Severance Packages: Why Employers Need to Consider Them

During the course of business, employers inevitably have to let employees go. In some cases, business just isn’t going well; in other cases, there may be a problem with a specific employee.

Whatever the case, employment sometimes must be terminated, and employers need to consider how to go about it. The most important question any California employer faces is whether to offer the departing employee a severance package. In most cases, California law does not require severance, but offering it can be a smart way for an employer to limit its legal risk.

A severance package is a payment by an employer to an employee at the time of the employee’s termination. It is usually given in exchange for a written promise from the employee that they will not file a lawsuit against the employer.⁠1 This written promise is usually called a severance agreement.⁠2

Most employees do not have a legal right to receive a severance package when their employment is terminated. But because severance agreements can help reduce an employer’s legal liability, many companies offer severance packages regardless of whether they are required to do so.

Why are severance packages a good idea?

Even if an employer hasn’t done anything wrong, severance pay can help them from a legal, social, and economic standpoint.

Legal Benefits

From a legal standpoint, severance pay is a routine way to prevent potentially litigious employees from suing down the road. It’s often impossible to tell what kind of grievances an employee might have and how legitimate those grievances might be.

For example, an employee might have been assigned too much work and kept working off the clock without telling anyone. They might have been sexually harassed and not reported it. Or they might feel the termination was based on a discriminatory motive. In each of these situations, an employee might have a lawsuit and the employer wouldn’t even know about it. It is also possible that the employee simply dislikes the employer and is willing to make up a story to bring a lawsuit.

So many, if not most, employers will err on the side of caution and provide terminated employees with a severance package.

Other Benefits

Beyond the legal benefits, severance pay can help ensure a smooth transition. Employees who receive a severance package are less likely to be angry at their employer. They’re also less likely to badmouth the employer to clients, friends, customers, or other employees.

If other employees find out about the circumstances of the termination, they may feel more secure in their own jobs knowing that severance pay was provided. Severance indicates to existing employees that their employer respects them, even after they leave, and that it values their commitment to the business. In that way, severance pay can increase employee loyalty.

Finally, from a moral standpoint, severance pay can help alleviate any guilt an employer might feel, because they’ll know the employee will have money to live on while finding a new job.

Imagine for a moment that you’ve just been fired. You’re upset, of course, but what are your first thoughts? You might initially think about your family, your mortgage, or your bills. If you have no savings, you might even worry about what you’re going to eat.

If these fears are running through your head, your first reaction might be to blame your employer. But if your employer just offered you a nice severance package, it’s a lot harder to be angry at them. You’re also far less likely to feel helpless if you have enough money to survive until you find a new job.

Overall, severance pay is just the right thing to do.

Are there any risks in offering severance pay?

As with any business deal, there are risks. Offering a severance package could signal to the employee that the employer is concerned about being sued. It could also remind an employee of potential lawsuits they hadn’t planned on pursuing.

The most common risk is that an offer of severance pay incentivizes an employee to contact a lawyer to negotiate a higher package. The difficulty in measuring that risk, though, is that it’s impossible to tell whether the employee would have contacted a lawyer anyway.

The likelihood is that an overly litigious employee will react the same way to being terminated no matter what. Other employees, by contrast, might be dissuaded from pursuing legal remedies if they’re offered severance. So most people who carefully weigh the question of severance packages end up deciding in favor of offering one.

California’s Evidence Code also prohibits an offer of severance from being used to prove liability.⁠3 So even if an employer runs the risk of reminding an employee about a potential lawsuit, the offer itself cannot be used to prove the employer is liable.

Are employers required to provide severance pay?

An employer is not required to provide severance pay. Even when it is in the employer’s best interest to do so, there is usually no legal requirement to offer any kind of severance package. Offering severance also generally will not jeopardize the employee’s unemployment benefits: California’s Employment Development Department does not treat true severance pay as wages that reduce or delay those benefits, though pay characterized as wages “in lieu of notice” is treated differently.⁠4

The exception to this rule is where an employment contract or other agreement provides for severance or other benefits on termination, retirement, or discharge. In that situation, the employer may be contractually bound to pay severance when the employment ends. These kinds of packages, however, are often reserved for executives or other high-profile employees.

How much severance pay should be provided?

The answer to this question changes in every case. From a purely pragmatic standpoint, the employer should ask how much is necessary to convince the employee to sign the severance agreement. Some employees may need the money more than others and may be willing to sign for less.

At the same time, the employer should consider how much is fair. If the employer is concerned about the employee saying negative things to clients or coworkers, a fair severance offer can help ensure the employee leaves satisfied.

The employer should also adopt some ascertainable standard for determining what kind of severance package to offer. For example, an employee may find out that a coworker was offered a severance substantially different from their own.

If the offers are not fair and relatively consistent, the employee may reject the offer or even be offended by it. Adopting a consistent standard for severance offers avoids much of that problem.

One standard that many employers adopt is based on how long the employee has been with the company. An employer using this approach might offer two weeks of severance pay for every year of service, and may also continue the employee’s health coverage for a period. In practice, continued coverage usually runs through COBRA, for employers with 20 or more employees, or Cal-COBRA, for those with 2 to 19, which the former employee normally pays for, though an employer can agree to cover the premiums for a set time as part of the package.⁠5

Whatever amount an employer settles on, the payment has to be real consideration: something the employee is not already entitled to.⁠6 Final wages, accrued and unused vacation or PTO, and earned commissions belong to the employee no matter what, and are due on their own strict timeline, so they cannot serve as the severance.⁠7 Rolling them into a single “severance” payment is a common and avoidable mistake: an agreement that offers only what the employee was already owed may lack the consideration needed to make the release enforceable.

Common Rights That May Be Waived

Only claims for civil violations, not crimes, can be legitimately waived in a severance agreement.⁠8 While many legal rights can be waived, these are the ones most commonly seen in severance agreements:

• The ability to sue for wrongful termination, harassment, or defamation.⁠9
• The ability to sue for unlawful discrimination on the basis of the employee’s gender, race, sex, age, religion, sexual orientation, and similar protected characteristics.
• The right to keep the amount of the severance payment confidential.⁠10
• The right to discuss the employer’s trade secrets.⁠11
• The right to say negative things about the employer (a non-disparagement provision), within the limits California law places on such clauses.
• The ability to discuss the circumstances that led to the departure, so long as those circumstances do not involve unlawful conduct in the workplace.⁠12
• The ability to sue for other known and unknown claims.⁠13

An important limit applies to several of these items. Since 2022, California’s Silenced No More Act has barred a severance agreement from prohibiting the employee from disclosing information about unlawful acts in the workplace, such as harassment, discrimination, or retaliation, or any other conduct the employee has reason to believe is unlawful.⁠14 A confidentiality or non-disparagement clause that touches on workplace conditions is unenforceable unless it also states, in substance: “Nothing in this agreement prevents you from discussing or disclosing information about unlawful acts in the workplace, such as harassment or discrimination or any other conduct that you have reason to believe is unlawful.”⁠15 An employer may still keep the amount paid confidential and may still protect genuine trade secrets.⁠16

A separate, federal layer can also apply. The National Labor Relations Board has held that offering a nonsupervisory employee a severance agreement with an overly broad confidentiality or non-disparagement clause may itself violate the National Labor Relations Act, though the current Board has signaled it may reconsider that rule.⁠17

Of course, there are many other potential issues an employer might ask an employee to waive.

Are there any claims that cannot be waived?

Yes. Several types of claims cannot be waived in a severance agreement. The most common examples include the following:

• The employee’s right to pursue violations of California’s wage and hour laws, such as the right to claim earned wages, unemployment insurance, minimum wage, or overtime pay.⁠18
• An employer may not require an employee to sign a severance agreement before paying owed wages.⁠19 Employers must pay any owed wages whether or not the employee signs the severance agreement.
• The employee’s right to report crimes.
• The right to file a charge with, or take part in an investigation by, the EEOC or the California Civil Rights Department. An employee can be asked to give up the right to personally recover money through such a proceeding, but not the right to file the charge or cooperate.⁠20
• Any promise that would require the employee to break the law, such as committing perjury if called to testify against the company in court.⁠21
• A provision that unlawfully restricts an employee from working for the former employer’s competitors, often called a “non-compete clause.”⁠22
• Waivers so broad or vague that they would bar the employee from seeking employment at all.⁠23
• If the employee is 40 or older, a waiver of age-discrimination claims will not be valid unless the employee is given enough time to consider it: at least 21 days for an individual severance agreement, or at least 45 days if the severance is offered to a group of employees as part of a termination or exit-incentive program, along with at least 7 days after signing to revoke.⁠24

Beyond these rules, an employer may not induce an employee to sign a severance agreement through fraud, duress, or undue influence.⁠25 Nor may a severance agreement contain terms that are unconscionable. Each of these terms has a specific legal meaning, explained below.

Fraud

Fraud can occur where the employer deceives the employee about an important fact, or makes a promise it has no intention of keeping. It can also occur when the employer conceals an important fact that it has a duty to disclose.⁠26

A severance agreement will often be unenforceable if it was signed as a result of the employer’s fraudulent misrepresentations.⁠27

Duress

Duress occurs when an employer threatens an employee in a way that compels the employee to sign the severance agreement out of fear.⁠28 The threat usually must be an unlawful one to meet the standard of duress.⁠29

A severance agreement entered into under duress can sometimes be rescinded by the employee.⁠30

Undue Influence

Undue influence is a legal phrase describing a type of coercive persuasion.⁠31 It occurs where an employer exerts excessive pressure on an employee to sign, exploiting the employee’s mental, moral, or emotional weakness.⁠32

An employee who has been induced to sign a severance agreement by undue influence can sometimes rescind it.⁠33

Unconscionability

The legal doctrine of unconscionability is somewhat complicated. In general, courts look at two aspects of a severance agreement to decide whether it is unconscionable:⁠34

• Procedural unconscionability. If one party has significantly more bargaining power, or the circumstances of the agreement were unfair to the employee, the agreement is more likely to be found unconscionable.⁠35
• Substantive unconscionability. If one or more promises in the contract are one-sided or harsh, a court may find them substantively unconscionable.⁠36

When a contract is unconscionable, courts have the power to refuse to enforce all or part of it.⁠37

Additional Concerns

Beyond these requirements, other legal limitations may apply. For example, the employer must give the employee time to review the agreement. When a severance agreement includes a release of claims under the California Fair Employment and Housing Act, which most general releases do, the employer must tell the employee in writing that they have the right to consult an attorney and must give them at least five business days to do so.⁠38

There are also special rules for severance agreements that release claims of age discrimination, discussed above.

Finally, a severance agreement may be unenforceable if it violates public policy.⁠39

If you are unsure whether the waivers in your severance agreement are valid or enforceable, discuss the terms with an experienced California employment or contract lawyer.