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Severance Pay: The First Key to an Executive’s Contract

I wish I had a dime — ok, a dollar — for every time an executive client of our firm, confronting  her involuntary termination (i.e., being fired without cause) has said to me, “when I took the job, the last thing I was thinking about was severance.”

On one level, this is wholly understandable.  At the euphoric beginning of an executive’s new contract, particularly if it is a new job with a new employer, the last thing any executive wants to think about is its ending.

The cold, hard truth, however, is that the amount (and computation) of severance, its conditions and its timing, is one of the most important issues to think about during an executive’s contract negotiations.  Indeed, as executive compensation attorneys, experience has taught us that severance may be the most important issue.

A New World of Executive Compensation Agreements

In part, severance has become more important because of a nationwide shift in the structure of most executive compensation agreements.

Historically, a senior executive was hired for a term of years:  two years, three years, five years, sometimes more.  Such a contract would often provide for payment of salary and benefits, and sometimes even bonuses, to the end of the contract, even if the corporate employer decided to replace the executive midway through the term of the contract for reasons unrelated to the executive’s malfeasance (i.e., “Jack Welch has just become available to run the company, so let’s put Joe Blow out to pasture by paying him out the remaining 3 years on his 7-year deal”).

These days — and it is hard to pinpoint exactly when this gradual change became a landslide — executive contracts for a fixed, irrevocable term are the exceptions rather than the norm.  Today’s executive compensation agreements are far more likely to be “at will,” meaning that the employer can terminate the executive at any time and without any specific reason (other than a discriminatory reason which would run afoul of Federal, State or local laws).  In such a case, how can an executive protect herself?

The Importance of Severance

The answer is to provide for adequate severance compensation, taking into account salary, bonus and benefits (primarily but not exclusively health care benefits) in the event that the executive is terminated without “Cause.”  Accordingly, the computation, amount, conditions and timing of that severance payment (along with a tight definition of “Cause”) is one of the most carefully and tenaciously negotiated areas of any executive’s compensation agreement.

Such severance must be adequate to protect and cushion the executive against the negative economic repercussions of an inadvertent job loss.  It should also be sufficient to make the employer understand the consequences of dismissing the executive without Cause.

Some specific questions which your executive compensation attorney should, along with the executive, carefully consider in contract negotiations include the following:

  1. To the extent that the executive is leaving a secure situation for a new job, is the amount of severance, and how it is to be computed and paid, adequate to the risk which the executive is taking, including the upheaval caused by such a change of employment?
  2. Is the new employer imposing restrictions on the executive’s ability to compete (and thereby earn a living) after the end of the executive’s employment, particularly if the executive’s skill and experience are not easily transferable to a different industry or job sector (e.g., it’s probably not wise to accept only a year’s severance if the contract contains a two-year non-competition restriction)?
  3. Realistically, how easy will it be for the executive to find other employment if the new job “doesn’t work out”?  How old is the executive?   Is all of his experience and training in a single field and not easily transferable in today’s marketplace?  Does the executive have specific family circumstances — ranging from being a single “breadwinner” to having a disabled child to being unable to move geographically — which require extra severance compensation?
  4. And how should severance be structured, as a series of regular paychecks or one lump sum payment?  What happens if the executive finds herself hired by a new employer more quickly than could have been anticipated, and does that affect either the fact or the amount of severance to which she is entitled?

These are just some of the issues which require us, as executive compensation attorneys, to “drill down” on the executive’s real and individual, sometimes even unique, situation and needs when entering into negotiations for a new employment agreement.  We do this through timely research and rigorous analysis of the individual client’s situation and leverage, and of what the market can be made to bear at any given time.

About the Author

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George Birnbaum

Since 1980, sophisticated business people have relied on George to apply the meticulous preparation, attention to detail, and devotion to his clients he learned from fabled trial lawyer Louis Nizer. A graduate of Harvard College and Harvard Law School, George has over 35 years of distinguished deal-making, litigation, mediation and arbitration experience which he has used to negotiate high-stakes agreements for senior executives and select business clients throughout the United States.