Why Should Clients Have Severance Agreements Reviewed?

A sad, but current, reality is the “downsizing,” “right-sizing” and closure of businesses due to the severe economic downturn we are facing.

I have had the unfortunate occasion to review a number of severance agreements for clients during the past several months.  In doing so, a number of relevant factors have come to my attention about these agreements.

Most severance agreements recommend that the employee have the agreement reviewed by counsel.  This is not (generally) being done by some egalitarian sense of concern for the employee’s welfare.  Under the Age Discrimination and Employment Act (ADEA), it is actually a requirement that they make that recommendation for employees over age 40.

Another reason is that it is more difficult for the employee to later argue that they did not understand the contract, if they have had it reviewed by counsel.  I still believe review by an attorney is worthwhile.

Severance Agreements are not usually required because most employees are employed “at will” in Michigan.  Nonetheless, employers are offering them in part, perhaps to assist the severed employee in a difficult time of transition.

A primary purpose of severance agreements is to induce the departing employee to waive any possible present and future claims they may have against the employer, including claims they may not even know exist.

Severance agreements typically exchange some form of extended pay or benefits, in return for the waiver.  When the employer is a very large corporation, the likelihood that the client will have any bargaining ability to negotiate the agreement is small.  So it is important to explore whether, and to what extent they may be giving up something of real value, to determine whether to sign the agreement at all.

It is also important that the agreement address benefits.  There is some “grey” area regarding if, and what benefits may be waived under the federal ERISA statute.  There may also be instances in which the waiver of claims should be mutual, i.e., the employer should waive any rights against the employee, under the same theory as the employee is waiving claims.

If you have clients, or know people going through this difficult time, who have severance agreements, encourage them to take some time to have these carefully reviewed.

This Newsletter is intended to be informational only, and does not constitute legal advice.  If you have questions, concerns or comments, please contact me at: arichards@smithbovill.com, or by Telephone at 989-652-9923.

Andy Richards

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Dismaying New Rules for Employer-Owned Life Insurance

During the nearly 25 years I have practiced law in the area of Estate Planning and Business Succession Planning, No “technical” tax change has personally caused me more dismay or made less sense than Congress’ most recent blunt instrument approach to “fixing” a perceived abuse of life insurance policies.  New IRC §101(j), added by the Pension Protection Act in 2006, is ostensibly directed toward major public corporations’ practice of insuring virtually any employee (so-called “janitor insurance”).  It has, I believe, unfortunately unfair and far-reaching consequences for the 1000's of closely held business companies in the United States.

Ownership of life insurance on key participants has long been an important tool for funding Buy-Sell obligations.  In many cases, it is the only way a business can insure that upon the untimely death of a participant, his or her family will receive fair payment for the decedent’s interest in the business.

Like life insurance proceeds in the hands of individuals, the proceeds of such business-owned policies have always been income tax free under §101(a) of the IRC.  Now, Congress has set a major trap for the unwary!

New Section 101(j) reverses the time-honored rule that such proceeds are income tax free and replaces it, instead, with the presumption that the proceeds will be income taxable, unless the employer meets certain exceptions and new requirements created by the section.

Under §101(j), in order for such proceeds to be received by the business free of income tax, the insured employee must be (1) employed by the business during the 12 month period prior to death, or (2) a director or (3) a “highly compensated employee,” (4) or used to purchase an equity interest from the decedent’s family or estate.

It may seem that this will not be a problem in most cases.  However, the section additionally imposes Notice and Consent requirements, which require that the employer give written notice to the employee of the intent to obtain insurance, of the maximum face amount of the policy, and that the employer will be the owner and beneficiary of the policy--and which require that the employee sign a written consent to such insurance, before the issuance of the insurance contract.  It does not appear that the IRS would accept a confirmation of such intent at any time after the contract has been issued.  This seems to go far beyond addressing the problem it was intended to address.

When advising your clients regarding the purchase of “Buy-Sell” insurance policies, it will be important that all the advisors are aware of this issue and that the written consent and notice requirements are followed and well-documented.

  

This Newsletter is intended to be informational, only and does not constitute legal advice.  If you have questions, concerns or comments, please contact me at: arichards@smithbovill.com, or by Telephone at 989-652-9923.

Andy Richards

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