Articles on Severance Pay
ERISA and the IRS Code of 1986, as amended (the IRC) are the two principal federal laws governing employee benefit plans. Although the complexity of ERISA, the IRC and the associated regulations relating to benefit plans precludes a complete discussion of all possible issues, we will highlight some of the important considerations relating to severance pay plans.
The granting of severance pay under certain defined circumstances is a common business practice. However, employers should make it clear that they retain discretion over whether to grant severance pay and that it is not automatic or a vested job right. Federal law does not require nonunion employers to give terminated employees any kind of severance pay. Many employers do so voluntarily, especially for permanent layoffs.
How ERISA Affects Severance Pay
Although federal law may not require severance pay, there is the danger that a voluntary severance plan could be an employee benefit under ERISA. Whether a severance pay policy is a "plan subject to ERISA" depends on whether the employer has a legal obligation to make severance payments (such as a union contract) or if it constitutes a "plan, fund or program-established or maintained by an employer." (In one California case, an employee handbook describing severance benefits constituted a severance plan under ERISA.) Employers may choose to make severance payments in lump sums or in periodic payments (such as through an annuity.) Severance plans that make payments on a periodic basis are governed by ERISA. An offer to make a one-time lump-sum payment triggered by a single event is not an ERISA plan.
WARNING: Even without a formal plan document, a court may determine that an informal ERISA plan exists based on oral representations, the existence of a fund or account from which benefits are paid, the actual payment of benefits, past practice, the reasonable expectations of employees or the intentions of the sponsor.
NOTE: As part of the due diligence process in an acquisition, it is important that the buyer determine whether the seller has any severance practices and whether a formal written plan or an informal arrangement has been adopted. The buyer should inquire whether the seller has filed annual reports in connection with the severance plan or whether an initial "top hat" informational filing was made with the United States Department of Labor.
A plan will comply with ERISA as long as the plan provisions are reasonable and administration of the plan is not arbitrary and capricious and treats all employees uniformly and is executed in good faith.
There are two types of ERISA plans: "welfare benefit plans" and "pension plans." Only those that make payment contingent on the employee retiring, pay more than twice an employee's annual salary and make payments over more than two years are pension plans.
Severance pay plans that qualify as welfare benefit plans are subject to the following federal regulations:
- Reporting to the Department of Labor,
- Reporting and disclosure of the severance pay plan to employees and
- Providing a claims procedure concerning employee eligibility for severance pay.
Structure of Severance Plan
An employer can structure its severance pay policy in any fashion it chooses, such as by department or work group, by seniority or age. The severance package can be tied to years of service and/or level of position. However, all similarly situated employees must receive equal treatment. ERISA allows employers to unilaterally amend or eliminate promised benefits that are not vested. Employees, however, may be able to sue in state court to enforce severance pay promises that are not ERISA plans despite the employer's withdrawal of the offer.
In drafting a plan, consider provisions that:
- Cover common situations, such as layoffs resulting from internal reorganization (and indicate that action regarding other situations will be determined by management as necessary).
- Specify that the purchase of the business by another company will not require the payment of severance, unless employees are actually laid off.
- State that severance pay is intended to provide assistance during an employment search (allowing for the cessation of periodic severance payments as soon as the former employee finds work).
- Require signing of a waiver/general release prior to remittance of any severance pay, absolving the employer from employment-related liability. To be an effective release, the signing of the release must be knowing and voluntary. There are also additional legal requirements that must be considered for a valid release. State within the policy that the benefit is extra and not something that the employer is required to pay. If the plan includes those statements, the employer may generally deny or reduce severance pay when an employee refuses to sign a release.
- Employers should be careful to reserve the right to terminate or alter the policy. They should avoid making statements outside of any written policy that might alter the terms of the policy.
Reduction in Force
Employers that need to reduce staff will often offer early retirement as an inducement for older employees to leave work. Such programs are allowed, but cannot be used as a subterfuge for discrimination against older workers. Please note, under the Age Discrimination in Employment Act (ADEA) and Older Workers Benefit Protection Act (OWBPA), a program that denies severance pay to employees who are eligible for retirement while paying it to other employees is not allowed. The OWBPA also allows an employer to deduct the value of certain benefits from a retiree's severance pay, such as post-retirement health coverage and increased pension payments, which were offered in an early retirement incentive.
There also was concern about the prevalence of non-negotiable releases and the practice of linking severance benefits to a release of claims. Congress felt that older workers were being confronted en masse with a choice between a termination without benefits or receipt of benefits only upon a complete release of potential claims, including age discrimination claims. The end result, to the congressional eye, was that the ADEA was being undermined by employers who routinely were securing either uninformed or coerced releases of protected rights.
If the employer must undertake an involuntary RIF, consider offering a severance package in exchange for a release that complies with the waiver provisions of the OWBPA. If the employer cannot undertake a voluntary Employee Retirement Incentive Program (ERIP) first, it should elect to terminate individual employees over a period of time, paying severance pay and/or early retirement benefits in return for individual releases to avoid litigation. The OWBPA imposes requirements on any release that purports to waive any age discrimination claim. These requirements are:
- Employees must receive something of value to which they are not already entitled. For example, giving a terminated employee something to which he may already be entitled as part of a severance program or pursuant to an existing policy, e.g., accrued sick and vacation pay, will not support an effective release. The employee must receive something of value over and above anything that he would receive upon termination even if he did not execute a release of claims. In those situations where there is a standard severance package in place, for example, the employer will have to offer employees enhanced severance pay to purchase effective releases.
- The release must be part of an agreement between an employer and employee, must be written in simple English and must specifically make reference to the employee's rights under the ADEA that are being waived.
- The release must be limited to claims or rights that arose before the employee executed the release.
- The employee must be advised in writing to consult with an attorney before signing the agreement.
- The release must allow the employee a seven-day period in which to revoke the agreement after it is signed.
- When the release is requested in connection with an ERIP offered to a group or class of employees, each employee must be given at least 45 days to consider the agreement; for a release outside a ERIP group termination program, each employee must be afforded 21 days to consider the agreement.
- When a release is requested in connection with an ERIP offered to a group of employees, the employer must provide at least 45 days for deliberation by affected employees. Furthermore, the employer is required to disclose in writing in ordinary English the class, unit or group of individuals covered by the program, the eligibility factors and time limits applicable to the program, and the job titles and ages of all individuals eligible or selected for the program and the ages of all individuals of the same job classification or organizational unit who are not eligible or selected for the program.
Who Offers Severance Pay
From studying the Employer's Association of New Jersey and Wyatt surveys, generally more large employers than small ones have formal termination policies, including allowances for severance pay. There are a great variety of formulas, although nearly half of the companies give white-collar and exempt employees one week of severance pay per year of service and one-third of them give the same to blue-collar employees. However, many employers do have informal means of determining the amount, if any, of an employee's wages to be paid in the case of certain types of separations. Severance is most common when employees are separated as part of a reduction in workforce. It is least common when employees quit or are discharged for cause. In between are employees terminated for poor performance. This category is sometimes given severance in lieu of notice to avoid retaining, even for a brief period, individuals whose behavior has the potential of damaging general employee morale. Probationary, part-time and temporary employees are not usually included in severance pay policies.
Employers usually base severance on length of service, most often one to two week's pay per year of service. Employers should base severance payments on the number of years of continuous service from the most recent date of hire. Otherwise, employees who are laid off and recalled may be able to claim that they should receive benefits based on the date they were originally hired by the organization. Some companies pay a fixed benefits amount, either one or two weeks' pay. Some companies combine length of service with other factors such as employee classification. The most common form of payment is a lump sum, while some companies pay installments or a combination.
Many companies have written policies regarding termination and severance arrangements. In lieu of a written policy, a plaintiff's attorney would likely consider what the employee was told, along with examining past and current practices of the company in granting severance. There are advantages and disadvantages to having a formal severance pay policy.
On the positive side, such a policy:
- Promotes equity in the treatment of employees, thereby preserving the morale of remaining personnel.
- Maintains a company's reputation in the labor market (for future recruiting purposes).
- Reduces the stress of terminated employees between the time of their release and securing other employment.
- Eases, if only slightly, the psychological burden on executives who must make difficult but necessary decisions to separate unsatisfactory employees.
On the negative side, it may be difficult to design a policy that:
- Adapts well to unpredictable changes in the economic climate.
- Deals effectively with both the wide variety of circumstances that contribute to the necessity for the separation of an individual employee and the vastly different circumstances surrounding mass layoffs, disaster and plant relocation.
- May be subject to ERISA reporting and disclosure requirements.
Article by Terry L. Baglieri from http://www.shrm.org/hrresources/whitepapers_published/CMS_000049.asp