In negotiating employment agreements, employers and employee executives often discuss the issue of severance. In a prior post, we described some examples of “cause” that are often included in employment agreements to enable an employer to terminate the agreement without paying severance. There are other agreement termination events that are frequently negotiated such that they do require the payment of severance. The employee’s death or disability is usually included in this category.
The definition of disability in an employment agreement may be tied to how long the employee is unable to work or when the applicable long-term disability policy is triggered. Severance payments made because of disability must be made without violating state or federal law, including Internal Revenue Code, Section 409A.
Many employment agreements also provide that employees may collect severance if they terminate the employment agreement for “good reason”. Good reason may be defined as including a material reduction in the employee’s (or the employee’s supervisor’s) duties or authority, a material reduction in the employee’s salary or total compensation, relocation of the employee’s primary office, the employer’s material breach of the employment agreement, and the employer’s failure to require any successor to assume all of the terms of the employment agreement. The word “material” is frequently included in these provisions so that insignificant changes do not trigger a severance right, but otherwise the intent of them is to prevent the employer from constructively discharging the employee without paying severance where good cause to terminate does not exist. As above, any severance payments made when the employee terminates the employment agreement for good reason must comply with IRC, Section 409A.