Labor and Employment

When and How to Offer Severance Pay to Employees

By Lisa Guerin, ​J.D., Boalt Hall at the University of California at Berkeley
If your company is laying off or firing employees, you may want to consider offering severance.

Should your company offer severance pay to departing employees? The answer depends on many factors, including your company’s contractual obligations, written or spoken policies, and past practices. Unless you’ve made an enforceable promise to pay severance, you generally won’t be legally obligated to do so. However, paying severance might be a good idea in some situations, not only to create good will but also to protect your company from lawsuits.

What Is Severance?

A severance package (sometimes called “severance pay” or simply “severance”) is a bundle of benefits offered to employees who are fired or laid off. Severance almost always includes compensation, often based on the employee’s salary and years of service. For example, a severance policy might give employees two weeks of pay for every year that they have been with the company. A severance package might also include other perks, such as continued health benefits, outplacement and job search services, or allowing an employee to keep a company laptop or signing bonus.

When Is Severance Required?

No federal law requires employers to pay severance to employees when the employment relationship ends. However, a few states do require employers to pay a small severance when a large number of employees lose their jobs in a mass layoff or plant closing. In Hawaii, for example, employers must supplement unemployment payments for four weeks for workers who lose their jobs in a mass layoff. Unless your company is located in one of these states, the law does not require you to provide severance packages as a matter of course.

Your company may, however, be contractually obligated to pay severance to certain employees. If your company has promised severance to an employee orally or in a written contract, you must provide it. Similarly, if your employee handbook promises severance, you must pay it when the criteria are met. Even your company’s past practices may create an obligation to pay severance, if your company has paid it so consistently and regularly as to create an enforceable promise. For example, if employees who are laid off always receive ten weeks of severance pay, and managers stated repeatedly that this was the company’s policy, an employee who is laid off might argue that he or she is contractually entitled to that money. (For more on how employment contracts are created, see Employment Contract Basics for Employers.)

Should You Offer Severance?

Even if your company is not legally or contractually obligated to pay severance, you might consider doing so anyway. Of course, it’s kind to give laid-off employees some money to help them bridge the financial gap until they find a new job; this kindness will help you build good will with former employees and current employees alike.

What’s more, providing severance can help you avoid lawsuits from disgruntled employees. Many employers couple a severance package with a release: an agreement by the employee not to sue the company for disputes arising out of the employment relationship. An employee release can be very valuable, particularly if your company has legal concerns about the way the employee was treated or company policies during the employee’s tenure. In exchange for a severance package, your company can ask an employee to sign a release, giving up the right to sue.

If you want an employee to sign a release in exchange for a severance package, you should absolutely have it prepared or reviewed by a lawyer. A release is valid only if it meets very specific criteria. For example, it must be voluntary, and it must provide benefits to which the employee is not already entitled. You could not withhold the employee’s final paycheck until the employee signs a release, for instance; the employee is already entitled to that money.

Special release rules also apply to workers who are 40 or older. If you are asking an employee to give up the right to sue for age discrimination under the Age Discrimination in Employment act (ADEA), you must give the employee 21 days to consider the release (or longer, if you are offering severance in the context of an early retirement program). You must also give the employee seven days to revoke the agreement after signing it, among other things. An experienced employment lawyer can help your company draft an effective, fair release that will stand up in court. (For more information, see The Older Workers Benefit Protection Act.)

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