Separation Agreements: Smart Strategies for Breaking Up with Employees

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1 By Anne DeAcetis May 25, 2012 Brought to you by the TemPositions Group of Companies - Separation Agreements: Smart Strategies for Breaking Up with Employees While both companies and workers hope to find employment relationships that last, separations are an inevitable part of doing business. They re especially common today in this era of recession-driven workforce reductions. As difficult as separations are, HR should take heart that they can be handled with surety. Companies can reduce legal risks by crafting smart, strong written agreements that both honor relationships with workers and protect the company s future. Howard Schragin, Esq. (senior associate) of Sapir & Frumkin LLP visited TemPositions HR Roundtable Series on Thursday, April 26, 2012 to offer his insights on handling separations in a session aptly titled, Breaking Up is Hard to Do. Schragin touched on recent developments in anti-discrimination laws that may impact separation practices, and he made detailed recommendations on crafting sound separation agreements, releases and restrictive covenants. In his own practice, Schragin handles litigation for both employees and company management. This experience gives him a unique perspective, he explained. He s familiar with the core components of all kinds of separation agreements and why employers value them. And he s well-acquainted with how common separation practices make employees feel and react. Schragin began his session by reminding attendees to take employees feelings into account when making separation decisions. Former workers more often sue when they feel they ve been treated unfairly and don t understand the reasoning behind the company s decisions. Agreements that are both clear and fair will be the most successful, he counseled, because employees are less likely to fight them in court. And even when they do, courts are more likely to find them reasonable and enforceable. Separation Agreements Many employees commonly sign separation agreements when they end an employment relationship, voluntarily or involuntarily. These agreements clarify the details of the separation: when it will take place, what the company will do and, in most cases, pay the employee upon termination (in terms of severance), and whether or not the parties have any remaining obligations to one another.

2 These agreements are primarily designed to protect the employer, but they should also establish generally favorable conditions for the departing employee, Schragin explained. He outlined the following basic components. Introduction Introductory paragraphs in separation agreements establish the parties: the employee, the employer, the termination effective date, and any relevant details about the separation (e.g., workforce reduction, fired for cause, etc.). Consideration Agreements then detail the consideration, or parting benefit, that the employer has offered the employee. In most cases, consideration is made in the form of a severance payment. Employers can also choose to extend other or additional benefits, like continuing to provide the individual with health insurance coverage or taking care of their COBRA payments for a period. Consideration is often critical to the enforceability of an agreement seeking a release of claims, Schragin stressed, so it s essential that employers understand what does and does not qualify. Notably, consideration must extend above and beyond any benefits the employee is guaranteed under their employment contract. Suggested Employer Protections Schragin recommended a serious of company-friendly clauses. They won t be appropriate under all circumstances, but when relevant, companies should consider including them: Company benefits termination date (i.e., health insurance coverage) Notification that the company will issue COBRA paperwork as required by law Statement that the consideration offered exceeds any payments or benefits to which the employee is otherwise entitled (establishing its value) Tax indemnification statement releasing the company from responsibility for taxes owed by the employee most appropriate when an employee requests a lump sum severance payment (to be reported to the IRS via 1099, with no taxes withheld) vs. severance payment through regular payroll (to be reported to the IRS via W-2, with taxes withheld) Severance The severance clauses clarify what severance pay and/or other benefits the employee will receive. Schragin recommended aligning these benefits with the terms detailed in the company s restrictive covenants (such as non-compete agreements). For example, a worker who is expected to wait six months before going to work for a competitor will more likely agree to this restriction if their severance pay will also last six months. A skilled employment attorney, he counseled, can help every company devise a general severance calculation strategy that makes sense. Industry norms are typically determined based on an employee s length of time with the company, their duties and/or special expertise, how easy or difficult it may be for the employee to find another position, the circumstances of their termination, etc. Determining what s fair may require considering these and other factors.

3 Severance and Extended/Advance Notice In some cases, employers give workers advance notice that they will be terminated. This enables the employee to begin a job search prior to leaving, and is usually intended to help end a relationship on favorable terms. Under these circumstances, it s both lawful and wise to include a clause in the separation agreement stating that wages received during the advance notice period are considered part of severance pay and will be subtracted from the employee s total severance package. Under this policy, for example, an employee who is entitled to 10 weeks of severance pay but receives five weeks of advance notice will collect only five weeks of severance. Severance Pay and Rehires In today s somewhat unpredictable economy, rehires are more common. And if they re not careful, companies that have offered severance packages can find themselves paying both wages and severance to rehired workers! Employers can guard against this by including a simple clause in their agreements. State clearly, Schragin counseled, that if the employee is rehired, they will owe the company whatever severance they have not yet received. Without this clause, employers will be legally obligated to continue paying severance, even after the employee has returned to work. And while the company can request that payments be returned, the money may prove very difficult to recoup if the employee refuses. Final Paychecks/Payments New York State law is clear on final paychecks to departing employees. Companies must issue final paychecks on or before the next regularly-scheduled pay day. These payments should include all wages the employee has earned, including pro-rated wages for any incomplete weeks. Final payments may include commission pay but only if it can be classified as earned per the details of the commission agreement. Companies have the right to exercise discretion in these agreements, and they may define commissions as earned upon customer payment, signing of the contract, or other activity that represents a completion of the transaction. If an employee chooses to leave too early in a sales process, they may forfeit commission pay. Unlike commissions, bonuses are not viewed by the law as earned wages, and companies are not required to pay bonuses at the time of termination, even if the employee would argue they have been earned. An annual December bonus, for example, need not be paid to an employee who chooses to leave in late November. However, be careful of laying off a large number of workers immediately prior to a bonus issue date, Schragin warned. This may inspire action. Similarly, the law does not require companies to treat accrued but unused vacation time as earned wages. But companies should clarify their position in a written policy. It is lawful to state that the company will compensate employees for this time upon termination, or that the company will not. Either way, in order for an employee to forfeit accrued vacation time, the employer must have a clear policy providing for forfeiture.

4 Special Payments & Related Taxation Generally, Schragin explained, all payments to an employee are taxable with the exception of job-related damages for personal physical injuries or physical sickness, which can be paid directly to medical care providers or attorneys offices as well as to the employee (in a payment to be reported with a 1099). The IRS permits employers to deduct this from gross income. When employers extend consideration in the form of extended health insurance benefits or COBRA payments, they may want to offer to make payments directly to the health insurance provider rather than to the employee. Payments made directly to health insurance carriers are not taxable, while payments to the employee, even to cover these expenses, must be taxed. Deferred Compensation Some highly-paid executives receive their severance in deferred compensation plans. Under ERISA code 409A, this income can be subject to a 20% tax (paid by the employee). But there are payment structures that are exempt from this code, and employers can save their departing executives a great deal of money by crafting their severance plans with 409A in mind: Short-term deferral exemption: Deferred payments are not subject to 409A if the payments will be made within two and half months of the same tax year as the termination, and if the employee is only eligible for the payments in the case of involuntary termination Separation pay plan exemption: Deferred payments are not subject to 409A if they do not exceed two times the employee s annual compensation or $500,000; if all payments will be made before the second calendar year following termination; and again, if the employee is only eligible for the payments in the case of involuntary termination Separation Releases Releases indemnify the employer from liability moving forward, and are an important part of any separation. In many cases, the terms of separation (including severance and other forms of consideration), are specifically geared toward persuading an employee to sign a release. Releases can be extraordinarily broad, Schragin noted. Companies can ask employees to agree to dismiss pending litigation or filed claims, or to agree that they have no claims against the company and no plans to file. That said, there are certain rights which employees cannot legally waive, and they therefore cannot be included in separation releases. Employees cannot be restricted from: Filing claims under the FLSA (unless by court order or by special approval of the Department of Labor) Filing charges with the EEOC (though they can waive their rights to damages) Mutual Releases As much as companies want to be protected from departing employees, workers want their own protections and many request mutual releases. Some companies are reluctant to sign these,

5 Schragin noted, but they re worth considering. Mutual releases can be helpful in persuading workers to respect restrictive covenants and other terms that ultimately benefit the company. Most employees will be satisfied if the company agrees to release all claims (i.e., state that they have no pending claims against the employee and no plans to file). But it s critical, he stressed, that the company carve out (i.e., reserve the right) to file future claims if they discover evidence of crime, fraud or gross misconduct. Companies should also protect their right to countersue in the event of future action by the employee. Confidentiality Many releases include a clause in which the company asks the employee to keep details of their release confidential (i.e., the terms and conditions, and sometimes related information). Liquidated damages can be set for any breaches of this agreement. Exceptions should be made for close family, legal counsel, accountants/financial advisers and company representatives. It s also appropriate to include a reminder that court orders and subpoenas override this obligation. If confidentiality is truly important to the company, the employer should make a similar pledge to the employee. The company can even specify the guarded language it will use if asked about the matter, such as, Claims have been resolved or settled to the satisfaction of the parties. Proprietary Information Confidentiality should extend to proprietary company information like trade secrets, patents and other intellectual property. A clause in the separation release can reaffirm the confidentiality agreements that most employees sign upon hire. Ensure that the clause is consistent with all other published company policies, Schragin advised, and be sure to state that all previously-signed agreements or privacy acknowledgments are incorporated in this final agreement. References Releases can also clarify how the company will or will not provide references for the employee. Many workers still expect to receive something specific in writing, a reasonably-personalized account of their work from a supervisor, for example. But so-called prepared letters like this are rarely provided anymore. Today, most companies opt to provide a neutral reference. A neutral reference acknowledges the employee s tenure with the company but does not address their performance. The letter may include the worker s name, employment dates, title and salary (though not all companies provide compensation information). This type of reference, while rather bare, helps protect the employer from post-employment liability, like claims of defamation or tortuous interference: the intentional infliction of harm on a person s business relationships. Suggested Employer Protections Schragin recommended additional clauses in releases that benefit the employer. (Again, while some may initially appear employee-focused, it s important to remember that they offer balance to other extremely employer-focused aspects of any release.)

6 Return of company property an acknowledgement of company-owned items still in the worker s possessions (e.g., laptops, smart phones or other personal technology) and a signed employee pledge to return them No reemployment if an employee has been terminated for gross misconduct, fraud or other serious misbehavior, or if the company fears future litigation, the employer can guard against future claims of unlawful employment practices by stating the employee is not eligible for rehire (safeguarding against claims of discrimination or retaliation for filing a claim) Continued cooperation most appropriate to secure from executives or other high-level managers, this agreement establishes that the employee will cooperate on behalf of the company, as appropriate and lawful, in future legal actions (this clause is largely a formality, as a company s counsel can always subpoena a past employee) No admission of liability the company states it is not liable to the employee for any reason Outplacement services typically offered to executives, these agreements establish that the company will offer job-placement assistance (as a means of keeping the departing employee focused on their future prospects, not dwelling on perceived slights) Benefits for Older Workers The Older Workers Benefit Protection Act (OWBPA) of 1990 amended the Age Discrimination in Employment Act (ADEA) of Among other things, it expanded ADEA to prohibit employers from discriminating against older workers in the distribution of benefits including severance. If the company wants a worker over 40 to release all claims, the employee s participation/agreement must be knowing and voluntary according to very specific criteria. The company must advise older workers to consult with an attorney before signing their release. As Schragin stressed, this statement must be bold, clear and unequivocal. He counseled attendees to state assertively that workers should and must see an attorney prior to signing. Waivers of age discrimination claims must be clearly itemized in the written agreement it is not sufficient to state that the employee releases all possible claims. And any clause related to this law must be written in a manner calculated to be understood by the employee that they are waiving their rights to a discrimination case under ADEA. (An important note: While some aspects of a release can be very broad and include references to future actions, the company cannot ask older workers to waive their rights to future claims under ADEA.) ADEA requires a clause stating that in exchange for a release, the older employee will receive adequate consideration (greater in value than their entitled benefits). While such a clause may be optional for younger workers, it is required in releases for those over age 40. Finally, the company must give older workers 21 days to review the agreement. And after signing, it must also give them seven days to revoke their decision. Releases only become enforceable on the eighth day. Severance Programs for Reductions in Force

7 In today s economy, mass layoffs are unfortunately common and any serious review of separation agreements must include a discussion of how to handle reductions in force. Labor law prescribes very clear standards for ensuring mass layoffs are fair. In the agreement, the company must define the decisional unit (the group of employees from which some workers will be released) along with the basis for dismissals. For example, a company might define its decisional unit as an underperforming plant in Omaha, NE. Deciding factors in the force reduction might be: years of service, duties or responsibilities etc. Time limits for joining the layoff program may also be included, as some companies offer early retirement. A company must also disclose all the job titles and ages for both the workers it will lay off and those it will retain. In the interest of sensitivity, some companies try to offer age ranges (e.g., 40-50), but by law, this is not acceptable. The courts want to see that no one age group has been singled out, so it s important, when choosing the factors for separation, to consider disparate impact. As Schragin put it, You get into trouble when everyone you let go is over 50. In cases of reduction in force, employees must be given a full 45 days to review and consider signing their agreements. And while employers are not required to advise all workers to speak to counsel, this generous time span certainly affords workers adequate time to do so. EEOC Regulations and Disparate Impact Claims Recently, the EEOC made changes to ADEA in an amendment titled, Disparate Impact and Reasonable Factors other than Age. This amendment ensures, once again, that older workers do not suffer discrimination in this case, during reductions in force. Under the disparate impact doctrine, the EEOC never wants to see any one group of employees (e.g., older workers, women, minorities, etc.) affected more greatly than another other during seemingly-neutral employment decisions. These new regulations may frustrate companies, Schragin noted, because they may require additional work on the part of employers to support the legitimacy of reductions in force. Reductions in force are lawful when they are reasonably designed to further or achieve a legitimate business purpose and administered in a way that reasonably achieves that purpose in light of the particular facts and circumstances that were known, or should have been known, to the employer. Businesses are permitted to consider their needs, but must define them thoroughly and truly make decisions based on reasonable factors other than age. For HR departments preparing for a reduction of force, Schragin offered the following suggestions: Clearly document the goals of the layoff in specific business terms Ensure no age-related factors can be tied closely to these stated goals and terms Review the plan carefully with disparate impact and other negative results in mind Present the plan to an experienced employment attorney for feedback Conduct a disparate impact analysis prior to making any final employment decisions

8 Rely on documented performance records (a compelling reason for regular, ongoing performance reviews) and avoid grade inflation or subjective downgrading prior to a layoff, which may give the impression or inappropriate favoritism or bias Carefully train executives, managers and other decision-makers on ADEA and EEOCcompliant practices to avoid disparate impact and age discrimination As much as possible, limit the amount of subjective discretion afforded to these decisionmakers, thereby reducing the likelihood of intentional or inadvertent discrimination Restrictive Covenants Finally, Schragin turned his attention to restrictive covenants, agreements that can powerfully protect a company s business interests. The most common non-compete and non-solicitation agreements prevent departing employees from going directly to work for competitors or taking important client relationships with them. But they must be drafted carefully. In order to be enforceable, restrictive covenants should be no broader/greater than necessary to protect the legitimate interests of the employer, and must be reasonable. The Reasonableness Test Protectable interests do have limits and this is where the issue of reasonableness comes in, Schragin noted. Courts will only enforce restrictive covenants to the extent reasonable and necessary to protect valid business interests. Restrictive covenants cannot pose an undue hardship on the worker, they cannot be injurious to the public, and they must be reasonable in duration and geographic scope. Most workers that fight non-compete agreements, he noted, do so on the basis that either the duration or geographic scope is unreasonable. Courts recognize that companies have a right to protect their business interests. But they also support employees rights to earn a living. Companies that go overboard in their restrictive covenants can expect New York State courts to blue pencil, or revise, agreements to make them more fair for both parties. Determining duration and geographic scope should be grounded in reality and based on individual circumstances. Asking an employee to avoid working for a competitor within miles for six months can be reasonable (especially if their severance pay will last that long). If a worker is highly skilled and specialized, a longer term may be appropriate; for an employee who principally works online, a greater geographic scope may be reasonable. When terms are unduly difficult to determine, it may be helpful to focus on customers rather than duration or geography, Schragin counseled. The company may permit the employee to go immediately to work for a competitor (or to do so relatively quickly). But they can ask the employee to agree not to perform work for any clients that they serviced during their time with the company. This approach skirts difficult issues, and permits employees to get back to work. Ultimately, these terms really depend on what an employee does and how they do it, Schragin explained. With the goal of protecting their businesses, some companies have enforced non-

9 compete agreements that prevented former employees for working for years, or on a worldwide basis. In other cases, far fewer restrictions have accomplished the same goal. Clear, Reasonable, Enforceable In closing, Schragin urged attendees to prepare their separation agreements, severance agreements, releases and restrictive covenants with care but confidence. It s a fact that employment law is very worker-friendly, and courts have demonstrated sympathy for employees. But with HR s help, companies can establish clear and defensible positions. The key is for HR to understand the law and draft agreements tailored to the company s precise circumstances. The more specific, the more targeted and the more reasonable these agreements are, he stressed, the more likely they re going to be enforced. Anne DeAcetis is a freelance writer based in New York. Reach her at anne.deacetis@gmail.com. The HR Roundtable is a breakfast forum for human resources professionals in New York City sponsored by The TemPositions Group of Companies. TemPositions, one of the largest staffing companies in the New York tri-state area with operations in California, has been helping businesses with their short- and long-term staffing needs since Visit them online at or them at info@tempositions.com.