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May 18, 2012
Avoiding Problems with Severance Pay

When you think about your employee compensation systems, you probably think about the ease with which employees receive their pay, or the great system you use that generates reports and alerts you of data errors, or maybe the comparative data from which you prepare salary ranges. All of these are important. But have you considered the compensation you pay when employees are on the way out the door, perhaps due to a reduction-in-force or another kind of layoff?

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Eric B. Meyer, a partner in the labor and employment group at law firm Dilworth Paxson LLP ( counsels employers to think about equity when making any kind of employment decisions – including those involving severance pay.

Severance agreement, severance pay go hand-in-hand

The term “severance pay” generally refers to money paid to an individual who is being separated from employment. The pay, though, is actually just one part of a two-part process, in most cases. The second – and perhaps the most important – part is an accompanying severance agreement between the employer and the former employee.

“The severance agreement is basically a security blanket,” Meyer says. “It offers peace of mind to the employer. Some money flows from the employer to the former employee and, in exchange for that, the former employee agrees not to sue the employer for anything that has transpired between them, from the beginning of time through the date of the agreement.”

Some altruistic employers may provide the severance pay without requesting a severance agreement. Meyer says that could indeed send a positive message to employees about the value the employer places on their personnel, and expresses that company leadership feels bad about the layoffs. But, he wonders, will the message be received in that way? “That’s a different story. If the employee feels that he or she is being treated differently on the basis of their protected class, whether it is gender, race, religion, national origin, or any other class, that severance payment without a signed release could end up being used to fund a lawsuit.”

And that is the main reason most employers want a signed severance agreement in return for the severance pay. “Employers will give former employees money in order to ease their transition. At the same time they want to make sure the parties know they don’t believe the former employee has any claims against them. They want to be nice and altruistic, but it has to be a clean break and the former employee has to agree not to sue them.”

Possible reasons for different severance amounts

As in all employee interactions, an individual’s status as a member of a protected class should not enter into decisions surrounding severance. For example, says Meyer, you cannot legally pay different amounts of severance based solely on gender, race or another protected distinction. Meyer illustrates: “Let’s assume 'Mary' and 'Bob' are, in all relevant characteristics, equal. They have the same experience, the same supervisor, they generally performed the same; they have the same skill set, and so on. Bob is offered 6 weeks of severance pay, and Mary is only offered 3.” The question to consider is, “Why?”

Among the many possible explanations for the difference in severance pay is a simple error made by the company. In that case, Meyer says it would be ideal for the company to own up to the mistake. “That would be an accident, not gender discrimination,” he says. “If the company realizes the error, they can go to Mary and apologize for the mistake and tell her they’re going to make it right by giving her a full 6 weeks of severance pay, just as they did for Bob. That’s the right thing to do, instead of kicking the situation under the rug and hoping that Bob and Mary don’t talk to each other.”

Another explanation might be that enough time has passed between Bob’s layoff and Mary’s. Meyer explains that differences might arise when time passes, but there is no hard-and-fast rule. “If two people are part of the same reduction-in-force, you want to make sure you’re not treating them differently. Of course, you never want to treat someone in a protected class differently on that basis, but you should be extra careful in this situation. If the layoffs are a week apart, you still want to pay very close attention.

"If it is 6 months, or a year, circumstances at the company may have changed; maybe the company is a lot worse off financially as they are laying off Mary than they were 6 months earlier when they laid off Bob, who was similarly situated. What it comes down to is whether or not you’re treating someone differently because they belong to a protected class. If being in a protected class is motivating whatever it is you’re doing, it shouldn’t.”

Does that mean you can’t give a man more money than a woman? No. There may be other factors which could dictate why a male employee would be offered more severance than the separated female employee. Those factors could include, among other things, tenure, salary, overall skill level, and others.

Don’t just wing it – make a plan instead

Meyer suggests that advance planning is crucial for avoiding problems that might arise from severance pay. “Rather than determining severance on an ad hoc basis,” he says, “the company should have some kind of formula that it applies to determine the amount that will be offered. The amount could change, based on any negotiations between the former employee and the company. But at least at the initial offer, there should be consistency. And you get consistency through a formula of some sort. Management should be involved in this discussion, and HR can be involved, too.”

There are some things companies should do as part of a layoff, which of course, can be a very stressful time for employees. By taking the time and effort to remind former employees that these things will happen whether or not they sign the severance agreement, anger may be mitigated to some degree. Employers make themselves less likely to be a target of an employee’s wrath if they think the process through ahead of time, and show consideration for the former employee. Besides offering severance, employers should

  1. Reaffirm to the employee that if another company asks for a reference about the employee, the company is willing to provide one. The reference should be neutral, including only dates and titles, and possibly salary.
  2. Remind employees that you’re not going to contest unemployment.
  3. If the company has 20 or more employees and the former employee is covered under a medical plan, make sure the employee knows they will be offered COBRA coverage.
  4. Make sure they know they will be paid through their last day of employment.
  5. Let them know you will be paying out all benefits that are due and payable upon separation, like unused vacation time, if that applies in your state.

Finally, Meyer says employers should be aware of pertinent policies and procedures, both legally and based on their own internal systems. “Don’t use guesswork,” he says. “Check handbooks, policies, procedures, Summary Plan Descriptions, etc. It’s when you deviate from those parameters that employees feel like they’re being mistreated, and if they are, they may feel it’s because of a protected class rather than a mistake. Misconceptions have a funny way of turning into expensive lawsuits.”

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