What is a severance clause?

What is a severance clause?

A severance clause is a contractual provision that establishes an employee’s right to receive a severance payment when his or her employment with an employer is severed. In many cases, the clause addresses circumstances in which an employer terminates an employee’s employment. However, in some jurisdictions, “severance” of employment may be defined under applicable law to include additional circumstances beyond just termination, such as constructive dismissal and certain categories of layoff. Note, as well, that an employee may be entitled to severance when he or she resigns for “good reason” or “just cause” (see, for instance, examples 9, 12 and 14 below).

Although the severance clause may apply in the same circumstances as a payment in lieu of notice clause, the termination payment under a payment in lieu of notice clause and a severance payment are typically not the same thing. Generally speaking, a termination payment is an amount that an employer pays to an employee instead of providing the required notice of termination; whereas a severance payment is an amount to which an employee becomes entitled on termination (or other “severance” event) that compensates that employee for losses occasioned thereby, often taking into account factors such as seniority, long-term employment with the employer, etc. Severance is usually payable in addition to any termination payment an employee may receive in lieu of notice. Like the termination payment, the amount of severance may be prescribed by law.

The severance clause is usually found in employment agreements, including those for ordinary employees, management and executives. Alternatively, a company may have separate severance agreements with certain employees, which outline, among other things, the financial terms of each such employee’s departure under qualifying circumstances. These severance agreements typically supplement the company’s employment contracts.

How do you review the severance clause in contracts?

If a contract contains a severance clause, it will typically be in a section or part of the agreement addressing termination of employment. Although these clauses often include the word “severance”, this won’t always be the case. Careful review may therefore be necessary to locate the severance clause in some contracts.

After locating all the severance language in each agreement, key things to focus on when reviewing these provisions include:

1. When the employee is entitled to severance. The severance clause will set out the circumstances in which the employee is entitled to receive severance and may also include circumstances in which the employee is not entitled to severance (see, for instance, example 2 below). In some clauses, entitlement to severance may be limited to certain events, such as termination by the employer “without cause” (or “without Cause”) and/or resignation by the employee for “good reason” (or “Good Reason”). In such cases, be sure to check the definition of any applicable defined terms like “Cause” (see, for instance, examples 2 and 6 below), “Qualifying Termination” (example 3 below) and “Good Reason” (see, for instance, examples 7 and 9 below) to determine the exact circumstances to which the clause applies. Note that some of these definitions may reference the provisions of applicable statutes or regulations, in which case it will also be necessary to check any such legislative provisions to ascertain the full meaning of the term for the purposes of the contract. Pay particular attention to severance entitlements that arise on a “change in control” (see, for instance, example 7 below). As noted above, the severance benefits that are triggered by an acquisition of the employer (or other “change in control” event) are often greater than those to which the employee would be entitled in other circumstances. Finally, when reviewing the circumstances in which severance is payable (or not payable), be sure to confirm that these terms are consistent with the requirements of applicable law.

2. How the severance payment is calculated. The amount of severance is, at a minimum, typically calculated as a function of the employee’s base salary. Other forms of remuneration, including bonuses, stock options (or other share-based compensation) and benefits, may also form part of the severance calculation. The severance payments in the examples below range from 6 months’ worth of salary (see example 13 below) all the way up to several times the employee’s annual salary, bonus, etc. (see examples 1 and 3 below). At the high end, therefore, severance payments can represent quite a significant cost to the employer. Where applicable law mandates a minimum amount of severance to be paid to qualifying employees (including rules governing how this amount is computed), be sure to confirm that the terms of the severance payment in the clause align with the requirements established by law. Clauses that try to limit or reduce the amount otherwise payable by law may not be enforceable.

3. Manner of payment. Severance payments are often paid as a lump sum on or shortly after the date on which the employee ceases to be employed by the employer. However, some clauses may state that severance is payable in instalments according to either the employer’s regular payroll schedule (see example 9 below) or some other agreed periodic schedule (see example 2 below). Note that, regardless of the manner of payment, the amount received by the employee is typically net of any deduction or withholding required by law (e.g., taxes), and the clause may state this for greater certainty (see, for instance, examples 1 and 9 below).

As with the review of any contractual provision, it’s also important to be aware of other provisions that may affect the interpretation of severance clauses. Defined terms, for example, were mentioned in point 1 above. The termination of employment section may specify other rights or obligations that may arise on termination, including an employer’s option to provide payment in lieu of any required notice of termination. Finally, provisions outlining an employee’s entitlement to salary, bonuses, vacation, benefits, etc. should help with determining the amount of any severance payment made pursuant to the contract.

Software that uses AI to identify and extract severance clauses (as well as other terms that may affect their interpretation) can accelerate the work of finding these provisions and enable a more comprehensive review than can otherwise be done manually.

Examples of the severance clause

Below are some examples of severance clauses from different kinds of agreements. While these examples do not necessarily cover the full range of severance clauses one may encounter, they are meant to illustrate the degree to which these provisions can vary from contract to contract. Where an example includes broader contextual language, the severance clause is highlighted in bold.

Example 1: From an Employment Agreement

4.2 Termination Without Cause. If Employee’s employment is terminated without “cause” as defined in Section 4.1(a), or if Employee is Involuntarily Terminated (as defined below), the Company (or its successor, as the case may be) shall pay to Employee (i) any accrued but unpaid Base Salary and vacation through the date of termination, (ii) reimbursement for any expenses as set forth in Section 3.5, through the date of termination and (iii) a severance payment in an amount equal to four times Employee’s Base Salary and Annual Bonus, payable in one lump sum on the date of termination, subject to withholding as may be required by law.

Example 2: From an Employment Agreement

8. Severance Payment. (a) If the Corporation and the Employee do not enter into a renewal agreement to be effective September 1, 2004, for a period of at least two years and containing similar terms and conditions to those set forth herein, then the Corporation will pay the Employee, as additional compensation, an amount equal to the Employee’s then current annual Base Salary, as determined under Section 4, payable semi-monthly in arrears for the twelve months ending August 30, 2005; such compensation is hereinafter referred to as the “Severance Payment”.

(b) Notwithstanding the provisions of Section 8 (a) above, the Employee will not receive the Severance Payment if,

(i) the Corporation declines to enter into a renewal agreement with the Employee because the Employee breached the confidentiality and/or non-compete provisions of this Employment Agreement or any other material terms or conditions of his employment;

(ii) the Employee has been terminated for Cause hereunder;

(iii) the Employee declines to enter into a renewal agreement with the Corporation, and the Corporation has offered a renewal agreement for a period of not less than two years, containing similar terms and conditions as discussed herein; or

(iv) the Employee has received a change of control payment from the Corporation that provides change of control benefits that are at least equal to the amount that would be received by Employee pursuant to Section 8(a) above.

(c) If the Employee’s employment is terminated for Cause, the Corporation’s sole obligation hereunder shall be to pay the Employee (i) any accrued and unpaid Base Salary as of the date of termination, (ii) an amount equal to such reasonable and necessary business expenses incurred by the Employee in connection with the Employee’s employment on behalf of the Corporation on or prior to the date of termination, but not previously paid to Executive, and (iii) the Employee’s base Salary (at the rate in effect on the date of termination) through the twelve-month anniversary of the date of termination in accordance with the normal payroll practices of the Corporation with respect to Base Salary.

Example 3: From an Executive Employment Agreement

5. Payment of Compensation upon Termination of Employment. If, during the Termination Period, the employment of the Executive shall terminate pursuant to a “Qualifying Termination” (as defined herein), then the Company shall provide to the Executive the payments described in this Section 5 and, if applicable, Section 6.

(a) Cash Payments. If, during the Termination Period, the employment of the Executive shall terminate pursuant to a Qualifying Termination, then the Company shall provide to the Executive the following cash payments:

(i) Within ten (10) days following the Date of Termination (or such other date, if any, as may be required under applicable wage payment laws), a lump-sum cash amount equal to the sum of (A) the Executive’s base salary through the Date of Termination and any bonus amounts which have been earned or become payable, to the extent not theretofore paid or deferred, (B) a pro rata portion of the Executive’s annual bonus for the fiscal year in which the Executive’s Date of Termination occurs in an amount at least equal to (1) the Executive’s Average Bonus Amount, multiplied by (2) a fraction, the numerator of which is the number of days in the fiscal year in which the Date of Termination occurs through the Date of Termination and the denominator of which is three hundred sixty-five (365), and reduced by (3) any amounts paid from the Company’s incentive plan for the fiscal year in which the Executive’s Date of Termination occurs and (C) any accrued vacation pay, to the extent not theretofore paid; plus

(ii) A severance benefit equal to the sum of (i) three (3) times the Executive’s Average Base Salary, plus (ii) three (3) times the Executive’s Average Bonus Amount. The severance benefits provided for pursuant to this Section 5(a)(ii) shall be paid in a lump sum within ten (10) days after the Qualifying Termination occurs, subject, however, to the Executive’s compliance with the terms of this Agreement, including but in no way limited to the Executive’s obligations under Section 7 herein. For the purposes of Section 5(a) herein, “Average Base Salary” shall mean the average annual base salary paid or payable by the Company (or its affiliates) to the Executive during any two (2) years in the three (3)-year period prior to the Executive’s Date of Termination (including the year in which the Qualifying Termination occurs if the base salary payable during such year, on an annualized basis, would produce a higher Average Base Salary). Also, for the purposes of Section 5(a) herein, “Average Bonus Amount” shall mean the average annual incentive bonus earned by the Executive under any incentive bonus plan or plans of the Company (or its affiliates) during any two years in the three (3)-year period prior to the Executive’s Date of Termination (including the year in which the Qualifying Termination occurs if the annual incentive bonus earned in that year would produce a higher Average Bonus Amount).

Example 4: From an Offer Letter

In the event (i) the position of Executive Vice President, Consulting Services is eliminated within the first two years of your employment or (ii) [redacted name] leaves the company within the first year of your employment and within three months thereafter your employment is terminated for any reason, then you shall be provided with the following severance package, payable at the next regularly scheduled pay period after termination: (a) six months of base salary, at the rate in effect on the date of termination, (b) 50% of your target bonus in effect for the year of termination and (c) accelerated vesting of options to purchase 10,000 shares from your initial option grant referenced in paragraph 3 above.

Example 5: From an Employment Agreement

B. If Employee’s employment is terminated by the Corporation without cause, the Corporation shall:

(i) pay Employee a severance allowance equivalent to twelve (12) month’s then current base salary, payable as a lump sum, within sixty (60) days following the date of such termination;

(ii) pay to Employee within two (2) weeks of the date of termination all outstanding vacation pay and any earned but unpaid salary or bonuses to the date of such termination and reimburse Employee for any business expense incurred by him up to and including the date of such termination following provision by Employee of all applicable and necessary receipts.

Example 6: From an Employment Agreement

8.1 Termination and Payments Upon Termination.

(a) Employee or the Employer may terminate this Agreement for any reason or for no reason at all at any time, with or without Cause (as defined below), during or after the Term, by providing the other party with notice of termination as provided in Section 8.1(c). The Employer shall pay Employee his Base Salary and all other amounts, in each such case, actually earned, accrued or owing as of the date of termination but not yet paid to Employee through the date of termination; provided that if the Employee is terminated by the Employer without Cause (as defined below) after the date of this Agreement, then, in addition to the payments described in this Section 8.1(a), the Employer shall pay Employee a lump sum payment in an amount equal to fifty percent (50%) of Employee’s then-current annual Base Salary at the time he is terminated. The payment of the lump sum amount under this Section 8.1(a) shall be made on the earlier of the date ending on the expiration of thirty days following the earlier of the date of termination of Employee’s employment or the death of the Employee; provided that notwithstanding the foregoing, to the extent any payment under this Section 8.1(a) is “nonqualified deferred compensation” and/or the Employee is considered a “key employee” of the Employer within the meaning of Section 409A of the Internal Revenue Code and the Treasury Regulations promulgated thereunder, then such payment shall be made on the date ending on the expiration of the sixth month following the earlier of the date of termination of Employee’s employment or the Employee’s death.

Example 7: From an Executive Employment Agreement

4.3 Termination By Company. If Executive’s employment hereunder shall be terminated by Company prior to expiration of the term provided in paragraph 2.1, then, upon such termination, regardless of the reason therefor, all compensation and benefits to Executive hereunder shall terminate contemporaneously with the termination of such employment; provided, however, that, subject to paragraph 4.7 below, if such termination shall be for any reason other than those encompassed by paragraph 2.2(i), 2.2(ii), or 2.2(iii), then Company shall provide Executive with the Termination Benefits, except that if Executive is entitled to the Change in Control Benefits pursuant to paragraph 4.5 as a result of such termination, then Executive will not receive the Termination Benefits provided by Company under this paragraph. Any lump sum cash payment due to Executive pursuant to the preceding sentence shall be paid to Executive within five business days of the date of Executive’s termination of employment with Company; provided, however, that if the lump sum cash payment would be subject to additional taxes and interest under Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”), then payment of the lump sum cash payment shall be deferred to the extent required to avoid such additional taxes and interest.

4.4 Termination By Executive. If Executive’s employment hereunder shall be terminated by Executive prior to expiration of the term provided in paragraph 2.1, then, upon such termination, regardless of the reason therefor, all compensation and benefits to Executive hereunder shall terminate contemporaneously with the termination of such employment; provided, however, that, subject to paragraph 4.7 below, if such termination occurs for Good Reason, then Company shall provide Executive with the Termination Benefits, except that if Executive is entitled to the Change in Control Benefits pursuant to paragraph 4.5 as a result of such termination, then Executive will not receive the Termination Benefits provided by Company under this paragraph. Any lump sum cash payment due to Executive pursuant to this paragraph shall be paid to Executive within five business days of the date of Executive’s termination of employment with Company; provided, however, that if the lump sum cash payment would be subject to additional taxes and interest under Section 409A of the Code, then payment of the lump sum cash payment shall be deferred to the extent required to avoid such additional taxes and interest.

4.5 Change in Control Benefits. If Executive’s employment is terminated pursuant to paragraph 2.2(iv) or paragraph 2.3(i) in connection with, based upon, or within 12 months after, a Change in Control, then Company shall provide Executive with the Change in Control Benefits. Any lump sum cash payment due to Executive pursuant to the preceding sentence shall be paid to Executive within five business days of the date of Executive’s termination of employment with Company; provided, however, that if the lump sum cash payment would be subject to additional taxes and interest under Section 409A of the Code, then payment of the lump sum cash payment shall be deferred to the extent required to avoid such additional taxes and interest.

Example 8: From an Employment Agreement

(d) Termination Without Cause. Upon 30 days prior written notice to the Employee, the Employer may terminate this Agreement for any reason other than a reason set forth in sections (a), (b) or (c) of this Section 6. If, during the Agreement Term, the Employer terminates the employment of the Employee hereunder for any reason other than a reason set forth in subsections (a), (b) or (c) of this Section 6:

1. The Employee shall be entitled to receive accrued Base Salary through the date of the termination of his employment, and other employee benefits to which the Employee is entitled upon his termination of employment with the Employer, in accordance with the terms of the plans and programs of the Employer; and
2. a one time lump sum severance payment equal to 24 months of his Base Salary, as defined herein, as of the date of the Employee’s termination.

Example 9: From an Employment Agreement

6. Severance Payments. After the first six (6) months of your Initial Term have elapsed, if during the remainder of the Term the Company terminates your employment without Cause (as defined in Section 5(b)), or you resign for Good Reason and comply with the obligations set forth in Section 5(c), then the Company will pay you at the rate of your then current base compensation, less applicable taxes and withholdings, for 6 months (“Severance Payments”). If, following the end of a calendar year but prior to receiving your bonus for the completed calendar year, you are terminated without Cause or resign for Good Reason, you shall also receive your bonus, less taxes and withholdings, for the completed calendar year as part of the Severance Payments. The Severance Payments shall be made over a period beginning on the Termination Date and ending 6 months from such date (the “Severance Period”), to be paid on the Company’s regular payroll cycle during the Severance Period; provided that your bonus for the completed calendar year, if any, shall be paid at such time in such next succeeding year as the Company deems appropriate, consistent with the payment of other executives’ bonuses. If you timely apply and qualify for COBRA, the Company will pay your COBRA premiums, at your current level of coverage, for 6 months, unless you become covered by another employer’s health insurance, in which case the COBRA coverage will be terminated when your new coverage commences. You agree to notify the Company immediately if you become covered by another employer’s health insurance plan. To receive the Severance Payments and COBRA premiums you must sign a release of any and all claims in the form provided by the Company. Such Severance Payments and COBRA premiums shall begin at the later of (i) the first pay period following your Termination Date or (ii) ten (10) days after you deliver the signed release to the Company. Notwithstanding the foregoing, you will not be eligible for COBRA premiums from the Company if, as of your Termination Date, there is a governmental subsidy available such that more than 50 percent of your COBRA premiums would be paid for by a government entity.

Example 10: From an Executive Employment Agreement

(b) Termination without Cause or for Good Reason. If the Executive’s employment is terminated by the Company without Cause or by the Executive with Good Reason, then Executive shall be entitled to receive:

(i) an amount equal to Executive’s Base Salary through the Termination Date, plus continuation of Executive’s Base Salary for a period of 18 months from and after the Termination Date (the “Severance Period”), in each case payable ratably over such period in regular installments in accordance with the Company’s general payroll practices as in effect on the Termination Date;

(ii) any Performance Bonus amounts pursuant to Section 3(b) (if any) awarded, but not yet paid, to Executive in respect of a fiscal year that ended prior to the Termination Date, which amount shall be paid at the same time and on the same terms it would have been paid pursuant to Section 3(b); and if Executive’s employment ends during a fiscal year, his Performance Bonus shall be prorated based upon the portion of the fiscal year worked and the Performance Bonus for the prior fiscal year;

(iii) reimbursement of reimbursable expenses incurred on or prior to the Termination Date in accordance with Section 3(f); and

(iv) direct payment of Executive’s COBRA premiums for continued health insurance coverage for the Executive and his dependents through the end of the Severance Period or until such earlier date as Executive is eligible for substantially similar health insurance benefits from a subsequent employer;

(v) payment to an accountant reasonably satisfactory to Executive for tax planning services (provided that the aggregate amounts paid pursuant to this clause (v) and clause (vi) below shall not exceed $50,000);

(vi) payment for executive-level outplacement for Executive for up to one year after notice of termination at Crenshaw Associates or substantial equivalent (provided that the aggregate amounts paid pursuant to clause (v) above and this clause (vi) shall not exceed $50,000);

in each case, the payments under (i), (iii), (iv), (v) and (vi) above shall continue beyond 60 days following the termination of employment if and only if Executive has executed and delivered to the Company a General Release in form and substance as set forth in Exhibit B attached hereto (the “General Release”) prior to the 45th day following the termination of his employment and the General Release has become effective prior to the 60th day following the termination of his employment.

Example 11: From an Employment Agreement

16. Severance Payment

In the event that the Company terminates your employment other than pursuant to clause 15 above, you shall be entitled to a termination payment equivalent to twice the sum of your annual basic salary at the Termination Date and your then on-target annual bonus, such payment to be inclusive of any payment in lieu of notice or any payment in respect of any period of garden leave, or, in the event of your redundancy, under the Company’s redundancy policy.

Example 12: From an Executive Agreement

(b) If the Employment Period is terminated prior to the Expiration Date:

(i) (A) by resolution of the Board (other than for Cause) or by Executive resigning for Good Reason or (B) if the Employment Period expires on the Expiration Date, the Executive shall be entitled to receive (1) all previously earned and accrued but unpaid Base Salary and vacation and unpaid business expenses up to the date of such termination or the Expiration Date, as applicable, (2) any bonus (if any) earned by Executive for the fiscal year prior to the Termination Year or the Expiration Year, as applicable, but then unpaid, (3) the pro rata portion of Executive’s target bonus during the Termination Year or the Expiration Year, as applicable, to the extent targets thereunder are achieved for such year, after such termination or expiration, prorated based on the number of days of the Termination Year or the Expiration Year, as applicable, prior to the date of termination or the Expiration Date, as applicable, which payment shall be made when the bonus payments for such Termination Year or the Expiration Year, as applicable, are otherwise due; (4) severance pay in the full amount of Base Salary at the time of termination or expiration from the date of termination or the Expiration Date, as applicable, through the period ending on the first anniversary of the date of termination or the Expiration Date, as applicable, and a Bonus equal to the Bonus earned in the year prior to the Termination Year or the Expiration Year, as applicable, payable on the first anniversary of the date of termination or the Expiration Date, as applicable; and (5) full continuation of Executive’s health, disability and life insurance Benefits during the one year severance period (to the extent any of those Benefits cannot be provided by Company during the one year severance period, the Company will provide Executive with a sum of money calculated to permit Executive to obtain the same benefits individually, grossed up for tax purposes so that Executive remains whole);

Example 13: From an Employment Agreement

6. Termination by Company Without “Cause”.

The Company may terminate this Agreement and the Employee’s employment without Cause at any time and for any reason upon written notice to Employee. In the event that the Company terminates the Employee’s employment without Cause, the Company will pay the Employee severance pay in installments in the aggregate amount of the greater of: (a) the amount of remaining Base Salary described in Paragraph 3.a hereof that would otherwise have been payable for the remainder of the Term; or (b) an amount equal to six (6) months of Base Salary described in Paragraph 3.a hereof. The Employee shall be required to execute a Severance Agreement and General Release in a form that is reasonably satisfactory to both parties in order to receive severance pay. The Employee shall not be entitled to any compensation or benefits from the date of her termination forward. Any severance pay owed to Employee shall be offset by any repayments owed by the Employee pursuant to the terms of the Relocation Expense Agreement attached hereto as Appendix A.

Example 14: From an Executive Agreement

8. Termination. (a) Termination by the Company for Cause or Resignation by the Executive Without Good Reason. If, during the Employment Term, the Executive’s employment is terminated by the Company for Cause or the Executive resigns without Good Reason, the Executive will not be eligible to receive Base Salary, to receive an Annual Bonus or to participate in any Employee Plans with respect to future periods after the date of such termination or resignation, except for the right to receive (i) accrued but unpaid Base Salary through the date of termination of employment; (ii) in the case of a termination other than for Cause or by the Executive without Good Reason, a pro rata bonus for the year of termination under any bonus program or profit sharing plan, payable within 30 days after the date of termination; (iii) any accrued unused vacation time, to be paid in accordance with the Company’s normal payroll practice; (iv) any unreimbursed business expenses incurred by the Executive prior to the date of termination, to be paid in accordance with the provisions of Section 7; and (v) all compensation and benefits payable to the Executive under the terms of the Employee Plans or incentive arrangements in which the Executive participated prior to the date of termination of employment, in accordance with the terms of such Employee Plans or incentive arrangements (together, the “Accrued Compensation and Benefits”).

Example 15: From an Offer Letter

SEVERANCE: The Company maintains an Executive & Officer Severance Pay Plan (“E&O Plan”) and should your employment be terminated (other than under circumstances entitling you to severance benefits under your Change of Control Agreement, described below) your eligibility for severance will be determined under the terms of the E&O Plan, as in effect at the time of such termination of employment; provided, however, for a period of eighteen (18) months following the Commencement Date, you will remain eligible to receive severance benefits at the same level and under the same terms and conditions as provided under the E&O Plan in effect as of the effective date of this agreement evidenced by your signature and date below and/or that would apply to other similarly situated executives. Following this eighteen-month period, your eligibility to receive severance benefits, and the applicable level of severance benefits, will be as provided at the same level as similarly-situated executives of the Company under the E&O Plan (or such other applicable severance plan, if any, or Change of Control Agreement) in effect at the time of your termination of employment.

In addition, you will be provided with a Change of Control Agreement, with terms consistent with Change of Control Agreements of other senior executives of the Company, which will become effective as of the Commencement Date. In the event that you become entitled to severance payments or benefits under the E&O Plan or the Change of Control Agreement, as applicable, such payments and benefits will be your sole and exclusive severance payments and benefits (unless an employee benefit plan or applicable law provides otherwise) and you will not be entitled to any other severance payments or benefits from the Company, including, without limitation, continued base salary or bonus entitlements pursuant to this letter agreement. For the avoidance of doubt, in any event if your employment ends prior to the expiration of the Term, you will not be eligible for: 1) continuation of your Base Salary; or 2) bonus; or 3) an additional grant of a long term incentive award for the remainder of the Term. The foregoing sentence will not reduce or eliminate any rights or benefits you are otherwise eligible for under the E&O Plan (or the 18 mos. severance benefit level described above) or the Change of Control Agreement.