A severance agreement is a contract between an employer and an employee who is being terminated from his or her job. Some employers use severance agreements to reward employees who are leaving after a period of long and distinguished service. Other times, a severance agreement can protect the employer from the risk of a lawsuit filed by a disgruntled employee.
Generally speaking, the employer pays the former employee a severance – an extra payment beyond the wages the employee has earned. Severance pay is intended to help ease the former employee during the transition to a new employer. The amount of severance is negotiable, and employers should be thoughtful about how much severance pay they offer. Severance pay is taxable, and it is important that the employer and employee understand that and reach agreement about how the tax consequences of the severance pay will be handled.
In exchange for the severance payment, the former employee generally agrees to waive his or her right to sue the employer and releases any legal claims he or she may have. In other words, the employee agrees not to sue the employer for wrongful termination, breach of contract, etc. This is done by signing the severance agreement.
In addition to the waiver of claims, severance agreements often address other issues that arise when employment is terminated. They may set out an employee’s right to continued health insurance under COBRA or address what will happen regarding the employee’s retirement plan. Some severance agreements contain confidentiality provisions or noncompete agreements.