When an employer decides to terminate an employee, or when an employee decides to move on to another job, the employer may offer the employee a severance (or separation) agreement as a way to potentially mitigate its future legal risks. For the employer, severance agreements always include a general waiver of all claims the employee may legally waive or give up under the law. In consideration for the mitigation of its risks under the terms of a severance agreement, the employer agrees to provide the employee with some kind(s) of additional value. The additional value is usually in the form of added compensation or modified rights to bonuses or stock option agreement.
Severance agreements are legally binding contracts between an employer and an employee, outlining the terms and conditions under which the employment relationship will end. Here is what both employers and employees should consider when negotiating a severance agreement.
Understanding the Purpose of Severance Agreements
Severance agreements serve multiple purposes. They can provide financial compensation to employees who are losing their jobs, offer continued benefits for a certain period, and include other provisions such as non-disparagement clauses. For the employer, severance agreements are a means of avoiding future claims by terminated employees.
In California, severance agreements almost always include a waiver of the protections afforded by California Civil Code § 1542, which provides:
In exchange for additional compensation and/or other post-employment benefits, the employee agrees that even if they discover grounds for a lawsuit against their employer later, they may not sue the employer for things that happened before the employee signed the severance agreement.
Sometimes, proposed severance agreements contain clauses that are unenforceable in California, such as anti-competitive provisions. In Edwards v. Arthur Andersen LLP (2008) 44 Cal.4th 937, the California Supreme Court emphasized the importance of allowing employees to pursue new employment opportunities without being unduly restricted by non-compete agreements, highlighting the need for careful consideration of such provisions in severance agreements.
Unlike many other states, in California non-compete agreements are generally unenforceable and are subject to specific statutory restrictions. California Business and Professions Code § 16600 states:
Section 16600 specifically references Edwards v. Arthur Andersen LLP as providing a clear definition of California law on non-compete agreements in the employment context.
While there are a few limited exceptions to this rule, such as for the sale of a business or dissolution of a partnership, non-compete agreements in the context of employment contracts are unenforceable in California. This means that employers cannot require employees to sign agreements that restrict their ability to work for competitors or start their own competing businesses after leaving their current employment.
It is important for both employers and employees to be aware of this statutory prohibition when drafting or reviewing severance agreements in California. Employers should avoid including non-compete clauses that would likely be unenforceable, while employees should understand their rights under California law regarding non-compete agreements.
Voluntary vs. Involuntary Severance
Severance agreements can be offered voluntarily by an employer or may be mandated by law in cases of mass layoffs or certain terminations. (See the California WARN Act and the Federal WARN Act)
Employees also should understand whether the termination of the employment relationship is voluntary or involuntary, as it can impact their eligibility for unemployment benefits and other protections (See, for example, California Unemployment Benefits)
Negotiating the Terms
Both employers and employees have the opportunity to negotiate the terms of a severance agreement. Employees should carefully review all aspects of the agreement, including the amount of severance pay, continuation of benefits, stock options, and any restrictive covenants.
Legal Considerations
Severance agreements must comply with state and federal anti-discrimination laws. Additionally, employees who are 40 years or older are entitled to 21 days to review a severance agreement before signing it. The Age Discrimination in Employment Act (ADEA) is a federal law in the United States that prohibits employment discrimination against individuals who are 40 years of age or older. The Older Workers Benefit Protection Act (OWBPA), which is an amendment to the ADEA, specifies that employees have 21 days to consider a severance agreement and 7 days to revoke it after signing. Additionally, if an employer is offering a severance package to a group of employees as part of an exit incentive or other employment termination program, they must provide specific information to those employees, including the job titles and ages of individuals who are eligible and not eligible for the program.
Consideration and Release of Claims
Severance agreements must provide an employee with some kind of additional value, above that which they have earned. Thus, a general release cannot be obtained in exchange for wages or other benefits that are due the employee. This requirement has significant implications for employees whose compensation is based in whole or in part on commission wages. (See Commissions Due After Termination)
Consultation with Legal Counsel
Both employers and employees are encouraged to seek legal advice before signing a severance agreement. A well-qualified employment attorney can review the terms of the agreement, ensure compliance with applicable laws, and advise on the implications of signing the agreement.
Severance agreements can be valuable tools for both employers and employees during the termination process. However, it is essential for both parties to approach these agreements with caution, carefully review all terms, and seek legal advice when necessary to ensure their rights and interests are protected. In summary, severance agreements can be complex legal documents with significant implications for both employers and employees. Understanding the purposes, negotiation process, legal considerations, and consulting with legal counsel are essential steps in navigating severance agreements in California.