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By: Marc E. Bernstein, Paul Hastings LLP
This article addresses initial preparations for drafting a separation agreement and common terms that employers ordinarily should include, or at least consider including, in separation agreements.
WHEN TERMINATING AN EMPLOYEE’S EMPLOYMENT, THE employer often requests that the departing employee execute a separation agreement. In doing so, the employer seeks to obtain a comprehensive and defensible release of all real or perceived claims that the employee may legally waive in exchange for payments and/or benefits to which the employee is not otherwise entitled, which will be the consideration for the agreement. As the employer’s attorney, you must ensure that the separation agreement is comprehensive, valid, and enforceable so that the employer can successfully avoid litigation and other risks stemming from the termination.
If possible, the employer should have the separation agreement prepared in advance so that it is available for distribution to the employee at the time of the termination. The earlier you become involved in separation discussions, the more valuable you will be to the employer during the preparation and negotiation of a separation agreement.
Once involved, you should review the relevant employer policies and documents relating to the specific termination at issue—whether related to a layoff or a one-off termination—to ensure that the separation agreement is consistent with them. The documents that you should review ordinarily include:
Any of these documents may contain formulaic separation payments based upon position and years of service, partial incentive payments, payment for accrued sick or vacation days, and outplacement. Agreements specifically between the employer and the employee may also contain non-standard severance terms, such as continued vesting of incentive compensation, bonus payments, and restrictive covenants that often remain in effect following termination.
You should also consult with the employer’s managers and decisionmakers to understand the reasons for the termination and anticipate any actionable issues that may arise—such as alleged discrimination, retaliation, federal Fair Labor Standards Act (FLSA) issues, whistleblower activities, or breach of contract claims—and any special business risks, needs, or concerns. In conjunction with these discussions, you should review relevant personnel and disciplinary documentation about the employee.
If the termination may involve multiple employees or a plant closing, you should ascertain the applicability of the federal Worker Adjustment and Retraining Notification Act and any state analogs and ensure that the employer has provided any required notice.
This section addresses the most essential clauses in a separation agreement. In addition, this section discusses some provisions that employees may propose during the course of negotiations.
Release of Claims
The release of claims provision is perhaps the most important part of a separation agreement. This provision provides that the employee— broadly defined to include the individual and his or her heirs, representatives, and agents—will dismiss and waive all potential or pending causes of actions, claims, charges of discrimination, complaints, etc., against the employer, whether known or unknown— broadly defined to include the company, its affiliates, employees, agents, representatives, and assigns.
In drafting the release language, you should avoid legalese and describe in plain language understandable to a non-lawyer that the employee is giving up his or her right to bring various claims in exchange for the consideration provided.
If a claim is pending before a court or administrative body, you should specify the case or charge number of the claim that the employee will withdraw or stipulate to dismiss with prejudice.
Enumerating Released Claims
To ensure that the release broadly covers all types of claims that an employee may bring under federal, state, and local law, the release should state that the employee releases all claims against the employer “to the extent permitted by law,” including claims alleging unlawful discrimination, breach of contract, tort claims including without limitation negligence, and claims for the non-payment of wages. You should also list the main employment statutes “without limitation,” including the following:
Consult state and local law regarding which relevant claims the employer must list in the release or language that employers must use for employees to waive certain claims. For example, a waiver of claims under the Minnesota Human Rights Law requires that the employer provide the employee 15 days to revoke the separation agreement after the employee signs it. Minn. Stat. § 363A.31.
Older Workers Benefit Protection Act (OWBPA)
If the employee is at least 40 years old, you will want the employee to release age discrimination claims under the Age Discrimination in Employment Act (ADEA). To execute such a release, the release must comply with OWBPA.
OWBPA requires that the employer provide specific information and consideration periods to an employee from whom it seeks a waiver of ADEA claims. For example, under OWBPA the release regarding an individual termination should (1) explicitly release ADEA claims, (2) not release future ADEA claims, (3) specify the consideration for the release, (4) advise the employee to consult with counsel, (5) provide the employee at least 21 days to consider the release, and (6) provide seven days to revoke the release after signing.
Releases in connection with a termination program have different requirements. For example, to obtain an ADEA waiver from an employee terminated as part of a termination program the employer must also provide the employee:
The employer should avoid agreeing to a mutual release of claims because the employer may not know of causes of action it may have against the employee, such as claims for fraud, theft or conversion, violations of restrictive covenants, or other compensable claims that have not come to light.
When drafting the release, note the following:
Last Date of Employment
You should specify the effective date of the employee’s termination.
You should specify the last day of the employee’s eligibility for medical coverage and other benefits including, inter alia, dental coverage, life insurance, or participation in the employer’s retirement plan. You should also enumerate any vested and accrued benefits to ensure that the employer does not overlook any required benefit payments.
Consolidated Omnibus Reconciliation Act (COBRA)
The agreement should explain that the employee may be eligible for continued health benefit coverage under COBRA and that, if the employee elects COBRA, the employee will bear the expense of such continuing coverage.
The separation agreement must be supported by consideration beyond that which the employee is already entitled. The departing employee often will request additional separation compensation. In responding to a request for more separation pay, your initial research regarding the employee and the circumstances of his or her termination will prove indispensable.
Additionally, providing or extending certain benefits may bridge the gap between what the employer is willing to provide consideration-wise and what the employee seeks. Some examples that may arise include:
Method of Separation Payments
The separation agreement should specify whether the employer will pay the consideration in one lump-sum payment or over a period of time.
If the separation agreement provides for a future stream of payments, you should discuss with the employer whether the agreement should provide that these payments will cease if the employee finds new employment. You will also need to consider I.R.C. § 409A (Section 409A) implications.
Brief Introduction to Section 409A
Section 409A generally provides that most deferred compensation plans, which may include separation agreements, must comply with various rules regarding the timing of deferrals and distributions. Deferred compensation generally occurs for Section 409A purposes when compensation is paid in a different tax year than the year in which the employee first vested in the right to be paid. Section 409A was added to the Internal Revenue Code in 2004, in part as a response to the practice of opportunistic executives at Enron Corporation accelerating the payments under their company’s deferred compensation plans to access money before the company went bankrupt. Note that Section 409A also applies to independent contractors and imposes a six-month delay rule on non-exempt severance payable to certain officers of public companies.
Section 409A Penalties
The penalties for violating Section 409A apply primarily to the employee, although the employer has W-2 reporting and tax withholding obligations. The penalties for an employee include (1) the full amount of the severance pay (even if it is to be paid over several years) becomes taxable, except to the extent it is exempt from Section 409A; (2) the employee pays an additional 20% penalty tax on the severance pay; and (3) the employee may also have to pay additional interest.
Complying with Section 409A
The first way to avoid the negative implications of Section 409A is to ensure that any payments meet the short-term deferral exemption. This exemption is generally available if the employer pays the severance payments within two and one-half months after the end of the year in which the termination occurs. Note that a Section 409A violation could occur if the employer has a preexisting obligation, such as under an employment agreement, to pay severance over a longer period and then accelerates payment to occur within that two and one-half month period.
A second safe harbor for separation pay exists for payments that do not exceed the lesser of either two times the employee’s annual compensation or twice the compensation limit in I.R.C. § 401(a)(17)—set at $275,000 in 2018. The termination must be involuntary and the employer must pay the separation pay by no later than December 31 of the second year following termination of employment.
You should also consider including provisions stating that although both the employer and the employee intend the agreement to comply with Section 409A, the employer and the employee agree that the agreement will be interpreted in a manner to comply with Section 409A. In addition, if any provision of the agreement is found not to comply with Section 409A, the parties will cooperate to execute any necessary amendments to accomplish compliance with Section 409A.
You should state in the agreement that applicable tax withholding (and other authorized or required deductions) will be deducted from the separation payment(s) made to the employee.
Confidentiality of Separation Agreement
You should include a clause stating that the employee agrees not to tell anyone about the separation agreement and not to provide any information in the separation agreement to anyone, other than his or her attorney, financial advisor, close family members, or as legally required. The agreement should also state that if the employee tells anyone on this list about the agreement, the employee must simultaneously instruct them to maintain the confidentiality of the terms of the separation agreement.
Confidentiality of Proprietary Information
The agreement should contain the employee’s promise to keep the company’s proprietary information confidential. You may define proprietary information simply as any confidential non-public information of the employer. This provision should state that the employee may disclose such information only if required by law. This clause should also state that the employee agrees not to use the employer’s proprietary or confidential information to harm or damage the employer.
You should determine if the employee previously signed a confidentiality agreement at the outset of or during employment that may contain much or all of this content. If so, this provision should incorporate by reference that previous agreement.
Return of Company Property
The agreement should memorialize that the employee will return all company property, including electronic devices, documents, and electronic data by no later than a specified date.
The employer may want to incorporate in the separation agreement new or existing restrictive covenants, such as non-disclosure, non-solicitation, non-competition, and provisions concerning the ownership of work product and intellectual property. Examine existing policies and agreements to determine which restrictions may apply to the employee and carefully review state law to determine the extent of enforceability.
This provision is designed to protect the employer from disparagement by the former employee. An example of this clause is a statement that:
Carve-out Relating to Administrative Agencies
To reduce the risk that administrative agencies will take issue with the confidentiality, non-disparagement, or similar clauses, you should include a disclaimer that such provisions do not preclude the employee from filing an administrative charge or otherwise communicating with or reporting possible violations of law or regulation to any federal, state, or local government office, official, or agency.
While an employee may request a mutual non-disparagement provision, the employer should reject this request. First and foremost, it is impractical for the employer to monitor and filter comments made by its myriad employees. Further, if the employer has to provide evidence to a court, administrative, or regulatory body in a matter relating to the employee, such a restraint may impede forthright disclosures about the employee’s performance or conduct.
Job references, if any, should be in writing. Agreeing to an oral reference inevitably leads to “he said, she said” issues. If the employer agrees to provide a specific reference letter, the employer should have the employee agree in writing to the exact terms of the reference. The employer must also ensure that the reference is accurate and provide the reference exactly as written.
This clause states that the employee will not apply for reemployment and waives the right to be hired again by the employer. It may foreclose future retaliation suits against the employer for denying a future application.
The EEOC discourages no-rehire clauses. The courts, however, generally have upheld such provisions. See, for example, Jencks v. Modern Woodmen of Am., 479 F.3d 1261 (10th Cir. 2007); Salerno v. City Univ. of N.Y., 2005 U.S. Dist. LEXIS 3825 (S.D.N.Y. Mar. 8, 2005). But see Golden v. Cal. Emergency Physicians Med. Group, 782 F.3d 1083 (9th Cir. 2015) (remanding employment litigation settlement agreement to district court to determine whether a no-rehire provision it contained violated the Cal. Bus. & Prof. Code § 16600 prohibition against restraints on the practice of a profession); Reyes, et al. v. HIP at Murray Street, LLC, et al., No. 1:15-cv-00238 (S.D.N.Y. Jan. 6, 2016) (rejecting proposed settlement agreement because the agreement’s no-rehire provision was inconsistent with the purposes of the FLSA). Courts have also specifically held that a no-rehire provision/policy does not in itself constitute retaliation. See, for example, Jencks, 479 F.3d at 1263; Franklin v. Burlington Northern & Santa Fe Ry., 2005 U.S. Dist. LEXIS 3288 (N.D. Tex. Mar. 3, 2005), aff’d by 2006 U.S. App. LEXIS 8267 (5th Cir. Apr. 5, 2006).
The employer should generally require the employee to cooperate reasonably in any ongoing or future litigation, investigation, or criminal/legal matter. The employer often offers indemnification for the employee’s expenses and attorney’s fees. The employer should typically not agree to pay the employee for time spent cooperating.
The employer may also request that the employee inform it of any subpoenas or summons related to the employer that the employee receives within a prescribed time period (e.g., within three business days of receipt).
Liquidated Damages and Litigation Fees
The employer should generally require that the employee pay the employer litigation fees and liquidated damages, which are predetermined monetary damages for violating the agreement, for material breaches of the agreement, such as breaches of nondisparagement or confidentiality clauses. The liquidated damages provision will give teeth to the agreement and encourage ongoing compliance by the employee. Don’t set the liquidated damages amount too high, as courts will reject unreasonable liquidated damages provisions.
You should include an integration provision stating that the agreement reflects the complete agreement of the parties. The integration provision bars reliance by the employee on oral representations or agreements outside of the separation agreement.
The integration provision may, however, result in the unintended effect of superseding and extinguishing ongoing restrictive covenants or other agreements that the employer may want to continue to enforce against the employee. To avoid extinguishing these agreements you should include a carve-out in the integration clause that preserves these obligations.
Choice of Law/Choice of Venue
This provision permits the selection of the controlling law and jurisdiction, including arbitration, regarding an allegation of material breach of the separation agreement by either party.
You should include a paragraph regarding the severability of the agreement, which means that if one paragraph is deemed unenforceable, the rest of the agreement remains enforceable.
Marc E. Bernstein is the chair of the New York Employment Law Department at Paul Hastings. Mr. Bernstein has a broad-based employment practice, with a focus on trade secrets, covenants not to compete, unfair competition, and related business tort claims. Mr. Bernstein also represents companies in a wide range of employment litigation, including wage and hour class actions, employment discrimination, wrongful discharge, breach of contract, and ERISA litigation.
To find this article in Lexis Practice Advisor, follow this research path:
RESEARCH PATH: Labor & Employment > Employment Contracts > Waivers and Releases > Practice Notes
For additional guidance on separation agreements specifically tailored for executives, see
> DRAFTING COMMON PROVISIONS IN AN EXECUTIVE SEPARATION AGREEMENT
RESEARCH PATH: Employee Benefits & Executive Compensation > Employment, Independent Contractor, and Severance Arrangements > Executive Separation Agreements & Severance Plans > Practice Notes
For detailed advice on meeting the waiver requirement set out in the Older Workers Benefit Protection Act, see
> COMPLYING WITH THE HEIGHTENED WAIVER REQUIREMENTS UNDER THE OLDER WORKERS BENEFIT PROTECTION ACT
For a detailed discussion on the application of the non-qualified deferred compensation rules of Section 409A of the Internal Revenue Code, see
> SECTION 409A AND SEVERANCE ARRANGEMENTS
RESEARCH PATH: Employee Benefits & Executive Compensation > Nonqualified Deferred Compensation > Practice Notes
For an overview on how to use bargaining power and leverage to negotiate favorable separation agreements for executives, see
> STRATEGIES FOR NEGOTIATING EXECUTIVE SEPARATION AGREEMENTS FOR EXECUTIVES
For a sample annotated executive separation agreement with practical guidance and drafting notes, see
> EXECUTIVE SEPARATION AGREEMENT (PROEMPLOYER)
RESEARCH PATH: Employee Benefits & Executive Compensation > Employment, Independent Contractor, and Severance Arrangements > Executive Separation Agreements & Severance Plans > Forms
For state-specific separation agreements, see
> INVESTIGATIONS, DISCIPLINE, AND TERMINATIONS STATE EXPERT FORMS CHART
RESEARCH PATH: Labor & Employment > Investigations, Discipline, and Terminations > Discharge and Layoffs/RIFs > Forms