How Employee Separation Agreements Can Protect Your Business

An employee signs a separation agreement.

As laws shift, employers should have counsel review their employee separation agreements regularly. Here's what you need to know.

Many employers use employee separation agreements — outlining severance pay, extended insurance, noncompetes and confidentiality, for example — when an employee is terminated. These provisions, including others typically found in these agreements, can help protect the employer from certain kinds of potential litigation from former employees.

Sometimes these agreements use standard, boilerplate language or have not been updated in any meaningful way for some time. Based on changes in the law and actions taken by federal agencies, as well as the unique circumstances of each employment situation, employers will want their legal counsel to regularly review their separation agreements for any fact specific, nuanced issues, as well as those that may arise in relation to federal and state agency rules, including but not limited to the following three agencies:

U.S. Equal Employment Opportunity Commission (EEOC)

Most employers include standard waiver-of-claims language in their severance agreements, stating generally that an employee waives all claims in connection with the employment relationship against the company in exchange for a severance payment. Employers should be mindful of language that either expressly or implicitly can be construed to suppress an employee's right to file administrative charges, or participate in agency investigations. In 2014, the EEOC sued CVS Pharmacy over standard waiver language in its severance agreements, stating, amongt other things, that the agreement "violates Title VII of the Civil Rights Act because it interferes with the employees' right to file charges and participate freely in EEOC investigations." This case progressed all the way to the 7th U.S. Circuit Court of Appeals, affirmed the lower court's dismissal of the EEOC's claim.

Although the employer prevailed, the court did not decide this matter based on the merits. According to attorney Jon Hyman, "the prudent course of action is to make sure that your agreements clearly and unambiguously, in a provision separate and distinct from the release, waiver and covenant not to sue, state that employees retain their federally protected rights." Employers are still left without practial guidance on what provisions, if any, could be deemed to violate Title VII. There is also significant likelihood that the the EEOC will continue to challenge terms included in separation agreements on the basis that they infringe on employee statutory rights.

U.S. Securities and Exchange Commission (SEC)

Like the EEOC, the SEC also has employee separation agreements on its radar. According to Holland and Hart, the SEC is "cracking down on severance agreements that prohibit former employees from contacting regulators or accepting whistleblower awards under threat of losing their severance payments or other post-employment benefits."

This prohibition goes directly against Rule 21F-17 of the Securities Exchange Act of 1934 (amended by the Dodd-Frank Act), which which prohibits retaliatory action against individuals seeking to communicate with the SEC about potential securities law violations. Scrutiny and use of the rule in recent years has grown beyond large financial institutions to businesses of any size, in any sector.

Internal Revenue Service (IRS)

Finally, many employers want to be financially generous with their employees in order to help offset some of the financial burden tied to involunary separations, for example offering additional health benefits or compensation. But it's important for employers to be cognizant of the tax impact of these offers on the compensation structure. Is this compensation going to be paid in a lump sum or in installments? Tax rules come into play here, according to Foley & Lardner. The results — if not treated correctly under the law — can be significant.

Is the employee highly compensated? If so, different tax rules may apply. This applies for both compensation and extended health benefits. Benefits counsel should complete a tax analysis before adding this kind of generosity into your separation agreement and employers should ensure that extended health coverage is not applied in a discriminatory fashion amongst separating employees. Unfortunately, the simple act of trying to be nice could become an expensive mistake — for either the company or the soon-to-be former employee.

Just like all legal documents, employee separation agreements and other paperwork surrounding terminations need to be reviewed often. Laws change, and the three agencies above are active. So add reviewing these agreements and any applicable severance policy with your counsel to your regular to-do list. If you remain attuned to the laws and agency actions, these agreements can be an excellent tool to help protect your business.

This article provides general information, and should not be construed as specific legal, HR, financial, insurance, tax or accounting advice. As with all matters of a legal or human resources nature, you should consult with your own legal counsel and human resources professionals. ADP shall not be liable for any direct, indirect, special, consequential, incidental, punitive or exemplary damages in connection with the use by you or anyone of the information provided herein.