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A Clean Break

Tales of corporate largesse awarded to terminated executives have forged misconceptions concerning severance packages among workers and employers alike.

No U.S. laws regulate or mandate severance pay to employees. Many companies offer this benefit to remain competitive with rivals or to stave off lawsuits involving other issues. Factors that influence severance benefits include the company’s size and economic viability, as well as past practices and the policies of your regional competitors.

You must provide severance pay if you have promised to do so in an employee contract as part of a collective bargaining agreement or if your company has historically offered it. Several courts have found implied promises to pay severance in employee handbooks, so careful drafting of these documents is essential.

Large businesses generally favor formal written severance policies. New businesses and small companies prefer informal arrangements, often negotiating severance packages case by case. Frequently, severance pay is triggered by an event such as a merger, acquisition, economic downturn or planned reduction in the work force, which has prompted some employers to embrace event-driven severance plans that have a limited life of three to six months.

Make sure your severance policy explicitly articulates your right to withdraw or modify at your prerogative the benefits not governed by law or contract. In exchange for severance benefits, have employees sign a release from all potential legal claims, including discrimination, disputed wages or bonuses and wrongful termination.

What should you give?

Besides monetary compensation, there are no set ingredients in a severance package. Rather, the package contains whatever components you and the employee negotiate. Typically, benefits include outplacement services and either a positive reference letter or a neutral reference informing a prospective employer of the position, tenure and salary of the departing employee. Other severance benefits include: continued use of office space and secretarial assistance, continued payment of health-care premiums, immediate vesting of stock options and added pension service credit.

Regarding the amount of severance pay to offer, the general rule for rank-and-file workers has been one week of pay; for executives it’s one month’s salary for each year of service (up to 24 months). Many employers favor lump-sum cash payments because the clean break affords them the opportunity to discontinue medical benefits. Few workers paid an hourly wage receive severance benefits.

Severance pitfalls

Severance packages carry traps for the unwary. Overly generous benefits could trigger IRS "golden parachute" penalties if the value of the package exceeds 2.99 times the employee’s average annual compensation for the previous five years. Be aware that severance policies must comply with the Employee Retirement Income Security Act (ERISA). ERISA involves record keeping and notice requirements and carries penalties if you neglect to furnish copies of the severance plan to personnel. A related federal law, the Worker Adjustment and Retraining Notification (WARN) Act, could subject you to penalties if you fail to give workers 60 days’ notice before shutting your facility.

Severance pay should not be awarded arbitrarily, or else you could expose yourself to a discrimination lawsuit from a worker denied the benefit. Merging businesses face a pitfall in deciding whether to pay severance to employees of the acquired entity. In a recent case, a company had to pay employees of the acquired business severance, even though the purchaser kept on most of them. To avoid such problems, periodically review and update your plan.

Writer: Sheldon C. Toplitt is a lawyer and legal journalist concentrating on employment-law issues in Needham, Mass.