Severance Agreements and Unemployment Benefits – Potential Pitfalls for the Unemployed

There is no federal or California law that requires employers to pay “severance” pay to employees who resign or are terminated.  However, some employees may be offered severance pay – sometimes because the employer wants to “buy peace” to avoid a potential lawsuit and other times because the employer is required by union contract, severance pay plan, or other legal document to offer severance.  Severance pay is usually offered only in exchange for a release of any potential claims against the employer, and the “release agreement” is a legally binding contract.

The newly unemployed may encounter some issues when applying for unemployment insurance benefits if they have received severance pay.  In general, severance pay is usually not considered “wages” and thus the employee may begin collecting unemployment benefits after the initial waiting period.

However, if the employer terminates the employee, but continues to pay their wages, these payments may be considered “in-lieu-of-notice” or “wage continuation” pay.  In these situations, the employee will not receive unemployment benefits for the period covered by the payments.  The California Employment Development Department (EDD) considers several factors in determining if the payment is severance pay including whether: (1) a company policy or plan allows for severance pay; (2) the company policy indicates that specific reasons trigger the severance pay (e.g. job elimination, reduction in force); (3) the payments are available to a class of employees (although not necessarily all employees); and (4) plan does not state the purpose for the payment.  If the payment is made in a lump sum, it will almost certainly be considered severance pay and will not reduce the employee’s benefits.

On the other hand, when an employee is kept on the payroll after termination, receives paychecks on the regular payday, and continues to accrue benefits (e.g. vacation or sick time), the payments may be considered “wage continuation pay” or “in-lieu-of-notice pay” which would delay employee’s entitlement to benefits.  It is important to recognize that the label given the payments does not affect the EDD’s determination.

Since these distinctions are not always clear, employees should not wait to apply for unemployment benefits merely because they are kept on their employer’s payroll and continue to receive payments after termination.