A terminated employee’s primary interest is usually the bottom line figure when negotiating a severance package. With this goal in mind, the termination notice period is often viewed as the driving factor for how much compensation will be received (i.e. more months = bigger package). However, this viewpoint may be overly simplistic as other factors can often be relevant in such negotiations. Below are some elements of an employee’s total compensation that may have a material impact on their termination package:
- Accounting for mitigation;
- Lump sum discount;
- General damages; and
- Continuation of employee benefits.
This blog provides an example that illustrates how some of these factors may impact a hypothetical severance package negotiation.
As with any negotiation, the parties involved may reach an impasse which can benefit from creative solutions to bridge the gap between their positions. In this scenario, the employee wants to receive 14 months of base salary continuance while the employer appears to be steadfast at only 12 months. Both of these packages are only taking into account the employee’s annual base salary of $120,000.
However, there are two other compensation factors beyond the base salary that could be considered in the negotiation for this particular scenario:
- $60,000 of estimated annual commissions based on historical averages.
- $30,000 of general damages stemming from a potential human rights claim.
The graph below illustrates the impact of the additional compensation factors by comparing them to the cumulating values of both the employer and employee’s most recent offers (respectively, “Employer’s Offer” and “Employee’s Offer”). Given that most employees are primarily concerned with what amount ends up in their pocket, all figures are stated on an after tax basis (assuming a 40% tax rate).
Click here to view the image.
The graph above demonstrates that the employee will have already earned $84,000 (the total value of the Employee’s Offer) 9.3 months after the termination date if the severance package includes either prorated commission payments or $30,000 for general damages. As a result, the employee would be inclined to accept fewer months of notice than the Employer’s Offer if the offer included his commission or an amount for general damages. It is interesting to note that despite being half the amount of the employee’s commission, the general damages have a disproportionately significant impact on the bottom line because those amounts are often received on a tax free basis.
Below is a chart that summarizes the total after tax value of each of the packages and their respective calculations. In this scenario, the employee would be in the best position with a 12 month severance package that includes his base salary and commissions.
Click here to view the table.
This hypothetical scenario was simplified to highlight just a few of the compensation considerations in termination negotiations. The graph serves to illustrate how it is possible for an employee to settle on fewer months of salary continuance but still walk away with a larger settlement package.
During an initial consultation with a client, it is my practice to always discuss the various compensation items that can make up their severance package. In order to minimize the risk of a standoff, I put all these factors in play during the negotiation. The purpose of this strategy is to facilitate a quicker settlement by introducing more moving parts and creating the potential for an innovative solution that results in a better takeaway for my client.
Stay tuned for my upcoming blog where I examine whether a “mitigation claw back” clause is a penalty or a windfall.