Advice and Tips
What you should know about severance agreements
Are you in a situation that might require a severance agreement? Here’s a rundown of several terms associated with this agreement.
But first, a piece of advice: Contact us in Tekna’s legal department before signing off on any severance agreement!
What is a severance agreement?
An employer and employee often enter into a severance agreement is when they want to end their employment relationship, for example in cases of downsizing or accusations concerning breach of contract. A severance agreement contains terms on which both parties have agreed before the employee’s termination date and which is binding for both sides. Entering into a severance agreement is voluntary; it’s also not unusual for a severance agreement to contain points about both severance pay and non-competition/confidentiality clauses. Below you’ll find our list of definitions for many of the terms that may be included in a severance agreement.
What’s the difference between a severance agreement and dismissal?
A severance agreement is a mutual agreement signed by an employer and employee when ending their employment relationship, while a notice of dismissal is an employer’s unilateral termination of an employment relationship. A dismissal must therefore meet certain conditions in order to be considered valid: It must be objectively justified, respect an agreed upon notice period, and satisfy certain formal requirements in accordance with the Working Environment Act. When drafting a severance agreement, either party may deviate from these conditions through negotiations.
Read more about termination of employment,
and termination in the public sector
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What points are usually included in a severance agreement?
PurposeThe purpose of a severance agreement is to arrive at an amicable agreement about terminating the employment relationship to avoid the risk of having disputes arise between the parties at a later date.
Parties in the agreementThe parties in the severance agreement are the employer on the one side and you, the employee, on the other side.
Dealing with NAV/Entitlement to unemployment benefitsIf the severance agreement is entered into as an alternative to dismissal, which in turn is caused by organizational factors (f.ex. downsizing), you are as a rule entitled to receive unemployment benefits from the date you have both 1) registered as a job seeker and 2) submitted your application to receive unemployment benefits.
The severance agreement and reasons for it are therefore important documents which you, if required, must provide NAV with when applying for unemployment benefits. If a severance agreement has been entered into as an alternative to dismissal based on your own employee-related circumstances, you are as a rule not entitled to receive unemployment benefits during the first 18 weeks when you are unemployed. This waiting period is often called a «quarantine period».
Generally speaking, you are not entitled to receive unemployment benefits as long as you have an income after the severance agreement has been signed. If the severance agreement has a value that is greater than the agreed upon notice period, you will normally not be entitled to receive unemployment benefits during the period for which the severance agreement is intended to compensate. If a severance agreement is entered into that includes your right to receive severance pay for a six-month period, you will normally not be entitled to receive unemployment benefits before the severance pay period is over.
Notice period (or not)Generally speaking, you have both the right to work – and an obligation to do so – during the notice period. The length of this period depends on your age and length of employment. However, the parties can agree that you will either not work at all during the notice period (work exemption), or that its length will be reduced. In the latter case, any payment made in accordance with the agreed notice period is normally made as severance pay.
Explanation of termsEffective date of resignation: The date on which you no longer have to perform your work duties. This may be either from the moment you sign the severance agreement or at some point during the notice period.
Effective termination: The date on which the employment relationship is formally terminated, which is normally at the end of the notice period. Sometimes the effective termination date coincides with the severance date (but not always).
Severance pay/Severance pay period: Salary beyond the notice period and effective termination date. No one is entitled to receive severance pay outright; the severance pay period’s length varies as well with each individual case – in addition to what is agreed upon by the employer and employee. Severance pay may be awarded as a one-time payment or a limited number of monthly payments.
Regulating an employee’s duty to work/effective date of terminationYou will perform your regular work duties up to your termination date, meaning you will perform your usual tasks in accordance with your employment contract.
Having the right to accept other work (and when)?This depends on what the parties in the severance agreement have agreed. As a rule, you have the full and unlimited right to accept all other work. However, you might be bound by non-compete clauses that can limit where you can work after your termination date. Our recommendation is that a clause be included which states that you are to have complete access to accepting all forms of other work from the moment you no longer have any duty to work for your former employer, and you have the right to do this without losing any of the benefits listed in your severance agreement.
Non-compete clauses in the employment contractIf you have a non-compete clause in your employment contract, your employer may decide to enforce it in accordance with regulations listed in the Working Environment Act, section 14A. If they do this, they must give you a written account of the reasons for their decision within three weeks after you were given notice or resigned from your position. If the employer fails to provide you with this account, the non-compete clause becomes void in your employment contract. If the clause is to be enforced, the employer must provide you with an account of the reasons for this decision, state the length of your quarantine period and pay you your negotiated salary in accordance with separate regulations listed in the Working Environment Act, section 14A.
It is only clauses about accepting other work that competes with your employer that give you the right to receive compensatory salary. Other clauses (for example, customer clauses or non-solicitation of employee clauses), do not award you the right to receive compensatory salary.
If the employment relationship’s ending is caused by the employer (for example, dismissal because of downsizing), the non-competition clause does not apply.
What does severance pay include?/Terms of vacation pay and pensionAny severance pay you receive after your last day of work (termination date) is only compensatory salary and, as such, does not include any calculation of your vacation pay. Also, after the termination date, your membership in the pension fund is withdrawn, so no pension contributions are paid.
One-time payment or payment planThe general rule of tax law is that «any benefit awarded from working» is taxable income. Severance pay is therefore taxed, and your employer must therefore calculate and pay a levied withholding tax.
Salary that is paid during the notice period is normally paid in the usual way and is taxed continuously. The parties are free to negotiate if severance pay is to be made as a one-time payment or an ongoing future payment made on a monthly basis. If payments may be divided, it is natural to figure out if payments may be spread out over two income years. If necessary, you can ask for advice from the tax authorities.
Educational opportunity with tax benefitsYour employer can choose to offer you tax-free support to pursue education provided that it gives you skills that will increase your chances of getting hired by another employer. This kind of educational support is tax-free up to 1.5 G (The National Insurance Act’s basic amount) in accordance with certain terms and conditions. If you take advantage of this offer, your employer will cover your studies up to a certain amount upon receiving your invoices. This type of educational agreement should be entered into with the university/university college while you are still working for your employer.
Bonus pay/paymentYou might be entitled to receive a bonus for the time period you have been employed. The amount you are entitled to often depends on your bonus agreement’s wording (if such an agreement even exists). If no written bonus agreement exists, you will as a general rule be subject to your employer’s evaluation, who will decide if you have earned a bonus and, if so, you are to receive payment for it. We recommend that this point be regulated in your severance agreement. If a bonus has been included up to this point for calculating your pension, it is also important to specify this point in your severance agreement.
Shares and options – regulation of ownership/saleIn a severance agreement, it is common to regulate how any shares or options will be redeemed and on what terms this will happen. This will often appear in the wording of the shareholder agreement in the company where you work. It is also possible to discuss if you can keep the shares as a passive shareholder in the company in spite of your employment relationship being terminated.
Earned vacation pay/paymentThe severance agreement should include a date for payment of earned vacation pay. An agreement is usually made that earned vacation pay will be paid as a part of and together with your final settlement.
The Holiday Act regulates payment of earned vacation pay. Upon termination of an employment relationship, earned vacation pay is paid on the last regular payday. Vacation pay that is not calculable at this date can be paid in the final settlement, which should take place as soon as possible after the effective termination date.
It is helpful to be aware of the fact that an employer must withhold taxes on the portion of any vacation pay that has been earned and paid in the current year. As an employee, you can request that payment of your earned vacation pay in the current year be postponed until the following year in order to avoid having taxes withheld from it. Please note that even if this vacation pay is paid as a tax-free amount, this same amount will be included in your income tax and therefore considered to be regular taxable income.
Using vacation days/Opportunity and obligationsIf your notice period is three months or longer, your employer can require you to use your vacation days during the notice period; however, you and your employer can make an alternate arrangement in your severance agreement.
What about using vacation days during the summer?Both you and your employer are obligated to ensure that you use your current earned vacation days in accordance with The Holiday Act. Earned vacation days that have not been used are days for which you may be paid upon agreement with your employer. An employer often wants a severance agreement to state that all vacation days are to be regarded as having been used. This especially applies in cases where an employee has been exempted from working during the notice period. However, this is only a negotiating point, so it is not one that you have to accept.
Unused vacation days from the previous yearIf you have not used all of your vacation days from the previous year, the excess days are normally deducted when the annual ‘vacation pay payment’ is made in June. This payment is based on your having taken 25 vacation days the previous year. Yet if you used only 20 vacation days during this time, then 5 extra days were deducted from your pay; consequently, these 5 days will be refunded to you later in the form of salary.
Pension rights and pension plan membershipPension rights and pension plan membership (private sector): An employee has their membership in the pension plan withdrawn during what would otherwise have been the agreed notice period. Under certain conditions a paid-up policy (defined benefit pension) or a pension capital certificate (defined contribution pension) is issued. An employee who is on sick leave/disabled with a deposit exemption will not have their membership in the pension scheme withdrawn.
At the time of withdrawal, the employer must offer the employee continuous insurance coverage; upon receiving this offer, the employee must place their order within 6 months from the date of their withdrawal from the pension plan. The employee then has the opportunity to extract the insurance plans from the pension plan. Having continuous insurance coverage allows the employee to avoid having to submit a health self-certification, which may be significant if cases where they have experienced or are experiencing health problems. Please note that this type of insurance may be expensive.
AFP (Contractual Early Retirement Pension): Status/Additional earning of rightsIf you work in a company that has an AFP plan, you must qualify for withdrawal. This applies to among other things the number of years you have been in the plan and requirement that you have been employed in a 20% position or more on both the application date and withdrawal date (age 62). Your right to an AFP plan ends if you enter into a severance agreement before the withdrawal date; however, if you move to a new position in another organization that also has an AFP plan, your rights will still apply. We advise you to contact Tekna’s legal department if you are in this situation.
Dealing with NAV: Sick leave/DisabilityGenerally speaking, you are not entitled to receive sick pay while receiving severance pay. The exception to this rule is if there is a point in your severance agreement which states that you are free to accept other work during this period, and that any salary from your new employer will not lead to a benefits reduction after the severance agreement. On this date, you are entitled to receive sick pay from NAV for a period of up to six months in accordance with the rules in the National Insurance Act, section 8-47.
Be aware of the fact that in cases of work exemption during the notice period, you are not entitled to receive sick pay. If your illness continues after the notice period is over, you will not be entitled to receive sick pay at this time, either.
Both work assessment allowances and disability pensions are reduced accordingly when you receive any amount of severance pay.
Confidentiality clauses/Duty of loyaltyIt is common for severance agreements to contain a confidentiality clause. This often means that the content of the severance agreement is confidential; consequently, the agreement’s wording should explicitly state the terms of its confidentiality clause. For instance, it should be specified that the confidentiality clause does not block any information in the agreement being given to public authorities (for example in connection with an application to receive unemployment benefits from NAV).
Both employee and employer have a legal, mutual duty of loyalty to one another for the duration of the employment relationship, which will continue to a certain degree after the employee has left the organization. This may also be a consequence of the wording found in the employment contract or other signed agreements, or it may appear in the content of the severance agreement. Wording which states that you are obligated to maintain confidentiality about business and operational secrets (or any other confidential information that you have learned as a result of your employment relationship) is often included in the final settlement document.
IPR (Intellectual Property Rights) – Dealing with created intellectual property and ownership/remunerationIf you have created intellectual property (or anything else) through your position, you always have the right to be named as its author. You might also be entitled to remuneration for patentable inventions over which your employer has assumed control. We recommend that IPR be regulated in a separate point in your severance agreement.
Attest requirement/Content and timeWhen you quit your job, you have the right to receive a written attest from your employer. This attest must contain your date of birth, what your work has entailed in addition to the length of time that you have been in the employment relationship. You can read more about this point on Tekna’s webpages.
Legal consequences of entering into a severance agreement in relation to employment protection and right of priority
Once a severance agreement has been entered into, it is normally assumed that all rights and obligations between the parties are to be regarded as finally settled. This means that your right to dispute your case is dropped and all financial terms are regulated through the agreement. In cases where the background for the severance agreement is dismissal due to downsizing, many employers also want you to give up your right of priority for a new position. Our experience is that while the Working Environment Act’s right of priority regulation has little practical value, it may be wise not to waive this right when negotiating your severance agreement.