You're closing a restaurant location. Or restructuring your retail team. Maybe business is slow and you need to reduce staff. Whatever the reason, letting employees go is never easy. On top of that, it might cost you more than you expect if you haven't planned for severance.
Disclaimer: This article provides educational information only and is not legal advice. Employment law varies by state and situation. Consult with an attorney for guidance on specific severance decisions.
When Is Severance Required?
For most small and mid-sized businesses, severance is voluntary. However, several situations can create legal obligations:
The WARN Act: The Worker Adjustment and Retraining Notification Act requires employers with 100 or more full-time employees to provide 60 days' advance notice of mass layoffs or plant closings. A "mass layoff" means:
- Layoffs of 500+ employees at a single site, or
- Layoffs of 50-499 employees if they represent at least 33% of the workforce
If you fail to provide the required 60-day notice, you must pay employees for the period of violation. This applies even if you're closing multiple smaller locations whose combined layoffs meet the threshold.
Employment Contracts: If you've signed employment contracts promising severance, you're legally bound to provide it. Review any agreements with managers, executives, or key employees.
Employee Handbooks: If your handbook promises severance under certain conditions, you've created a binding policy. Courts have ruled that handbook promises can constitute employment contracts.
State Laws: Some states have specific requirements. California, for instance, requires five days for employees to review severance agreements. New York's "Mini-WARN Act" requires 90 days' notice (not 60) for businesses with 50+ employees.
Union Contracts: Collective bargaining agreements with an employee union often include specific severance provisions that you must honor.
Common Severance Formulas
While there's no standard requirement, most businesses use predictable formulas:
Years of Service Method: One to two weeks of pay for each year employed. A server who worked for you for five years would receive 5-10 weeks of pay.
Position-Based Method: Higher-level employees receive more generous packages. Hourly workers might receive two weeks regardless of tenure, while managers receive weeks per year of service.
Flat Rate: Every laid-off employee receives the same amount, for example four weeks of pay. This is simpler to administer but doesn't account for loyalty or position.
According to employment law resources, executives and senior managers often receive substantially more while hourly workers typically receive 1-4 weeks total.
What Severance Typically Includes
Beyond base pay, comprehensive severance packages often include:
Health Insurance Continuation: Offering to pay COBRA premiums for several months. This is expensive but prevents newly unemployed workers from losing coverage immediately.
Unused Vacation Payout: Many states require accrued PTO to be paid out regardless of severance. Check your state's final paycheck laws.
Prorated Bonuses: If someone is laid off mid-year, consider paying a prorated portion of any annual bonus they would have earned.
Job Search Support: Access to outplacement services, resume help, or references can ease the transition.
Equipment: Allowing employees to keep laptops or phones they've been using can be valuable and costs you little.
The Real Purpose: Buying Legal Peace
Here's what most business owners don't realize: severance isn't just about being generous. It's leverage.
When you offer severance, you typically require employees to sign a "release" or "separation agreement" waiving their right to sue you. This protects you from:
- Wrongful termination claims
- Discrimination lawsuits
- Wage and hour disputes
- Unemployment insurance appeals (sometimes)
For employees over 40, federal law requires special protections against age discrimination. The Older Workers Benefit Protection Act mandates:
- 21 days to review individual separation agreements
- 45 days to review agreements in group layoffs
- 7 days to revoke after signing
If you don't follow these rules, your release is invalid and the employee can still sue you, even after accepting severance.
Horror Stories: How Not To Handle Severance
Here are some hypothetical scenarios based on real cases:
The Insufficient Notice: A Texas restaurant chain closed five locations simultaneously, laying off 300 employees without notice. Each location had 60 employees, which was below the WARN Act threshold individually. But, the closures happened on the same day, triggering federal requirements. The company owed 60 days of back pay to everyone: roughly $2 million in unexpected costs.
The Handbook Promise: A retail chain's employee handbook stated that employees with 3+ years of service would receive "separation benefits" if laid off. When restructuring, management offered nothing. Thirty employees sued and won, arguing the handbook created a contract. The company paid $450,000 in settlements plus legal fees.
The Bad Release: A café owner offered two weeks' severance to a terminated manager but used a generic release form downloaded online. The manager signed, took the money, then sued for age discrimination. The court threw out the release because it didn't comply with federal requirements for workers over 40. The case settled for $75,000.
The Retaliation Claim: A hotel fired a housekeeper for poor performance and offered no severance. She had complained about unsafe working conditions two weeks earlier. She filed an OSHA retaliation complaint, arguing the termination was retaliatory. The investigation revealed the performance issues weren't well-documented. The business paid $28,000 to settle.
Practical Considerations for Service Industry Employers
Plan Before You Need It: Create a severance policy before layoffs are necessary. Decide:
- Who qualifies (full-time only? minimum tenure?)
- How much you'll offer
- What legal releases you'll require
- How you'll communicate the decision
Budget for It: Severance is expensive. A location with 20 employees averaging $35,000 annual salary, offering one week per year of service, with average tenure of three years, will cost about $40,000 in severance alone. Factor in COBRA payments and the real cost approaches $50,000.
Consistency Matters: If you offer severance to one person in a reduction, you may need to offer similar packages to others. Inconsistent decisions invite discrimination claims. Document your reasoning if you make exceptions.
Don't Negotiate Away Everything: While releases typically waive legal claims, they cannot waive:
- Unemployment insurance rights
- Workers' compensation claims
- EEOC charges (though they can waive the right to monetary recovery)
- Wage claims in many states
Get Legal Review: Have an employment attorney review your:
- Severance policy
- Release agreement templates
- Communication plans for layoffs
The cost of this review ($1,000-$3,000) is minimal compared to the cost of litigation.
Alternatives to Severance
If cash is tight but you want to minimize bad blood:
Reduced Hours Instead of Layoffs: Many states allow partial unemployment benefits when hours are cut significantly. Employees keep their jobs and health insurance while collecting some unemployment income.
Voluntary Separation Programs: Offer incentives for employees to resign voluntarily. This typically costs less than involuntary layoffs and creates better relationships.
Extended Notice: Instead of two weeks, give 30-60 days' notice. Employees stay on payroll longer and have time to job search while still employed.
Strong References: Commit to providing positive references. For service industry workers, references matter enormously for their next job.
Tax Implications
Severance pay is taxable income. You must:
- Withhold federal income tax
- Withhold Social Security and Medicare taxes
- Report it on Form W-2 (not 1099—severance is wages, not contract payments)
Some employers gross up severance payments to cover the tax burden, but this isn't required and significantly increases your costs.
State-Specific Considerations
California: Requires that employees have five days to review severance agreements. Final paychecks (including severance) must be provided immediately upon termination.
New York: "Mini-WARN Act" requires 90 days' notice for employers with 50+ full-time employees. Mass layoffs are defined more broadly than federal law.
New Jersey: WARN Act applies to employers with 100+ employees who lay off 50+ workers statewide (not just at one location).
Massachusetts: No specific severance requirements, but strong enforcement of anti-discrimination laws makes releases especially important.
Severance for Restaurant and Retail Employees
Service industry workers face unique challenges:
High Turnover: If average tenure is 8 months, years-of-service formulas result in minimal severance. Consider flat-rate packages instead.
Tipped Employees: Base severance on total earnings (wages plus average tips), not just the tipped minimum wage.
Part-Time Workers: Decide in advance whether to offer severance to part-timers. If not, document that policy clearly before layoffs.
Seasonal Closures: If you regularly close for seasons (beach town restaurants, ski resorts), clarify that seasonal jobs don't require severance.
Red Flags That Increase Your Risk
You're more vulnerable to lawsuits when:
- The layoff comes shortly after an employee complained about discrimination, harassment, or safety
- You're letting go someone who just filed a workers' comp claim
- The person laid off is significantly older than others kept
- You're laying off a pregnant employee or someone who just returned from FMLA-protected medical leave
- Performance documentation is weak or nonexistent
In these situations, offering severance in exchange for a release is often your best financial decision, even if you believe the layoff was legitimate.
Documentation Is Everything
Whatever you decide about severance, document:
- Why these positions were eliminated
- How you selected which employees to lay off
- Who made the decision and when
- Communications with employees
- Reasons for any exceptions or different treatment
This documentation protects you if someone later claims the layoff was discriminatory or retaliatory.
Parting Ways Well
Severance isn't required, but it's often smart business. A well-structured package can:
- Prevent expensive litigation
- Maintain your reputation as a fair employer
- Ease your own guilt and stress during difficult decisions
- Help laid-off workers survive until they find new employment
For service industry businesses operating on thin margins, severance feels like an unaffordable luxurwhen even one employment lawsuit can easily cost $50,000-$150,000 in legal fees alone, modest severance packages are often the cheaper choice.
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