, or interfere with employees' right to it, ERISA gives employees the right to go to court. Employees who win ERISA cases can also receive an award to pay for their attorneys’ fees.

For employees covered by a severance pay plan, ERISA means that they will know what severance they should receive and under what circumstances. Union employees covered by a collective bargaining agreement (CBA) could receive severance pay if it is a negotiated benefit in the CBA. A severance benefit in a union contract looks like an ERISA severance pay plan, but is regulated by federal labor laws.

While employers can create severance pay plans, most do not. Employers who create severance pay plans can and do specify the terms, choose who participates and decide what to pay and when. Employers can modify or terminate severance pay plans whenever they want, and owe only the severance resulting from a triggering that already occurred.

Voluntary Severance Pay

At one time some employers paid departing executives severance pay without any obligation to do so, and sometimes without requiring a release of rights in return. From the point of view of an owner or stockholder, voluntary severance pay to a departing executive is problematic. The company can hardly expect to get much of a return from an employee it just terminated. From a rational economic perspective, though, these companies arguably earn a reputation for fair play among the small universe of potential employees for top positions. This helps them secure leadership for jobs that are by nature risky and insecure.

Like coaches of major league teams, though, most executives now negotiate severance terms as part of their initial employment agreements. If they did not do so, their employer may still agree to pay them severance at the time of their termination, but in exchange for an agreement not to sue and a general release of rights. Both types of agreements are examples of bargained for severance agreements.

Bargained for Severance by Agreement

Employees can bargain with employers for severance pay at the beginning of their employment. Like any other bargain, a sought after employee with adequate leverage can negotiate severance pay following a change in control or other involuntary termination without “cause.” Cause usually means the employee is at fault or did something to contribute to the termination decision . Severance pay provisions in employment agreements may also cover employee resignations for “good reason.”  "Good reason” looks at changes made by the employer to the employee’s working conditions, like a reduction in pay, loss of responsibilities or a downgrade in title. If an employer fails to pay severance promised in an employment agreement, the employee can pursue a breach of contract claim.

Employees can also bargain with employers over severance pay at the end of their employment relationship. The employer may want a clean break and a promise by the employee not to suet. In that event, severance pay negotiations resemble any other bargain for the purchase and sale of property, where the property is the employee’s right to sue the employer.

The trick in such bargains is to figure out the value of the employee’s right to sue the employer. In general, an employee’s right to sue is what the employee would receive if he or she won in court, discounted by the probability that the employee will not win, and less the cost required to take a case through court. As discussed in greater detail here, if the employer and employee agree on the value of the employee’s claims, they can agree at the time of separation to pay the employee for those claims and both parties the risks, costs and distractions of a lawsuit.

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