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Negotiating Executive Severance Packages

By: R. Mark Fletcher
September 2007

The end of an employment relationship is commonly a stressful and uncertain time for any employee, even senior executives. Where the termination of the employment relationship is employer initiated, the senior executive may be caught off guard and at a loss to understand why the employment relationship has been terminated. Many individuals who are confronted with this diffi cult situation will suffer from fear of uncertainty associated with the job loss.

Severance

While this may be a time of stress and anxiety, it is critical for the executive to turn his or her mind to negotiating a fair and appropriate severance package that will provide an economic bridge to new employment. Accordingly, it is critical for the terminated executive employee to have a solid understanding of his or her legal rights together with knowledge as to what should be included in a fair severance package.

This article briefly outlines a number of the legal and practical points for a senior executive to consider when confronted with negotiating his or her severance package.

PLAN FOR THE END AT THE BEGINNING

Many employees, senior executives included, fail to appreciate the leverage and bargaining power they hold at the beginning of the employment relationship. When negotiating the employment contract, the employer may be willing to provide the employee with generous severance arrangements, while the good will and good faith among the parties is at its highest. Negotiating generous severance terms at the beginning of the relationship, before an offer of employment has been accepted, may give an executive employee more favourable treatment at the end of the employment relationship than if the executive is faced with negotiating such treatment at the end of the relationship when the parties no longer have a future together.

In addition, the inclusion of a termination clause that spells out the severance terms in the employment contract provides both parties with certainty. In the event that the employment relationship is terminated on a without cause basis, both the employee and employer will know at the front end what each party’s respective obligations are with respect to severance arrangements.

It is vitally important for employees who are presented with an employment agreement to ensure that the terms are fair and reasonable, and in accordance with the employer’s legal obligations upon the termination of the employment relationship. All too often, employees who are presented with contractual terms will focus on the positive features within the contract (salary, bonus, and benefits) instead of the potential negative consequences of minimal severance terms. It is, therefore, important for employees to understand their legal rights, particularly on the termination of the employment relationship, before agreeing to contractual terms presented by the employer. In fact, it may be a good idea to seek appropriate legal advice.

Notwithstanding the potential benefits for both employers and employees to agree on severance terms at the beginning of the relationship, employees and employers often either overlook or otherwise fail to include severance terms in the employment contract, preferring instead to leave that negotiation until the end of the employment relationship.

NEGOTIATING THE SEVERANCE PACKAGE

Provided that there is no contract which governs the severance arrangements between the employer and employee, the parties will be confronted with having to negotiate a fair and reasonable severance package.

Fundamentally, the severance package should be based on the employer’s common law legal obligation to provide the dismissed employee with either reasonable notice or pay in lieu of reasonable notice on the termination of the individual’s employment. The length of reasonable notice at common law required in any given case is based on the employee’s age, period of service, the nature of employment, and the availability of similar employment having regard to the employee’s skills and abilities. Each and every case is determined on an individual basis by reference to the aforementioned factors. It is important for the dismissed employee to seek legal advice from an employment lawyer to better understand his or her legal rights, entitlements, and obligations in order to engage in a meaningful and effective severance package negotiation. Accordingly, once the executive understands the range of his or her entitlement to reasonable notice at common law, he or she will then be able to approach the negotiation knowing his or her rights.

BASE SALARY

SeveranceOne of the key components to any severance package is provision for the employee’s base salary. The executive employee should attempt to negotiate either base salary continuance or a lump sum reflective of the base salary for the maximum period of reasonable notice possible. The employer will attempt to negotiate for the least amount of salary possible and ,accordingly, will attempt to obtain an agreement for the lowest possible payment to compensate the employee for lost base salary over a period of reasonable notice. The employer may also attempt to negotiate terms whereby salary continuance payments cease upon the employee obtaining new employment or self-employment and/or the incorporation of a mitigation clause which operates to reduce the employer’s liability to make payments to an employee following the employee obtaining alternate employment or self employment income.

A mitigation clause incorporates an important aspect of the common law that imposes a legal obligation on dismissed employees to search for alternate employment and to limit their lost employment income by securing alternate employment. According to the law of mitigation, the employee’s damages entitlement for wrongful dismissal is reduced dollar for dollar by any income earned from alternate employment or self-employment during the period of reasonable notice at common law. Obviously, from the employee’s standpoint, it may be more favourable for the employee to negotiate either base salary continuance without a mitigation clause or the payment of a lump sum in lieu of salary continuance, at a discount if necessary, in order to maximize the settlement monies paid to the employee.

BONUS

In recent years, bonuses have become a significant (in some cases worth more than base salary) component of the individual’s compensation. Accordingly, it is important for employees whose employment has been terminated to ensure that the severance agreement includes compensation for lost bonus monies. It is critical for employees to understand that, depending on the terms of the bonus plan, the employee is typically entitled to not only bonus payments that are earned prior to the termination of the employment relationship, but also, potentially, to lost bonus payments that, but for the termination of the employment relationship, would have been earned by the employee over the period of reasonable notice.

Some employers will attempt to exclude the payment of bonus monies from a severance agreement. However, the common law requires employers to provide the employee with reasonable compensation based on what the employee was actually earning prior to his or her dismissal. Accordingly, subject to the terms and conditions of the bonus plan in question, the courts will often award employees damages for lost bonus compensation over the period of reasonable notice as part of the employee’s damages for wrongful dismissal. Given the significance and size of executive bonus compensation, it is absolutely imperative that employees make bonus compensation, if applicable, part of the severance package negotiation.

BENEFITS

Benefits packages that provide for generous health, medical, short-term and longterm disability, and life and other insurance are often key components of an executive’s overall compensation package. Not surprisingly, the negotiation of benefits continuance is important to the severance package negotiation. For instance, ensuring that the employee’s disability insurance is in place over a period of reasonable notice provides for an economic safety net should an employee become sick or severely injured between the termination of his or her employment and the time that he or she secures new employment with alternate benefits coverage. All too often, employers will continue such benefit coverage only for the minimum amounts required under the Employment Standards Act legislation (sometimes not even for that long) which puts the dismissed employee at great personal economic risk should the unforeseen occur.

Some employers will take the position that short-term and long-term disability coverage cannot be continued owing to contracts between the employer and the third-party insurer. However, this does not overcome the employer’s legal obligation to provide the employee with benefits continuance over a period of reasonable notice and employees engaged in severance package negotiations should do whatever they can to ensure that the same benefits coverage is continued for the duration of whatever notional period of reasonable notice is agreed upon. For instance, if the employer and employee agree to six months salary continuance, benefits should be continued for that same period of time. Unforeseen medical costs, drug prescriptions, and other expenses normally covered by an executive’s benefit package can be very expensive and should be included within a fair and reasonable severance package.

STOCK OPTIONS AND STOCK OPTION RIGHTS

Executive employees will sometimes be entitled to certain stock options. Quite often the stock options awarded to the executive vest in increments over a period of time and serve as a kind of ‘golden handcuff’ to retain the employee’s services for the duration of the vesting period.

Where the employment relationship is terminated before the stock options have vested, the employee and employer will often get into a dispute over whether that employee should be granted the right to exercise the stock options awarded. The employee should do their utmost to negotiate the legal right to exercise stock options that have been awarded, including unvested stock options, and that the employee be entitled to either exercise those stock option rights immediately or over a period of time.

While the employee may encounter a legal hurdle to entitlement to the stock options that have not vested, depending on the terms and conditions of the stock option plan at issue, the employee may be able to negotiate greater or better stock option exercise rights than dictated under the stock option plan during the severance negotiation process.

PENSION AND RRSP CONTRIBUTIONS

Employer contributions to pension and/ or RRSP plans have become a lucrative and attractive element of executive compensation in recent years. The terminated executive employee is, for the most part, entitled to continuance of pension contributions and RRSP contributions made by the employer over the period of reasonable notice and should, accordingly, attempt to negotiate the inclusion of pension and RRSP contributions within the overall severance agreement.

CAR ALLOWANCE AND OTHER PERKS

Car allowances and other expenses paid for by the employer have also become an important element of executive compensation. Employers will often attempt to take such expenses and perks out of the severance negotiation process by maintaining that car allowance and other expenses are really business expenses paid for by the employer on the basis that such expenses are necessary to the employee performing his or her function. The employer may take the position that the employee is not entitled to such expenses as part of a severance agreement since the employee is no longer performing the role and functions which necessitated such expenses in the first place.

In some cases the employer will have a viable legal argument if such expenses are related for the most part to business use. However, where there is a personal element to the car allowance and other expenses and perks, the employee may make a successful legal argument to entitlement to such expenses over the period of reasonable notice.

RESTRICTIVE COVENANTS

Many employees, and senior executive employees in particular, have restrictive covenants as part of their employment agreement. In some cases, employers will attempt to make such restrictive covenants part of the severance agreement.

Restrictive covenants – such as confidentiality, non-solicitation, and non-competition clauses – may concern prospective employers and, in some cases, may require that the employee sit on the sidelines rather than joining a competitor within the industry, depending on the wording of a particular restrictive covenant in question.

While the legality and enforceability of non-competition covenants are often in question, it is important for an executive employee who either has restrictive covenants as part of his or her initial employment agreement or is faced with the employer insisting on such covenants within the severance agreement, to be alert to the potential legal ramifications of such covenants. He should be cautious when agreeing to an otherwise acceptable severance package where such covenants are included.

The employee should seek specific legal advice as to the ramifications of such covenants and, depending on the situation, may negotiate to minimize the scope, duration, and geographic application of such restrictive covenant provisions, if the outright removal of such covenants is not possible.

It is critical that the dismissed executive employee seek legal advice from an employment lawyer before signing off on any severance agreements and, ideally, before entering into the negotiation of severance terms. Quite often the employer’s first offer is a starting point for negotiation. In light of the sophistication of most employees, employers anticipate and expect some negotiation around severance terms. The initial severance offer is often not the maximum amount of compensation that the employer is prepared to put forward to the dismissed employee and the dismissed employee should be alert to this negotiation strategy and should approach the negotiation bearing this in mind.

It is also important for executive employees to recognize and appreciate the leverage they bring to the table in the severance negotiation. In the majority of cases, the employer will make the severance agreement contingent on the employee signing a full and final release of their legal rights to bring a wrongful dismissal claim and employers who engage in low ball tactics run the risk of wrongful dismissal litigation. Accordingly, employers will often make concessions or enhance initial severance offers to avoid unpleasant and costly litigation.

R. Mark Fletcher is an associate at Grosman, Grosman & Gale LLP in Toronto, ON.

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