Ask the Expert: Craft Severance Agreements Carefully with These Factors in Mind

Question: When crafting a severance agreement, should you follow the guidelines of the state the employee resides/works in or the state where the company is incorporated?

Answer: Before addressing the specific question about which state’s laws would apply for the enforcement or consideration of a severance agreement, let’s address the importance of such agreements in the first place. Certainty is vital in all business operations, and discharging employees is no exception.

When you are discharging an employee from your company, it may be beneficial in many instances to provide a severance package. While the employee may have no potential employment law claim against your company (i.e., for discrimination or otherwise), providing a severance package can give you certainty they are foreclosed from filing any action.

To that end, the severance agreement should contain a general release of claims in exchange for the employee’s receiving compensation. Note, most departing employees are not entitled to any severance at all, so providing compensation in exchange for a general release of claims is an important step for the certainty you’re seeking. There are also federal, state, and potentially local provisions you should incorporate depending on your location, the employee’s location, and the employee’s age.

A severance agreement is a contract. Generally speaking, the law of the state where the contract is enforced is the law that would apply. Many companies are incorporated in states far from where the employee lives or works, therefore the law of the state where the employee lives or works would apply.

Further, since the severance agreement is a contract, you could include a choice of law provision in the terms. That is, the agreement itself could dictate which state’s laws would apply. However, a choice of law provision could be defeated. While parties to a contract generally have the freedom to choose the governing law, this freedom isn’t absolute. If applying the chosen state’s law would significantly conflict with a fundamental policy of a state whose law would otherwise apply, the choice of law provision could be stricken. Fundamental public policy considerations of a state can take precedence over the choice of law provision in a contract.

The bottom line is that the determination of which state law applies in the enforcement of a contract is a nuanced issue that depends on several factors, including the specifics of the contract and the circumstances of its enforcement. Consult with experienced employment counsel when drafting severance agreements to be in compliance with all applicable laws.

Heath Straka is a partner with Axley Brynelson, LLP, in Madison, Wisconsin. He can be reached at hstraka@axley.com. 

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