Picture this: You terminate an employee and decide, without legal obligation, to offer the individual severance pay. In response, the employee asks you to make the check out to the lawyer he has just hired to sue you.
It sounds crazy, but, if you don’t make sure that you trade severance pay for some sort of legal protection, you may actually be helping to fuel litigation against your organization. The only difference is that in real life the employee might—just might—not have the nerve to make his intentions so obvious.
To avoid the risk of funding a lawsuit, secure a general release of claims against the company in exchange for the severance amounts, as well as for any other discretionary payments you make upon termination. (Note, however, that to secure a release, employers cannot withhold non-discretionary amounts such as vacation pay or other paid time off benefits to which the employee is entitled.)
Making a release the quid pro quo for severance pay is both lawful and wise. As 2003 comes to a close, many companies continue to grapple with the arduous task of implementing major layoffs. The same economic climate that contributes to that trend may prompt employees to challenge even the most apparently well-founded employment terminations.
All in all, it’s a good time to dust off some basic principles for drafting and securing releases that are not only enforceable, but also provide the broadest spectrum of protection for the employer.
This article covers how to secure an enforceable release—focusing specifically on the issue of “consideration”—and discusses some essential, basic provisions. The second article, to appear in next month’s Legal Trends, will address some procedural and additional substantive concerns involved in the execution of releases, particularly as governed by the Older Workers Benefit Protection Act (OWBPA).
To be sure, you normally will have your employment counsel draft releases for your organization. However, it’s important to understand not only the practical value of having a release, but also what provisions to include in the release and why, what kind of release to use for particular situations and how to carry out the transaction. And, with an educated eye, you can review and, if necessary, question any legal document that you put forth on the employer’s behalf.
Careful! Consideration Required
For a release to be enforceable, it must be supported by “consideration.” That does not mean kindness or thoughtfulness. It means you have given employees something of value—and something to which they would not otherwise have been entitled—in exchange for surrendering their right to sue you.
In simplest terms, you are buying protection. And, just as in the grocery store, you can’t pay once and get two items.
So, your first step in securing a valid release of claims is to determine if employees are already entitled to severance pay. If they are, and you ask them to surrender their right to sue without giving them some additional compensation, the release will not be enforceable.
As a general rule, employees have no right to severance pay. But they may be entitled to it by virtue of a state law, an employer’s unilaterally adopted severance plan, a collective bargaining agreement or an individual employment contract.
A few jurisdictions mandate severance pay upon the termination of employment in limited circumstances. In Maine, for example, employees who lose their jobs as a result of a plant relocation, as broadly defined by state law, are entitled to one week of severance pay for each year of employment. The severance requirement does not apply if the employee has worked for the company for fewer than three years. In addition, there are a number of other exceptions to Maine’s severance pay requirement. Other states that mandate the payment of severance in limited circumstances include Massachusetts and Rhode Island.
An employer generally cannot impose an added condition—a release of claims—on employees who already are entitled to severance pay by law or by agreement. Attempting to do so would expose the employer to a suit for breach of the applicable plan or agreement. In any case, such releases would be unenforceable without additional consideration.
To avoid this problem, it is recommended that severance plans state expressly that employees are not entitled to any severance unless they sign a general release upon the termination of employment. Similar language can be included in an individual employment agreement that provides for severance in limited circumstances. In both cases, the language makes clear that the employee is not entitled to the severance without the release so that the severance can serve as the consideration to support the release.
In the absence of language stating expressly that severance is conditional on the employee’s execution of a general release, there are still two ways employers may be able to obtain a valid release from employees who are in some way already entitled to severance pay.
First, many plans and agreements provide that an employee is eligible for severance only if the employee is terminated without “cause.” When there is a good faith dispute as to whether there is cause, the employer can waive the for-cause argument in exchange for the release.
Second, the employer can obtain a binding release by providing additional compensation or other benefits -- such as job placement assistance -- beyond what the employee already is entitled to.
Employers must be careful when they select which benefits to offer, however, because some can bring legal complications.
For example, in exchange for a release, some employers offer to keep terminated employees on the group health plan during the severance period, thus postponing the start of the employee-paid COBRA health care continuation coverage. But this approach may violate health plan documents and insurance contracts. And, if the insurance company denies coverage during the severance period, the employer could end up self-insuring. (Of course, this is only a problem if the employer is not self-insured.)
A less risky approach would be to acknowledge the termination as the qualifying event and to pay the individual’s COBRA premiums during the severance period.
The same self-insurance risk applies if the employer continues group life or disability insurance coverage during the severance period. However, the employer can offer to pay the premiums for a defined period, but only if the plan allows the employee to convert from group to individual coverage on termination of employment.
Some employers allow employees to continue to contribute to their 401(k) or other retirement plan during the severance period and/or make contributions on their behalf. However, this may run afoul of Treasury Regulation 1.401(k)-1(a)(3), which generally has been interpreted to prohibit employers from allowing former employees to direct severance payments into a 401(k) plan.
If there might be any possible ambiguity about what constitutes the consideration for a release of claims, address the issue expressly in the agreement and require the employee to acknowledge the adequacy of the consideration supporting the release.
Note, however, that courts generally do not assess the adequacy of consideration. At the same time, if the amount of severance or other consideration the employer is offering is so small that it offends a judge’s sense of fairness, a judge might hold there is not adequate consideration.
Obviously, the release waives only those claims that it covers. As simple as that sounds, drafting a release that effectively protects the employer against a broad range of possible claims is somewhat more involved. To that end, you will need to take into account several factors:
Who is covered. The release should be drafted broadly, protecting not only the legal entity that employed the worker, but also any related, affiliated, parent or subsidiary entities. If such entities are not mentioned, they may not be covered.
The release should cover not only corporate entities, but also persons—who are sometimes sued in their individual capacities. Accordingly, the release should explicitly cover, for example, the employees, officers, directors, partners, owners, insurers, attorneys and agents of each entity. Any category of individuals not specifically named may not be protected.
Scope of claims waived. Ordinarily, it is a good idea to draft a release as broadly as possible so that it covers any and all conceivable claims, known or unknown, asserted or unasserted.
When drafting the release, bear in mind any federal, state and local laws that may impose additional requirements or restrictions. In California, for example, it is not enough for employers simply to include in the release language stating that it covers both “known and unknown” claims. Rather, that state’s law specifically prohibits the waiver of unknown claims, unless the employee waives them pursuant to that law, which should be mentioned in the agreement containing the release. (California Civil Code Section 1542).
Courts generally have held that a release cannot cover prospective claims—that is, those arising after its execution. In addition to that general rule, the OWBPA expressly provides that a release of claims under the Age Discrimination in Employment Act (ADEA) will not be enforceable if it covers claims that arise after the release is executed. (29 U.S.C. § 626(f)(1)(C).) (The January Legal Trends column will address other OWBPA requirements with regard to the waiver of age claims.)
To ensure that a release is not too broad to be enforceable, employers can expressly exclude claims that arise out of events that occur after the employee executes the agreement. While that approach will help secure the enforceability of the release, it may call unnecessary attention to the employee’s retained legal rights.
A less blatant, but perhaps less certain, alternative is to insert in the release this statement: “This release covers only those claims arising out of events, occurrences or omissions occurring or existing prior to the employee’s execution of the agreement.”
Specific claims waived. Courts generally determine whether an employee’s waiver of the claim at issue was “knowing and voluntary.”
In the case of age discrimination claims, the OWBPA states that a release will be enforceable only if it specifically references age claims arising under the ADEA. (29 U.S.C. 626(f)(1)(B)). Accordingly, a general statement that employees waive all claims arising out of their employment and/or the termination of their employment will not, in and of itself, cover age claims.
No other federal employment law requires that releases specifically name a particular type of claim to be effective. In other words, there is no statutory counterpart to the OWBPA that is applicable to race, color, national origin, religion or sex discrimination claims under Title VII of the Civil Rights Act of 1964 or to disability discrimination claims under the Americans with Disabilities Act.
An employer’s position is stronger with regard to the “knowing” prong of the knowing and voluntary waiver test if the release specifically mentions the type of claim at issue. So, even though it is not statutorily required, employers should consider listing in the release some of the more common claims employees bring. To that end, releases should:
- At a minimum, expressly cover “any claims relating to or arising out of the employee’s employment and/or the termination of employment.”
- Include a clause covering compensation-related claims. Such a clause might state that the release applies to “any claims for unpaid or withheld wages, severance, benefits, bonuses, commissions and/or other compensation of any kind.” Customize the list to reflect in detail your compensation program. Even though employees cannot waive rights under the Fair Labor Standards Act (FLSA), they may be able to waive rights under state wage payment laws, which often have harsher penalties.
- To be safe, cover claims involving not only discrimination but also harassment under a list of federal and state laws and the classes of individuals they protect: A sample list might read as follows: “any claims for discrimination and/or harassment based on age, sex, race, religion, color, creed, disability, handicap, citizenship, national origin, ancestry, sexual orientation or any other factor protected by federal, state or local law (such as the Age Discrimination in Employment Act, 29 U.S.C. § 621 et seq., the Americans with Disabilities Act, Title VII of the Civil Rights Act, the State Human Rights Act, etc. …).
- Specifically refer to “any claims alleging retaliation and/or any whistleblower claims.” Technically, retaliation is a form of unlawful discrimination when it involves adverse action taken against workers who assert their rights under the anti-discrimination laws; however, most employees won’t be conscious of this.
- Mention “any claims for attorneys’ fees, costs or expenses.” If such expenses are not listed, they may not be covered.
- Mention specifically any employment agreements, especially in connection with the waiver of “any claims for breach of contract, libel, slander, fraud, wrongful discharge, promissory estoppel, etc.” To the extent that an employee tries to bring one of these claims, including them in the release makes it more likely that a court will find the waiver knowingly applies to it.
The above list is illustrative only—not exhaustive—and that same point should be made expressly in your release. Other possible claims that could be mentioned in a release include, but are not limited to, those arising under:
- The Employee Retirement Income Security Act. (Note, however, the release will not be effective against claims for vested benefits, as discussed below.)
- The Sarbanes-Oxley Act. While it is not entirely clear to what degree employees can waive whistleblower claims arising under this statute, it is clear that the employer’s waiver argument is stronger if the release mentions the statute.
- The Family and Medical Leave Act (FMLA). A recent case interprets the FMLA as prohibiting only the waiver of substantive rights as opposed to claims for monetary damages. (Faris v. Williams WPC-1 Inc. et al., 332 F.3d 316 (5th Cir. 2003)).
Limitations on the Release
Not every claim can be waived. For example, a release ordinarily will not cover claims with regard to vested benefits under a retirement plan, claims for workers’ compensation benefits, claims under the FLSA, claims to challenge the agreement or claims arising after the execution of the agreement.
Some employers specifically state these exceptions in the release. For example, to avoid employee anxiety and unnecessary discussion, it may be desirable to include language providing that nothing in the agreement results in the forfeiture of or waiver of any claims with regard to vested benefits under the employer’s retirement plan.
On the other hand, you might not want to call attention to the fact that the release won’t cover claims for workers’ compensation.
To ensure that the release is not interpreted as overbroad and consequently unenforceable in its entirety, the agreement should include language providing the court with authority to “blue pencil” or narrow any offending provision in the agreement to make it enforceable.
Making a bargain based on valid consideration—an offer of severance pay in exchange for a general release of employment-related legal claims—and the use of a properly drafted, broadly protective release document are fundamental steps in steering a terminated employee away from the courthouse door. But the employer also must observe additional protocols with respect to the timing of the release and other procedural and substantive protections for the employee to ensure that that door remains justifiably closed. Watch for discussion of those matters in January.
Author’s note: This article should not be construed as legal advice or as pertaining to specific factual situations.
Jonathan A. Segal, Esq., a contributing editor of HR Magazine, is a partner in Philadelphia in the Employment Services Group of WolfBlock LLP. His practice concentrates on counseling clients, developing policies and strategic plans, and training managers to avoid litigation and unionization.