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New dangers lurking in severance agreements

By Mark A. Addington

In recent years, there have been a significant number of severance agreements entered into between businesses and former employees due to turbulent economic times.

Two significant developments currently being litigated could impact potential liability lurking within such agreements. Both of these developments clearly demonstrate that a poorly crafted severance agreement can bring a business significant legal risk and problems.

Taxation of Severance Payments

Whether severance payments should be taxed remains an open question in which the federal appellate courts are split. Importantly, the United States Supreme Court has recently heard oral arguments on this issue.

The most conservative approach is generally to consider severance payments taxable as income to the employee. But in United States v. Quality Stores, Inc., the Supreme Court considered arguments about whether severance payments are taxable wages.

This case is significant for businesses that have entered into severance agreements and failed to tax the severance payments as wages. With an estimated $1 billion at stake in current claims before the Internal Revenue Service, the government takes the position that severance payments are related to the employer-employee relationship, and therefore included in the definition of wages.

Conversely, the business argued that payments under a severance agreement are supplemental unemployment benefits, and therefore not wages subject to taxation. To support its position, the business cites the definition of supplemental unemployment benefits and three different places in the legislative history where severance payments are not wages or remuneration for services provided to the business.

Should the government prevail, there undoubtedly will be a strong administrative push to identify and collect taxes and penalties based on the failure to pay the taxes due.

Title VII Issues in Severance Agreements

The Equal Employment Opportunity Commission (“EEOC”) specifically stated in its Strategic Enforcement Plan that it would:

target policies and practices that discourage or prohibit individuals from exercising their rights under employment discrimination statutes, or which impede the EEOC’s investigative or enforcement efforts. These policies or practices include retaliatory actions, overly broad waivers, settlement provisions that prohibit filing charges with the EEOC or providing information to assist in the investigation or prosecution of claims of unlawful discrimination, and failure to retain records required by EEOC regulations.

On Feb. 7, 2014, in accord with its Strategic Enforcement Plan, the EEOC filed a federal lawsuit against the CVS drug store chain that has the potential to be landmark and impact business liability dramatically.

In EEOC v. CVS, the EEOC took exception to a number of provisions in a severance agreement that was used in 2012 between CVS and more than 650 former employees. As a result, and apparently without a complaint from the former employees of discrimination or harassment, the EEOC filed a federal lawsuit indicating that the severance agreement at issue violated Title VII even though it explicitly states that:

[n]othing … is intended to or shall interfere with the Employee’s right to participate in a proceeding with any appropriate federal, state or local government agency enforcing discrimination law, nor shall this Agreement prohibit Employee from cooperating with any such agency in its investigation.

Notwithstanding this declaration directly addressing the issue, the EEOC has taken the position that the severance agreement runs afoul to Section 707 of Title VII, which prohibits employer conduct amounting to a pattern or practice of resistance to rights protected by Title VII. Moreover, it is very significant for employers that the EEOC is utilizing Section 707 to bring a suit against an employer independent of any employee complaint that the severance agreement is unlawful.

The EEOC contends that the explicit disclaimer in the severance agreement is insufficient to overcome the deterrent impact of the following provisions, of which very similar versions can be found in almost all employer separation agreements:

  • Cooperation Clause – employee agrees to promptly notify CVS’s general counsel if the employee receives a subpoena, deposition, or interview request by an investigator for an administrative investigation;
  • Non-Disparagement Clause – employee agrees not to make any statements that disparage the business or reputation of CVS;
  • Non-Disclosure Clause – employee agrees not to disclose to any third party or use for himself confidential information without prior written approval from CVS;
  • General Release Clause – employee releases CVS from all causes of action, complaints, charges and any claim of unlawful discrimination of any kind;
  • Covenant Not To Sue Clause – employee represents s/he has not filed or caused to be filed any complaint, claim or action, and agrees not to initiate or file, caused to be filed any action, complaint or proceeding, and agrees to reimburse CVS for any legal fees incurred by the employer as a result of any breach of the agreement.

These types of provisions are almost always included within separation agreements for legitimate business reasons, such as preserving confidential business information or preserving business goodwill. Employers frequently settle lawsuits and pay employees severance in exchange for some certainty that they can avoid claims and potential claims. While most employers seek to prevent being subject to litigation, these provisions are generally not intended to limit an employee’s right to file a charge of discrimination.

The Quality Stores and CVS cases both may have tremendous ramifications on employers. Employers who have provided severance payments to former employees in recent years may find themselves subject to IRS scrutiny based on the outcome of the Quality Stores case. However, the hardline stance taken by the EEOC regarding generally inoffensive provisions found in most severance agreements is even more disconcerting and cannot be understated.

Employers should monitor both of these cases, communicate about these issues with their legal counsel, and be prepared to adjust severance agreements accordingly.

mark addingtonMark A. Addington is the employer’s advisor and advocate. Mr. Addington is an attorney with Addington Law, based in Jacksonville, Florida. He can be reached at (904) 248-2429 and mark@addingtonlaw.com or visit http://www.addingtonlaw.com/


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