Using Severance Agreements to Avoid Wrongful Termination Lawsuits

If you’re an employer who fears a wrongful termination claim, consider asking a terminated employee to sign a severance agreement.

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• treated unfairly
• terminated improperly, or
• not adequately compensated.

When an employee's departure might be under less-than-genial circumstances, it's a good idea to have a severance agreement (also known as an "employee separation agreement") to avoid potential conflicts and protect your company's interests. In addition to that agreement, you should have a procedure for what to do and not do during the firing process.

• What Is Wrongful Termination?
• Avoiding Wrongful Termination Lawsuits: Dos and Don'ts
• What to Include in a Severance Agreement to Avoid Lawsuits
• Important Considerations When Drafting a Severance Agreement
• Consulting an Employment Lawyer

What Is Wrongful Termination?

Wrongful termination is when you fire an employee for an illegal reason or for a reason outside of what's allowed under the employee's contract. Your ability to fire an employee and under what circumstances will depend on what type of employee they are.

There are two main kinds of employees:

• Employees with employment contracts. This type of employee has a contract with you, their employer, that specifies the reasons that they can be fired. Usually, employees with contracts can only be fired for "good cause," such as poor job performance or frequent, unexplained absences.
• At-will employee. An employee at will can be fired at any time for any legal reason.

Many times, employment contracts will define an employee as at will. In that case, even though the employee has a contract, they'll generally be considered at will, and can be fired for any legal reason. (The at-will employee can't be fired for illegal reasons, such as those based on discrimination or for retaliation.) Designating an employee as at will can better protect employers against wrongful termination claims.

You can also better protect yourself from wrongful termination lawsuits by having your employees sign a severance agreement when they're fired.

Avoiding Wrongful Termination Lawsuits: Dos and Don'ts

Before we get to what should go in a severance agreement, let's cover some general best practices about the process of firing an employee.

When you fire an employee, you should follow a consistent procedure to avoid any missteps that could later turn into wrongful termination claims. What you do and what you don't do during the termination process are equally as important.

When firing an employee, you should do the following:

• Provide a detailed termination letter. You should give your employee an official termination letter that includes details about when the firing becomes effective and what follows next, such as when they'll receive their final paycheck and when their benefits will end.
• Document the details of the fired employee. You should add details and documents related to the employee's firing—such as the reason for the termination, unemployment forms, and insurance continuation forms—to their existing personnel file. Keeping a file will help protect your company from legal liability.
• Conduct an employee exit interview. At some point between when the employee is notified about their termination and their last day (or sometimes later), you or someone from HR should conduct an exit interview. Ask them about their experience, what they liked about the company, and what they would change. The interview will make the employee feel like they've been given an opportunity to tell their side and might offer you some useful feedback that you can implement moving forward.
• Change company passwords to protect sensitive and confidential information. You should periodically update company passwords to protect company data and documents. In addition to the periodic changes, you should also update company passwords when you fire an employee so that former employees can't later access company files.

On the other side, don't do the following when firing an employee:

• Fire via electronic means. You should almost never fire an employee over email. Firing over email communicates to the employee that the company doesn't value them enough for a face-to-face meeting, which can result in resentment and retaliation. If you can't meet with them in person (for instance, they work remotely), then you should arrange a video meeting. Otherwise, you should meet with them in person and be direct. (For more information, read our article on how to prepare and conduct a termination meeting.)
• Fire without any prior warnings. Whether you're firing for job performance or behavioral issues, the employee should have had prior notice that there's an issue. Before firing an employee, you should notify the employee in writing that there's an issue and keep a record of the communication. If the issue is job performance, you should give performance evaluations. If the issue is behavioral, you should conduct investigation interviews. If you're laying off an employee, beforehand you should let employees know that you're considering making layoffs and why.
• Conduct the firing one-on-one. While it might seem uncomfortable to include other people in the termination meeting, having an HR representative present is generally a good idea. They can provide support to the departing employee. And if the employee later says you handled the firing poorly or didn't provide the required information, the HR rep can help dispute those claims.
• Argue with the employee or end on a bad note. Perhaps one of the best ways to avoid a wrongful termination suit is to end the employment relationship amicably. If the employee becomes combative, stay calm and refrain from swapping insults.

For a list of detailed steps to take when an employee leaves your company, see our article on an employer's obligations.

What to Include in a Severance Agreement to Avoid Lawsuits

If you're worried about being sued by a terminated employee, you might want to consider asking the employee to sign a severance agreement: a promise not to sue you in exchange for receiving certain benefits. Some employers routinely ask their employees to sign an agreement as a condition of receiving a severance package.

Other employers ask only those employees who might have a legitimate legal claim against the company—or who seem especially motivated to sue—to sign an employee separation agreement.

Suppose Gideon Insights hires Spencer Reid, whose employment contract says he can only be fired for good cause. Fifteen years into his employment, another employee claims that Spencer was making threats. Gideon insights immediately fires Spencer without talking to him or conducting an investigation. It's probably a good idea for Gideon Insights to ask Spencer to sign a severance agreement since the firing was based on an accusation that was never investigated.

While a severance agreement can accomplish many important goals in protecting the company's interests, the most vital objective is typically to shield the company from potential legal liability. You can protect your company from liability by including a precisely drafted release provision in the employee separation agreement, together with related language that supports the agreement's intent and purpose.

Because some states have specific requirements about what language must go into a severance agreement, it's a good idea to consult an attorney for help in crafting a legal agreement that will meet your needs.

While state laws differ, a well-crafted severance agreement will usually include the following provisions.

Providing Consideration to the Employee

You're asking the employee to waive the right to sue you, and that right is worth something. As with any contract, severance agreements are only enforceable if both parties receive value (consideration). Providing consideration reflects the results of a good faith, arms-length negotiation between you and the employee.

Typically, companies provide consideration to employees in the form of:

• a cash settlement payment
• stock
• stock options
• promissory notes, or
• other items of value.

In exchange, the employee grants the company a full release of all claims the employee might have against the company related to the employee's employment.

Releasing You From All Claims

The release provision is the purpose of the entire agreement. Your release should detail what claims the employee is releasing your company from and who all can take advantage of that release. In short, the purpose of a release is to address two primary issues: prohibited claims and covered persons.

Prohibited Claims

The prohibited claims should cover everything under the sun. The language of your release should be broad enough to make it impossible for the employee to have a legitimate claim against your company. The release should be drafted to:

• cover all claims and losses under any legislation in existence, and
• specify those laws that might be of particular relevance to employment considerations and the company's business.

Covered Persons

The release should also include a promise (covenant) by the employee not to file any suits or claims against any covered persons. If the employee breaks their promise, they'll be liable for any attorneys' fees and other costs incurred by your company to deal with the action.

The "covered persons" are the people and entities protected against any claims by the employee. The covered persons should include not only your company, but also its:

• affiliates (including parent companies, subsidiaries, divisions, and joint venturers)
• equity holders (such as stockholders, members, or partners),
• managers
• directors
• employees
• contractors, and
• agents and representatives.

You should think of yourself as negotiating the release on behalf of your company and anyone else in its orbit who could be subject to a claim by the departing employee.

Admitting No Liability in the Termination

When you ask a departing employee to sign a severance agreement, it might seem like you're admitting or implying that you've done something wrong. After all, you're offering the employee money or other consideration in exchange for them promising not to sue you.

You should include a specific clause in your employee separation agreement that says that you aren't admitting to any wrongdoing by providing and signing the agreement. In other words, you offering the severance agreement to the employee isn't an admission of any liability.

Protecting Confidential Information

Your company's confidential information is among its most valuable assets. It includes your:

• customer and supplier lists
• financial data
• strategies
• business plans
• documents
• communications
• work product
• legal information, and
• contact information (including addresses, phone numbers, and email addresses) for people important to your business.

Employees often gain access to or are exposed to at least some part of a company's confidential information. A disgruntled employee with access to this sensitive information could share it with your competitors or the public. Releasing your confidential information could cause you to lose your edge over competitors and expose your company to legal or public relations issues.

In particular instances where the employee might be leaving on bad terms, an employee separation agreement can help ensure that the employee keeps all sensitive information confidential, regardless of any personal feelings the employee might have towards your company. You should include a confidentiality (also called "nondisclosure") provision in your agreement.

The confidentiality provision should be worded as broadly as possible to not only include all confidential information generally, but also those specific items that are particularly valuable to your company. For example, a technology company might be particularly interested in protecting its intellectual property interests. The manufacturer of a food product might want to ensure that the ingredients of their special sauce aren't revealed.

For further discussion on confidentiality provisions, see our sample confidentiality agreement.

Establishing Proprietary Rights

People often confuse confidentiality provisions with proprietary rights protection. But, the protection of proprietary rights is a separate and important matter that should also be covered to safeguard your company's trade secrets and other intellectual property.

The proprietary rights provision establishes that a company automatically owns any inventions or intellectual property that's created by its employees as part of their employment. For example, suppose Cisco Ramon invents a new kind of robot while working at Star Labs. Star Labs later fires Cisco and has him sign a separation agreement that says Star Labs owns the rights to everything Cisco worked on while at Star Labs. As a result, Star Labs, not Cisco, owns the intellectual property rights to the new robot.

Your company can also have the departing employee separately sign an intellectual property assignment agreement, transferring all their rights to any of their inventions or work product over to your company. And, if your company files a copyright, patent, or trademark for any of the relevant intellectual property, the proprietary rights provision should require the employee to cooperate with that process.

Returning Company Property

In decades past, it might've been the case that when an employee was terminated, they might take some random office items with them—like highlighters, pens, and paperclips. These days, though, employees can take terabytes of company data with them on a portable hard drive.

So, the severance agreement should contain a clause ensuring that the employee will return all company property before any of the severance consideration is delivered to the employee. You should either have the employee return the property or have a human resources (HR) representative collect the company belongings.

Company property can include:

• equipment
• documents
• memos
• emails
• customer lists
• keys
• disks, and
• passwords.

If the employee has already returned all company property, then this provision should include the employee's promise that all items have been returned and that they haven't made any copies or duplicates. For example, the employee would promise that they didn't keep any pictures of product designs on their phone or forward company emails to a personal email account.

This provision works alongside the confidentiality provision because it becomes much more difficult for the employee to share confidential information if they no longer have the company documents and data.

Responding to Employment Inquiries

At some point after leaving the company, your employee will be looking for new employment. Your severance agreement should include a procedure for your company to follow when an interested employer contacts you to ask about your former employee and whether you'd offer a recommendation.

A standard provision simply requires the company to acknowledge the employee's position and dates of employment—and nothing further. But the company can always make positive comments about the former employee if it wishes. (For tips on giving references, see our article on what to tell prospective employers about former employees.)

Including a Nondisclosure of the Agreement Clause

You and the employee will probably want to keep the contents of your agreement secret. In that case, your agreement should include a nondisclosure provision with respect to the terms of the agreement (not to be confused with a nondisclosure provision regarding the company's confidential information as discussed earlier).

This separate provision makes it clear that neither party will disclose the contents of the severance agreement to anyone, except to those on a need-to-know basis. Third parties that might be considered to be on a need-to-know basis are:

• immediate family members
• legal representatives
• accountants
• insurers, and
• tax authorities.

Important Considerations When Drafting a Severance Agreement

When drafting an employee separation agreement, you should keep in mind the following general considerations:

• Be clear about the rights the employee is waiving. Your agreement might say that the employee is waiving any right to sue you for claims that come out of the employment relationship, including the termination of that relationship. In any case, make sure the release provision is specific enough to prevent any later claim that the employee didn't know what the release covered—and comprehensive enough to cover every claim the employee might conceivably raise.
• Give the employee plenty of time to decide whether to sign. It's reasonable for an employee to take a week or two to decide whether to give up the right to sue you. You might even suggest that the employee consult with a lawyer to review the agreement. You should put in writing, whether in the agreement itself or in an attached email or memo:
  • how long they have to review the agreement
  • what they should do if they need more time, and
  • that they're encouraged to talk to an attorney about the agreement.

  Consulting an Employment Lawyer

  When you fire an employee, it's always a good idea to involve HR, or, if you don't have an HR department, to seek outside help from an HR specialist. They'll have a good idea about the procedures and laws you should follow.

  But if the firing is particularly sensitive (as where there have been sexual harassment claims) or involves an employee from a protected class, you should talk to an employment lawyer. They can help you interpret the relevant federal and state employment laws and make sure you're supplying the employee with all of the appropriate information and documentation.