Separation Agreements: For Employees

In reviewing a severance or separation agreement, employees and their attorneys should look for the following issues, and negotiate these terms in the employee's favor. Please read our separate article on negotiating separation agreements for employers1. Receipt of All Owed MoneyBecause the employee will likely be signing off receipt of all wages, business expenses and, if applicable, paid time off (PTO),[1] the employee should ensure that these payments have been made before signing the agreement.2. ConsiderationMake sure the employee is getting more than already bargained for. The employee may have already signed an employment agreement or be subject to a company policy under which he is entitled to receive a severance payment. Reference and compare any prior agreements or policies with the current agreement. You can use this information to increase any payment to the employee pursuant to the severance agreement.The employer may want the severance agreement for reasons other than a wrongful termination claim. You may be able to negotiate more money from the employer in certain situations, such as where the company raising venture financing or entering into an M&'A transaction (and wants to look more attractive to investors and avoid problems in the diligence process); where the company forgot to have the employee sign an inventions assignment agreement at the beginning of the employment; or where the employment agreement contains a "single trigger" provision providing the employee with certain benefits upon a change in control.3. Equity Vesting If the employee has been compensated with equity (such as common or restricted stock), the equity usually vests over several years subject to continued employment.[2] Negotiate accelerated vesting as part of the agreement.Employees at newer companies should also request anti-dilution protections. However, note that these are not usually granted.4. Deferred Payments (409A Exemptions)Highly-paid executives may receive severance payments in a deferred compensation plan. Where settlement payments are to be paid in a future taxable year, the payments may be subject to Section 409A of the Internal Revenue Code. [3] Such payments can be subject to a 20% tax paid by the employee. Structured correctly, the payments can be exempted from the code and save the employee significant tax liability.However, most severance payments can meet at least one of two exemptions from Section 409A: the (1) short-term deferral, and (2) separation pay plan.Under the short-term deferral exemption, deferred payments are not subject to 409A where payments are made within the short-term deferral period. Under the regulations, the short-term deferral period ends on the later of the 15th day of the third month following the end of the employee's first taxable year in which the right to the payment is no longer subject to a substantial risk of forfeiture or the 15th day of the third month following the end of the employer's first taxable year in which the right to the payment is no longer subject to a substantial risk of forfeiture.[4]Under the separation pay plan exemption (or the 2x2 Rule), deferred payments are exempt from 409A where the employee was subject to an involuntary termination (including certain terminations for "good reason") or a voluntary termination during the 409A "window period" and the separation pay meets the following requirements:

  • (1) The separation pay is not more than two times the lesser of: (a) the employee's total annual compensation for the preceding year, or (b) the qualified plan compensation limit under Section 401(a)(17).
  • (2) The separation pay is paid no later than the last day of the employee's second taxable year after termination.

The following severance benefits are not deferred compensation under Section 409A as long as they are provided for a "limited period of time," which generally means two to three years: (1) continued health insurance during the COBRA continuation period; (2) reimbursement of business expenses or moving expenses; (3) de minimus amounts; (4) reimbursement of medical expenses that are otherwise deductible under IRS Code Section 213.5. Mutual TermsMany severance agreements require the employee to release all claims against the employer, but do not require the employer to release claims against the employee. Make sure the release language is mutual.Similarly, any non-disparagement[5] language should be reciprocal. For example, the parties can agree that the employer will provide a letter of recommendation before the employee leaves, and agree on the content of the employer's response to any future reference call.6. Limit the ReleaseNegotiate to limit the claims that you release. Severance agreements typically include a release of wage, discrimination, and retaliation claims, which are standard.However, you should always carve out the right to indemnification against claims from a third party. You may also want to carve out the following types of claims and entitlements: disputes over company plans, including restricted shares, stock options, or accrued and vested pension benefits. A release should never include claims arising after the settlement agreement is executed..7. Restrictive CovenantsIf the employee is already bound by a non-compete or a non-solicit agreement (e.g., in an employment contract or other document), the severance agreement should not expand on those restrictions.If the employee has not previously signed any restrictive covenant, the employee should limit the scope and time of any new restrictions in the severance agreement.8. Proprietary and Confidential InformationWork to carve-out any documents or information that you think you may need. Carve out the employee's immediate family members from any clause requiring the separation agreement to be kept confidential.9. Ongoing ObligationsThe separation agreement may include language requiring the employee to assist with ongoing matters, even after the employee's employment has terminated. Make sure this is acceptable to the employee and consider including language limiting the number of hours per week that the employee can be called upon to do work.____________________________________________________________________________[1] Check your state's law to determine whether vacation must be paid out upon termination, or whether employees forfeit vacation time.[2] California law may allow the employee to recover equity, bonuses and commissions that would have been received but for a wrongful termination. DLSE v. Transpacific Transportation Company, 88 Cal.App.3d 823, 830 (1979) (upholding order requiring employer to pay bonus to employees terminated a few weeks prior to the date the bonus would have been due if they had remained employed because "the law does not support a forfeiture where the employees were terminated through no fault of their own after having substantially performed the services entitling them to a bonus"); Kelly v. Stamps.com Inc., 38 Cal. Rptr. 3d 240, 252 (2005) ("should the plaintiff establish that she was unlawfully terminated, she could assert that that termination excused fulfillment of the condition of [continued employment], and rendered the bonus payable upon termination"); Newberger v. Rifkind, 28 Cal. App. 3d 1070 (1972) (holding that employees provided sufficient consideration for options through their continued employment, even though the owner of the company died before the five-year options vested).[3] This section only serves to bring attention to the issues surrounding Section 409A. There are almost 400 pages of Treasury Regulations, and the separation agreement should be analyzed on a case by case basis.[4]See Treasury Regulation Section 1.409A-1(b)(4)(i)(A). For companies with a calendar year, you can use March 15th as the deadline. For companies following a fiscal year, using March 15th is a conservative approach. For example, if the fiscal year ends on June 30, the short-term deferral period would not end until September 15. Sample language for the agreement is as follows:All payments described in Paragraph __ of the Agreement shall be paid to Executive, to the extent earned, no later than the last day of the "applicable 2-1/2 month period", as such term is defined in Treasury Regulation Section 1.409A-1(b)(4)(i)(A) with respect to such payment's treatment as a "short-term deferral" for purposes of Section 409A.[5] Note that broad non-disparagement agreements may violate the employee's rights under Section 7 of the National Labor Relations Act (NLRA), which protects employees' rights to "engage in other concerted activities for the purpose of collective bargaining or other mutual aid or protection." For example, the National Labor Relations Board (NLRB) struck down a non-disparagement clause that limited an employee's right to criticize the employer and its products. See Quicken Loans, Inc. &' Lydia E. Garza, an Individual, Case No. 28-CA-75857, 2013 WL 100863 (Jan. 8, 2013).

Documate Newsletter

Sign up for our newsletter to get product updates, exclusive client interviews, and more.

Start a free trial, or
chat with our team today:

By clicking “Accept”, you agree to the storing of cookies on your device to enhance site navigation, analyze site usage, and assist in our marketing efforts. View our Privacy Policy for more information.