What is a Severance Agreement?
A severance agreement is a contract between an employer and an employee that outlines the terms under which an employee will leave a company, typically tied to a severance package. The goal of a severance agreement is for the employer to part ways with an employee on good terms, often making their financial departure easier and soothing hard feelings. Although your severance agreement may not be in the format of a contract, always make sure you understand the language, perhaps having an employment attorney look it over, before you buy into its terms.
The terms of a severance agreement may vary widely depending on the relationship between the employer and employee as well as the amount of compensation or benefits that change hands. In general, severance agreements will offer more to an employee who brought a great deal of value to the company than to an employee who is not a critical part of the business.
For the employee, the purpose of a severance agreement is primarily financial. From their perspective, the agreement constitutes a legally binding promise of payment from the employer . Although there are few legal requirements for severance agreements, there are a number of common reasons that employers use them. These include:
For employers, the purpose of a severance agreement can vary depending on the circumstances of the departure. Most employers use them as a way of both protecting themselves and paying an employee being let go either to retire or move to a new position. Often, the more valuable the departing employee is, the more the company is willing to pay them as a severance package, offering up to six months of salary along with benefits.
In practice, severance agreements both resolve the employer’s liability to the employee and provide the former employee with a continuing stream of income for a certain period of time. The agreement also serves as a way for the company to avoid spreading the word about any major issues the company may have with the employee. Thus, the company is able to keep the dialogue and the bad news within the company walls while still remaining friendly to the employee. In this way, the use of a severance agreement can reduce the impact of an employee’s departure on the company’s reputation to both outside individuals and other employees.
Legal Requirements for Severance Agreements in Illinois
Illinois Law prohibits severance agreements which place a restraint on a person’s ability to obtain employment. In particular, these restraints include an agreement not to seek other employment, an agreement to limit the number of jobs with which a job applicant may apply, or an agreement to refrain from working in an industry or geographic area. This prohibition was added to the Illinois Human Rights Act, 775 ILCS 5/1 et seq., by amendment in August 2019, which went into effect on January 1, 2020. Seventy-three Illinois municipalities already have enacted similar, although more specific, restrictions, like Chicago which is the largest municipality to enact such a law. This list is sure to grow over time.
The amendment also added that agreements that generally prohibit disclosure of information by a separated employee regarding unlawful employment practices existing at the time the severance agreement is signed are unenforceable, unless the employee had the opportunity to consult with counsel prior to signing the severance agreement, who can be an attorney, or any other individual chosen by the employee. The duration of the confidentiality provision must be specifically stated in the severance agreement. Furthermore, the provision cannot last indefinitely.
Illinois has long held that there is no requirement of consideration to support rescission of a contract, even when the person seeking rescission knew, and had full knowledge of, the facts upon which the sought-after rescission is based. However, consideration is required for ratification. Enforceability of an Illinois Severance Agreement where the employee has received benefits of employment, which were not contractually due to him, and then terminates his employment, relying on such benefits as inducement to continue employment, will be upheld if there is a severance agreement which serves as a release from all claims of the employee against the employer in exchange for continued employment of a certain duration. I am personally aware of no opinion holding that a mere offer of continued employment, coupled with a severance agreement as consideration, without more, has been held invalid for lack of consideration.
The standard of "good and sufficient consideration in law" is defined as "some right, interest, profit, or benefit to the promisor, or some forbearance, detriment, or liability taken, agreed to or incurred by the promise, which is not in law existing." "Any detriment sustained by the promisee or benefit received by the promisor, from the other can be good and valuable consideration."
Illinois Courts have held that "there need not be monetary consideration on both sides of a settlement agreement" under the Illinois Wage Payment and Collection Act, 820 ILCS 115/1 et seq. Courts have also held that "in accordance with the amicable termination provision of the severance agreement, separation payments are made only upon actual or anticipated termination of employment," such as retirement. I am personally aware of no opinion holding that a mere offer of continued employment has been held invalid for lack of consideration.
Under the Franchise Disclosure Act, 815 ILCS 705/1 et seq., franchisees are excluded from recovery of certain damages if they "sign a release of damage claims." Certain claims are not subject to limitation via waiver or release, which include "claims arising out of misrepresentations or breaches causing injury to person or property, frauds related to the sales or purchases of the franchises, and antitrust claims." Franchise agreements which involve franchisees using the franchisor’s legacy system (the franchisor’s standardize procedures and systems) are deemed "standardized agreements under the Franchise Disclosure Act. Even though the Franchise Disclosure Act allows "waiver, release, assignment, and hold harmless provisions" under standard form franchise agreements, it does "not allow a waiver or release of "claims arising out of misrepresentations" (Author’s note: Section 1(8) of the Franchise Disclosure Act voids any waiver or release "by a person injured by any act proscribed by the Act.") Exceptions to insurance coverage, corporate guarantees, express limitations or prohibitions of liability, and indemnity obligations are also void under the Act.
Employer Responsibilities
Employers should also be aware of a few obligations under Illinois law to disclose certain information to employees when an Illinois separation agreement is being drafted, reviewed or audited.
Mandatory Severance Payments. Under the Illinois Employee Classification Act (the "Act"), employers that misclassify employees as independent contractors on or after January 1, 2016 can be liable to the misclassified independent contractors for three times the misclassified contractor’s lost wages and benefits, plus penalties of $1,000 for each misclassified contractor. The Illinois Department of Labor ("IDOL") has interpreted the Act to mean that severance and other deferred payments owed to employees must be paid even where the employee does not sign an agreement. That interpretation appears to suggest that IDOL could order a severance payment be made to a former employee even if it is contractually conditioned upon the employee executing a separation agreement, if the employee refuses to sign such an agreement. A separated employee must be notified if he or she is entitled to severance or other benefits that are conditioned upon his or her execution of a separation agreement. Any time payment is delinquent, an employer may be subject to penalties.
Timing of Severance Payments. Under the Wage Payment and Collection Act, employers can be required to pay severance payments to separated employees as part of an agreed amount due in exchange for a release of claims by the employee. However, if the employer has sufficient assets to cover the amount, then the payment must be in full on or before the employee’s last day of employment. In the event that the employee resigns, or is terminated for any reason other than misconduct, then the severance payment must be made in 1/3 installments on the employee’s next three regular paydays.
Employee Rights and Considerations
Employee rights and considerations when dealing with these agreements include the following:
(A) while employers are entitled to protect their business interests through enforceable restrictions, they should be careful about what they actually are restricting
(B) employees who are actually commingling their employer’s trade secrets with that of other employers may not be so keen on protections of 18 months
(C) non-competes regardless of time are unenforceable if the "nonsolicitation" period is overly broad
(D) non-solicitation clauses should last no more than two years.
(E) they should consider what happens if they are part of a reduction in force, which could take the form of a downsizing, plant closings, mass layoffs, and relocations (and what rights do they have if they are sent packing).
Typical Provisions in Severance Agreements
In most severance agreements, the parties will agree to release claims, and there are a variety of provisions that may be included. The most common provisions are non-disparagement, non-compete, confidentiality, return of property, and resignation of position.
A non-disparagement clause typically says that the employee will not say anything negative to others about the employer (for example, it could say that the employee will not disparage the company, or its employees, officers, directors or agents). Sometimes it’s a mutual prohibition. I don’t think anyone reading this blog needs me to explain what disparagement is. There are issues for employers enforcing this provision, because it can be hard to prove disparagement. In addition, the National Labor Relations Act provides that employees cannot be prohibited from making statements regarding terms and conditions of employment, so an employer cannot enforce this provision if the employee is complaining about wages, safety or work conditions.
The non-compete provision prevents the employee from working for a competitor, or working for a competitor for a specific period of time or within a specific geographical area. There may also be a non-solicitation portion of this provision preventing the employee, for example, from soliciting former colleagues or clients or customers. For an employee who has had a kind of job that might be subject to a non-compete, for example a salesperson having access to a client list, your employer probably has a non-compete provision in place. In most states, these provisions can be enforced, at least in theory, if they protect a protectable interest and are reasonable in duration and area. A court in Colorado has in some cases invalidated non-competes on the grounds that they "included customers outside of what was necessary for protection of employer . " In other words there are some specific situations where a court can strike down a non-compete.
A confidentiality provision obligates the employee not to disclose the employer’s confidential information, such as customer identities, internet protocols, and trade secrets. A return of property provision requires the employee to return company property, like credit cards or keys. And a resignation of position provision can often be a statement on the part of the employee that they have resigned on the date they execute the agreement, or it may be a formal letter stating that the employee has resigned.
There may also be a provision stating that the employee cannot sue the employer. I don’t necessarily think that this provision adds too much to a severance agreement because if the employee agrees to release claims then it is clear that they cannot sue. But it can serve a purpose by letting the employee know that the agreement in exchange for the severance payment is final and that there won’t be any second-guessing.
Another common provision for a severance agreement is a calculation of the amount of severance and the reasons for that amount. This might include a reference to salary continuation, or explain that there will be payment of unused vacation days, or a reference to a particular formula used to calculate the severance pay. The severance calculation provision is not necessary in an Illinois severance agreement.
Finally, an Illinois severance agreement usually contains a provision explaining that the employee acknowledges that the employee has had the opportunity to consult with an attorney, if that is true. This is to show that the severance agreement meets the minimum standard of fairness and to prevent any challenges of unconscionability.
Severance Pay and How It Is Calculated
In Illinois, severance pay is generally governed by the common law rather than any specific statute. The common law is anything that is not codified statutes for example case law. Typically, employers and employees come to a private agreement as to how much an employee will receive in severance pay. An employer may offer a severance package as part of an employment termination agreement or as a condition of employment with the company. Severance packages are also used in a Reduction in Force offering which is when a company needs to downsize and offers certain employees a separation package instead of terminating them. This allows the company to retain a core team of employees and offer the others an option to be separated with severance pay. Many times an employer will ask the employee to sign a separation agreement in order to receive severance pay. This would include a release of claims against the employer as a condition of the severance package.
The amount of severance pay varies from employer to employer. Sometimes severance is offered at a fixed rate such as 1 week or 2 weeks severance for each year of service. Other times the severance is tied to the pay rate of the employee. For example, 2 weeks severance would equal 80 hours of pay.
In addition to cash compensation, employers sometimes offer a severance package as an in-place retainer or contemporaneous buyout for a non-competition clause. For a noncompete clause, sometimes employees offer within the release of claims a buyout of non-compete clauses. This is usually a period of time where the chosen employee would work in a similar field but not with our clients or direct competitors.
Many employers will choose to pay out severance by keeping the employee on payroll and also removing the employee from the payroll. The difference is the employee still receives the normal pay but isn’t expected to perform in their role.
It is not uncommon for employers to falsely assess the value of an employee. Illinois law has a created a cause of action for an employee to sue an employer when an employer incorrectly calculates the value of what an employee is entitled to receive.
Role of Legal Representation
Both employers and employees are well advised to seek separate legal counsel when involved in a severance agreement. The agreements are often drafted to protect the needs of the party being represented by the attorney and for the best interests of that party – not the one signing it. This means that it may make sense for an employer to have their attorney review the agreement, even if it has been prepared by the employee’s attorney, because it can help to meet the employer’s needs. Likewise, the employee should have their own attorney to confirm the rights that are being assigned and that their rights are being protected under Illinois law.
Our firm routinely helps both employers and employees review severance agreements to make sure parties aren’t giving up rights that they should be retaining. We can also assist clients in timing the signing of the letter so that they have the maximum period of time to determine whether to sign. In all severance agreement matters, however, it is important to give the client clear expectations about the costs. In many cases the cost of the consultation with an attorney reviewing the severance agreement greatly outweighs the benefit of obtaining that advice. In other words, sometimes it makes sense to just sign the agreement without asking for a lawyer to give a separate consultation.
Recent Legal Developments and Precedent
There have not been many recent developments in the case law that specifically address what is required in an Illinois severance agreement when it comes to waivers and releases. What Illinois courts seem particularly concerned about in cases involving waivers and releases associated with a severance agreement or a release generally is whether there was consideration of a sufficient kind in exchange for the waiver and release. Two recent Illinois cases worth highlighting illustrate this point.
In Fitzgibbon v. Cessna Aircraft Co., the court was faced with the termination of a former employee and the applicability of a waiver and release provision in an earlier severance agreement. The court stated that to avoid the waiver and release provision in such circumstances, the plaintiff would need to show that the waiver was obtained by fraud or some other means of illegitimacy. In making its decision, the court looked at whether the waiver and release agreement was supported by consideration. The agreement was executed in connection with the termination of certain employees following a corporate acquisition amendment and extension of the severance agreement for participating employees, including the plaintiff, to include all three years of employment under the earlier severance agreement . The court held that the amendment and extension of the severance agreement was valid consideration for the plaintiff’s waiver and release.
The court in Herron v. Antioch Community High School Dist. 117 found that the employer failed to provide the plaintiff with adequate consideration to support the plaintiff’s waiver and release of claims. The plan administrator of the employer’s severance plan repeated the language of the respective waiver and release provision in notice of preliminary determination letters issued to the plaintiff. Under the terms of the severance plan, an employee had to receive all benefits owing under the severance policy in order to release all potential claims under the severance policy against the employer. Because there was a discrepancy in the amount of severance owed to the plaintiff between what was stated in the notice of preliminary determination letter and the plan, the court found that the waiver and release provision had not been satisfied and summary judgment should not have been granted in favor of the employer.