Big Payouts for Getting Fired: Understanding Executive Severance Agreements

Severance Agreement
Share

When employees are caught engaging in illegal or improper behavior, their employers usually fire them. But sometimes, in addition to getting fired, the employee may also get a big payout, in the form of a significant amount of severance pay.

Why would a company pay someone for doing something inappropriate? This seemingly illogical scenario generally only happens when a high-level employee gets fired under an executive severance agreement.

What Makes an Executive Severance Agreement Special?

Executive severance agreements are special employment contracts that spell out the benefits that a departing executive-level employee will receive. In return for the payment, the employee may be agreeing to certain restrictive covenants, such as nondisclosure, noncompete, and/or nonsolicitation clauses.

It’s also possible for an executive severance agreement to be established when an employee is first recruited. In that case, the employee agrees to take the job and work for the employer in return for generous severance pay at the end of their relationship.

These plentiful severance benefits are often necessary to attract the most sought-after talent. Think professional sports coaches, chief executive officers, and well-known media personalities. Many of these individuals have a number of companies and organizations competing to hire them, allowing these in-demand employees to set forth the terms of their employment, including what happens when they eventually leave.

Who Benefits the Most From Executive Severance Agreements?

Generally, the biggest benefit an employee receives from an executive severance agreement is financial protection in case of failure. To illustrate, think about a historically successful corporate executive who is brought in as CEO to run a sinking company. When that executive is hired, the conversation probably goes something like this:

Company:           We’d love for you to come on as our CEO.

Executive:           You’ve got to be kidding. Your company is about to declare bankruptcy. You probably won’t even exist in a few years.

Company:           We know that, but we’re doing everything we can to survive, and you’re our best hope.

Executive:           You know that the odds aren’t in my favor, right? I’m a CEO, not a miracle worker.

Company:           That’s why we’re prepared to offer you $10 million in severance pay if you can’t save the company and the board of directors lets you go.

Executive:           If that happens, it’ll be the first time I’ve failed to successfully run a company. If I’m putting my reputation on the line, I want $20 million in severance pay.

Company:           Done.

In the above hypothetical, the executive severance agreement provides the CEO with an insurance policy of sorts, in case she is fired due to underperformance. But what does the employer get in return for the $20 million it’s offering in severance pay? Besides getting the best CEO possible, it also ensures that it can get rid of that CEO relatively easily.

This gives the company the flexibility to change CEOs whenever it believes the time has come, even if the current CEO disagrees. The severance agreement will set out what can constitute the basis for termination in a clause known as a “trigger” or termination clause. Four common termination clauses found in severance agreements are as follows:

  1. for death or disability,
  2. for no reason (this may sometimes be referred to as “without cause”),
  3. for good reason, and
  4. for cause.

Let’s look more closely at each of these.

Termination for Death or Disability

The “death or disability” clause defines what happens to the employment relationship if the employee dies or becomes incapacitated such that the employee can no longer fulfill his or her job duties.

Termination for No Reason

A “for no reason” clause is just what it sounds like: it allows an employer to fire its employee for absolutely no reason. In reality, there will be a reason, but a company can’t foresee every possible scenario that would lead it to want to fire the employee.

Termination for Good Reason

The “for good reason” clause is the least common of the four because it gives the power to the employee, allowing the employee to collect severance benefits if she chooses to leave the company “for good reason.”

Normally, an employee who voluntarily resigns will forgo severance benefits. Without a “for good reason” clause, the employee doesn’t receive severance benefits even if the employer indirectly forces the employee to resign. But with this clause, the employee can choose to resign and still receive severance benefits if the resignation was “for good reason.” This could occur when an employer unfairly creates a situation that gives the employee no choice but to resign.

Termination for Cause

This is where things get interesting. What constitutes “for cause” in a severance agreement can include a variety of scenarios. However, the severance agreement will usually say that if the employee does anything that is unethical, immoral, illegal, or against the best interests of the employer, that action will qualify as “cause” for termination. If an employee is fired for cause, she gives up her right to receive severance benefits.

Because severance benefits in executive severance agreements can be substantial, it’s understandable that lengthy negotiations, or even court battles, can arise when an employee is let go for cause. And it doesn’t help that there’s no set legal definition as to what exactly constitutes behavior that is unethical, immoral, or against the best interests of the employer.

But remember where we started: why do some executives still receive their severance payouts even though they are fired for cause? There’s no one reason that applies to every situation, but one common explanation is that the employer already knew of the improper conduct when it entered the severance agreement.

This might explain Bill O’Reilly’s payout upon his departure from Fox News. After the news broke about O’Reilly being accused of sexually harassing his fellow employees, Fox News fired him and paid him $25 million. How did O’Reilly get this huge payout if he was fired for cause?

One possibility is that Fox News knew all along about the allegations but wanted to renew O’Reilly anyway because he was such a big moneymaker for the network. Obviously, if this is what happened, Fox News was taking a sizable risk.

If the sexual harassment allegations against O’Reilly became public knowledge, Fox News would look bad—as it did—and would probably lose some advertising revenue. On the other hand, if it didn’t renew O’Reilly’s contract, he might go to another media company, taking loyal viewers with him.

What probably happened, then, is that as O’Reilly and Fox News renegotiated their contract, Fox News demanded the ability to fire O’Reilly if the sexual harassment allegations ever became public. In return for this power, O’Reilly insisted both on a large severance package and an exclusion of sexual harassment from the “for cause” justifications in his severance agreement.

Summing It Up

  • Executive severance agreements can provide huge severance payments to high-level employees who are fired for misconduct or poor performance.
  • While it seems like these huge payouts may unfairly benefit the employee, the employer is getting something in return. That might be the ability to attract the best talent or having the flexibility to fire the employee when it sees fit.
  • Executive severance agreements commonly have a termination clause that specifies when an employee can be fired: for death or disability, for no reason, for good reason, or for cause.

Are you subject to an executive severance agreement? Need help understanding your options or negotiating terms? Please contact our office; we’d love to help.

[gravityform id=”8″ title=”true” description=”true”]