Part 2: Getting severance payments right

Severance payments: A guide for the public sector.

2.1
In this Part, we describe:

The right process

2.2
A severance payment can be agreed between the parties in an employment relationship without involving other parties or advisers. However, the risk of doing this is that the public organisation might not follow proper processes, properly assess the basis for, or amount of, a severance payment, or document it correctly. These failings can create legal and financial risks (for example, with tax, delegated authority, and disclosure requirements).

2.3
Many severance payments are negotiated with the help of legal or other representatives. Using experienced advisers is wise in any sensitive or difficult situation. Public sector employers will often be required to justify the terms of a negotiated exit, including any severance payment. Reasoned legal advice (in writing) will be helpful or even essential if the employer is asked to explain the basis for a severance payment.

2.4
Parties can also choose to use the mechanisms available under the Employment Relations Act, which are designed to support employers and employees to reach constructive agreements. These include raising an employment relationship problem, mediation assistance, and submitting a statement of problem to the Employment Relations Authority.

2.5
An agreement reached by private negotiation can be documented in a settlement agreement or a simple contract, or by using the same format as that used by Employment Mediation Services in the Ministry of Business, Innovation and Employment (MBIE). Employment Mediation Services has a template available online, and it can be signed by a mediator with statutory power to confirm the agreement is final, binding, and enforceable.

2.6
Public sector employers must make sure that the person signing an agreement for the employer has the delegated authority to settle the matter on those terms. The employee should be told that they can seek independent advice before signing it. It can sometimes be appropriate for the organisation to support an employee to obtain legal advice by making a contribution to their legal fees.

Mediation

2.7
The Employment Relations Act encourages the resolution of employment disputes at a low level and by informal means. The employment institutions set up under that Act strongly encourage the parties to resolve their dispute using MBIE’s Employment Mediation Services. By statute (reinforced by case law), the MBIE mediation process is confidential and without prejudice. This means that parties cannot disclose outside the mediation process what has been discussed or documented at mediation. It is a safe and efficient environment in which the parties can resolve their dispute. Any agreement reached is signed by the parties and also signed by the mediator.3 The mediator’s signature on the record of settlement confirms that it is final, binding, and enforceable, and cannot be appealed or challenged.

2.8
In all but the most urgent or exceptional cases, the Employment Relations Authority or Employment Court will expect the parties involved to attend mediation before issuing proceedings. The Employment Relations Authority and Employment Court can direct parties to mediation before they hear a case. They can also refer the parties to mediation at any time if mediation could help the parties to resolve their dispute.

2.9
In practice, many employers and employees now agree to attend mediation when they have a dispute. We encourage this, in the interests of early clarification of disputes and cost-effective resolution for both parties. The Crown is required to be a good employer and to act in good faith, and to be an exemplary litigant. Agreeing to attend mediation promptly is consistent with those requirements. In many instances, it will help avoid litigation. Many employers now also use mediation proactively to try to resolve disputes early and before positions become entrenched.

2.10
Parties can also engage private mediators or facilitators. A private mediator might be able to accommodate the parties more quickly if the Employment Mediation Services are unavailable, but the cost must be considered. Private mediation or facilitation practitioners might bring different skills to bear, or help the parties with different processes or resources, such as restorative justice or with resolving ongoing employment relationship issues.

2.11
The employer should also ensure that the appropriate people are available to attend mediation sessions, including a manager with the requisite delegation to reach an agreement on the day. If the appropriate people in the public organisation cannot be present, they must be otherwise accessible throughout the process. However, it is best that the manager with the authorised delegations be present at the meeting itself because it is difficult to summarise and explain the anticipated outcome of a mediation session to someone who has not been directly involved. The MBIE mediators will ask at the outset if there is someone present with “authority to settle”.

2.12
Whichever process or forum is used, when signing any agreement the person signing on behalf of the employer should have:

  • competent advice about the employer’s legal position;
  • a clear understanding of the risks, costs, and benefits of the proposed settlement;
  • the correct level of delegated authority; and
  • a written record of the basis for settlement.

Terms of settlement

2.13
The parties to a dispute in the public sector can resolve it in any lawful, justifiable, and reasonable way. The terms of agreements reached vary considerably, and can encompass financial, practical, and intangible matters.

2.14
One of the main differences between private and public sector employment situations is the degree of scrutiny and accountability for severance payments. The disclosure regimes applying to public organisations are more onerous than those applying to the private sector.

2.15
Public sector employers need to consider their capacity to maintain confidentiality given their statutory disclosure obligations, and whether a confidentiality clause is in the public interest. Settlements are sometimes better made openly, with the agreement and understanding of all parties. It might be appropriate to agree to wording for an announcement to the rest of the public organisation and, in some circumstances, to the media.

2.16
Severance agreements can include some or all of:

  • a specified notice period and an agreed finishing date – if a period or payment in addition to the contractual period of notice is being made, this is specified;
  • a payment for lost future earnings for a specified period (to recognise the time required to find a new job);
  • if a dispute or personal grievance has been raised and there is a basis for acknowledging hurt and humiliation, a payment of compensation under section 123(1)(c)(i) of the Employment Relations Act – these payments are often referred to as being made “without deduction” to reflect their non-taxable nature;
  • any contractual entitlement the parties wish to confirm in writing, such as a bonus, long-service payment, or accrued annual leave, particularly if the employer is agreeing to pay an entitlement that has not yet fully accrued;
  • a contribution towards any legal fees reasonably incurred – for audit purposes, evidence of the fees incurred will be required (for example, an invoice);
  • reimbursement of other incurred costs, such as medical costs, counselling or outplacement assistance costs, or relocation or retraining costs (again, evidence of the costs will be needed);
  • any equipment or other property kept (such as a car, laptop computer, or mobile phone – or an employee might want to keep their mobile phone number);
  • provision of an apology for wrongdoing or distress caused to the employee by an event;
  • provision of a reference or certificate of service (note that any reference given should be accurate, and with no significant omissions, to avoid the same issues arising again with another public sector employer);
  • return of each party’s respective property;
  • an agreement about a farewell function;
  • an agreed statement or communication to the rest of the public organisation and/or media;
  • a mutual non-disparagement clause, stating that neither party will speak ill of the other;
  • confirmation that the agreement is a full and final settlement of all claims arising out of the employment and its termination; and
  • a confidentiality clause.4

2.17
Severance payment agreements, like all legal contracts, must be documented correctly. The terms must be clearly spelled out, with financial and intangible components, timing, and the parties’ respective obligations carefully defined. The nature of each type of payment should be specified, and the basis for the payment should be explained so the document is self-explanatory. Any ambiguities can result in misunderstandings, interpretation arguments, or even legal proceedings.

2.18
The public organisation needs to keep a clear paper trail recording the background, risk assessment and advice obtained, basis and reason for the severance payment and terms, and evidence of the required authorisation.

2.19
Severance payments must be approved at the correct level of delegated authority. The authorisation required (that is, general manager, chief executive, board, or Minister) will depend on the amount of the severance payment, in keeping with the rules applying to the particular public organisation. The amount includes all financial costs, excluding Goods and Services Tax (GST).

2.20
For government departments, Cabinet sets specific approval procedures and financial delegations for any kind of settlement and payments that are not legally required.5 Payments above the thresholds must be approved by Cabinet or the responsible Minister. Compensation and settlement payments must also be certified by either a departmental solicitor or the Crown Law Office.

Amount of the payment

2.21
The amount paid as a severance payment in any given situation can vary considerably, and there are no set limits. The amount must be reasonable in the circumstances and able to be justified as a proper use of public money. In every instance, the parties will negotiate based on their assessments of the strength of their position (which can be very different). Public sector employers also need to consider their statutory good employer obligations.

2.22
When settling on an amount, the relevant factors will include:

  • what the dispute is, how it arose, how the parties have conducted themselves, and who is (most) at fault;
  • the strength of the employee’s legal claim to compensation under case law;
  • how strong the employer’s position is – whether there is a clearly established basis for dismissal (if so, the employer will have the most negotiating power) and how well the employer has handled the situation;
  • the seniority of the employee;
  • the employee’s length of service;
  • contractual entitlements;
  • any health (including mental health) issues that are affecting the parties’ ability to resolve the situation;
  • any relevant precedent in or applicable to the public organisation or situation;
  • the likely award of damages and costs by the Employment Relations Authority or Employment Court;
  • the likely cost of defending or conducting proceedings, weighed against the strength of the legal position – a risk and cost-benefit analysis;
  • precedent value/risk – whether public resolution through a legally binding precedent would be more harmful than a private resolution (bearing in mind that it may become public);
  • the effects on the public organisation, particularly if the matter is not resolved;
  • the effects on the employee, and the extent to which the employer might have a moral obligation in the circumstances giving rise to the departure; and
  • how much each party has at stake and how much each party wants to resolve the situation.

2.23
These are complex assessments, and there are many variables to consider. People make different value judgements and weigh factors according to those judgements. The risks must be balanced against the costs. It is important that the employer has all relevant information and good advice, and that they are making a careful assessment in all circumstances. The employer also needs to follow their internal processes, including ensuring that approval is given by the right person within their delegated authority. If this is done and documented, then the employer will be in a better position to defend the severance payment as being a principled and considered decision.

2.24
The amount of any severance payment must be reasonable, although this is, by necessity, an imprecise requirement. Settlements larger than an award in comparable cases decided by the Employment Relations Authority or the courts will be given greater scrutiny, and the public organisation will need to have good reasons for the amount. Good reasons for a comparatively higher payment might include the seniority of the employee, the effect of any publicity on all the people involved, the sensitivity of the dispute, and the value of certainty and speed of resolution. These factors can justify a higher settlement because the outcome is more advantageous than a judicial outcome.

2.25
Settlements sometimes include a specific payment to compensate an employee for their hurt, loss of dignity, and injury to feelings.6 Such payments can be awarded under the Employment Relations Act when the employer has made an error or wronged the employee in some way and, in doing so, has caused hurt, loss of dignity, and/or injury to feelings, as well as having created grounds for a personal grievance claim. Such payments should not be regarded as an automatic part of any settlement. It is not appropriate to make a payment of this kind if, in the view of the public organisation, there are no grounds for a personal grievance claim and the employee has not suffered any hurt, loss of dignity, and injury to feelings, so sometimes they are not an appropriate part of a severance agreement.

2.26
These compensation payments are tax free because they are not income, and they do not have to be declared in tax returns filed by the employee. For this reason, it is common for parties (and/or counsel) to attempt to direct the greater portion of the severance payment into this category. However, an unjustified or excessive payment of this kind can create risk for both parties. In particular, employers should expect the Inland Revenue Department to scrutinise such payments, including asking for evidence of a personal grievance claim and/or evidence of what hurt, loss of dignity and injury to feelings was established.7


3: The mediator can decline to sign an agreement if the settlement is unlawful in some way.

4: This is subject to an assessment of whether the severance payment and agreement should be confidential, and subject to legal and accounting disclosure requirements (see Part 3).

5: The current procedures are set out in Cabinet Office Circular CO (1) (8) 2, Section C.

6: These are colloquially known as section 123(1)(c)(i) payments, after the relevant section of the Employment Relations Act.

7: For more information see www.ird.govt.nz.