design-severance-package

Design Severance Package

Design a legally compliant, equitable severance package that protects the organization from litigation while treating departing employees fairly.

Why This Is Best Practice

Adopted by: SHRM (Society for Human Resource Management, 300,000+ members) and EEOC guidelines govern US severance practices; WARN Act compliance is mandatory for large-scale layoffs; Fortune 500 companies standardize severance to ensure ADEA/Title VII compliance. Impact: Signed severance agreements with ADEA-compliant releases prevent 85%+ of EEOC charges from former employees; average wrongful termination lawsuit costs $200,000–$500,000 to defend regardless of outcome; structured severance programs reduce post-termination litigation by 60%. Why best: Severance packages serve two legal purposes — compensation for services and consideration for a release of claims. Without proper structure, the release is invalid and the company retains full litigation exposure.

Sources: SHRM Severance Pay guidelines; WARN Act 29 U.S.C. §2101; ADEA §7(f)(1) and Older Workers Benefit Protection Act (OWBPA); EEOC guidance on waivers (2009); ERISA §501 (if severance plan is an ERISA plan).

Steps

1. Classify the termination type — severance obligations differ by type: involuntary termination (company-initiated), reduction in force (RIF), executive separation, retirement, or mutual agreement. Each triggers different legal frameworks.

2. Check for WARN Act obligations — if the company has 100+ employees and is conducting a plant closing or mass layoff (500+ employees, or 50+ if ≥33% of workforce), 60 days advance notice is required. WARN violation penalty: 60 days back pay + benefits per employee.

3. Determine severance formula — common formulas: 1–2 weeks per year of service (standard); 2–4 weeks for senior roles; negotiated amounts for executives. Factor in: tenure, role level, local market norms, and budget. Apply formula consistently within employee classifications to avoid discrimination claims.

4. Define what's included beyond base pay — standard components: salary continuation or lump sum, COBRA subsidy (typically 3–6 months), pro-rated bonus, equity acceleration (if any), outplacement services, reference letter, and continued use of laptop/phone during notice period.

5. Draft the separation agreement — include: identification of parties, separation date, severance amount and payment schedule, return of company property, confidentiality and non-disparagement provisions, cooperation clause, and the release of claims.

6. Draft a ADEA-compliant release for employees 40+ — per OWBPA, employees 40+ must receive: 21 days to consider (45 days for RIF group terminations), 7-day revocation period after signing, written advice to consult an attorney, and disclosure of job titles and ages of affected group in a RIF.

7. Include lawful post-employment restrictions — non-disparagement (mutual is best practice), confidentiality of proprietary information, and cooperation with pending legal matters. Non-compete clauses are increasingly unenforceable and banned in several states (CA, MN, OK, ND, FTC rule pending).

8. Ensure consideration is adequate — a release requires consideration beyond what the employee is already entitled to (accrued wages, vested equity). The severance payment IS the consideration; it must be something the employee is not otherwise owed.

9. Obtain signed acknowledgment before final payment — do not pay severance until the agreement is fully executed, all revocation periods have expired, and company property is returned. Use DocuSign or wet signature; email-only acceptance is risky.

10. Handle benefits transition — provide COBRA election notice within 44 days of qualifying event. If offering severance as continuation of employment (vs. lump sum), benefits continue during the continuation period.

Rules

• Never condition severance on forfeiting vested benefits, 401(k) rights, or accrued wages — these are owed regardless.
• ADEA-compliant language is mandatory for employees 40+; invalid releases leave the company exposed while having paid severance.
• Apply severance formulas consistently; inconsistency creates disparate treatment evidence.
• Get tax advice — lump sum vs. installments has different withholding and tax implications; severance is subject to FICA and income tax.

Common Mistakes

• Releasing future claims — releases can waive past claims but cannot release future claims; courts will strike such provisions.
• No WARN Act analysis — companies that skip WARN analysis in layoffs face massive back-pay liability discovered only after the fact.
• Non-mutual non-disparagement — one-sided non-disparagement where only the employee is restricted is increasingly void under NLRA (NLRB McLaren Macomb, 2023).
• Inadequate consideration for executives — offering standard-employee severance to executives without reviewing their employment agreements may breach contract.

When NOT to Use

• When terminating for cause (gross misconduct) where company policy explicitly excludes severance — document cause carefully before refusing severance.
• When operating in a jurisdiction with statutory severance obligations (EU, many Asian markets) — statutory requirements apply regardless of this framework.
• When the employee is a contractor, not an employee — different legal framework applies.