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Severance Agreements

§ 8.22.01
Key Point 8-22.01. Churches should consider using a severance agreement when a decision is made to dismiss an employee. Such agreements set forth the terms and conditions of an employee's separation. In most cases, the employer agrees to pay the employee a specified sum of money (often expressed in terms of so many weeks of pay) in exchange for the employee's consent to the termination of the employment relationship and a release of any legal claims against the employer. Such agreements should be drafted by an attorney to ensure enforceability.

The termination of an employee is often a traumatic event that can expose a church to litigation. This risk should be taken seriously, since such disputes are a common form of church litigation, and many church insurance policies contain no coverage for employment practices. If your church does not have employment practices coverage, you may have to retain and compensate your own attorney if sued by a current or former employee, and pay any settlement amount or court judgment.

Tip. Ask your church insurance agent if your church has employment practices coverage. If not, find out how you can obtain this coverage.
Tip. Some churches have purchased officers and directors insurance. In some cases, this insurance may cover some employment claims, often with a large retention (deductible).

Many employers resolve employment disputes by using severance agreements. A severance agreement is an enforceable contract, signed by both the church and employee, in which the employee agrees to voluntarily terminate his or her employment and release the church from any liability in exchange for the church's agreement to pay specified benefits. These agreements avoid the expense and inconvenience of litigation, and often result in an amicable resolution of an employment dispute.

There are several points that church leaders should consider when proposing a severance agreement, including the following:

1. Voluntary termination of employment. The employee voluntarily terminates his or her employment, as of a specified date.
2. Release of rights. The employee releases specified claims against the employer. It is important for these released claims to be described fully. For example, the agreement should identify by name all state and federal statutes that confer rights that are being released. When severance agreements contain only vague references to released rights, employees may later argue that they did not understand what rights were being released and so the agreement is void.
3. Consideration. The employer must provide the employee with something of value in order for the employee's duties under a severance agreement to be legally enforceable. The legal term for the "value" that must be provided by the employer is consideration. Often, it is in the form of a lump sum amount of money, or a continuation of salary and benefits for a specified number of weeks. The value provided by the employer should exceed what is provided to employees who voluntarily terminate their employment without being asked to sign a severance agreement.
4. Legal review by employee. The agreement should encourage the employee to retain an attorney to review the agreement's provisions.
5. Legal review by employer. The employer should have the agreement drafted by an attorney to ensure compliance with all applicable laws. Some states impose specific requirements upon severance agreements.
6. No duress. Several courts have found severance agreements to be null and void on the ground that the employee was "coerced" into signing it. This a good reason to allow the employee several days to evaluate the agreement, and to seek legal counsel.
7. Older workers. The Older Workers Benefit Protection Act, which applies to any employer with 20 or more employees that is engaged in interstate commerce, prohibits employees at least 40 years of age from "waiving" their rights under federal age discrimination law unless the waiver meets several specific requirements, including the following: (1) the waiver is in simple language; (2) the waiver specifically refers to rights arising under the federal Age Discrimination in Employment Act; (3) the employee does not waive rights or claims that may arise after the date the waiver is executed; (4) the employee must receive some benefit for signing the waiver in addition to salary; (5) the individual is advised in writing to consult with an attorney prior to executing the agreement; (6) the individual is given a period of at least 21 days within which to consider the agreement; and (7) the agreement provides that for a period of at least 7 days following the execution of such agreement, the individual may revoke the agreement. This law will not apply to most local churches, since they have fewer than 20 employees. Even churches with 20 or more employees are not subject to these requirements unless they are engaged in interstate commerce.
8. Confidentiality. It is common for severance agreements to contain a confidentiality clause that prohibits the employer and the employee from disclosing the terms of the agreement, except as specifically permitted (such as discussions with a tax advisor).
9. Fringe benefits. A severance agreement should clarify the status of fringe benefits. For example, what happens to accrued vacation or sick time? Retirement plan benefits (such as those payable under a rabbi trust)? Unreimbursed business expenses? Also, the agreement should address the continuation of medical insurance.
10. Employer property. The agreement should address the return of all employer property (keys, computers, cell phones, credit cards, etc.).
11. Board approval. Have the final agreement reviewed by the church board prior to legal review and signature.
12. Tax withholding. Payments made to a former employee pursuant to a severance agreement ordinarily constitute taxable income and therefore payroll taxes need to be withheld (unless the person is a minister who was employed to perform ministerial services, and did not elect voluntary withholding). The tax regulations state: "Any payments made by an employer to an employee on account of dismissal, that is, involuntary separation from the service of the employer, constitute wages regardless of whether the employer is legally bound by contract, statute, or otherwise to make such payments." There is one exclusion that may apply in some cases. Section 104(a)(2) of the tax code specifies that gross income does not include the amount of any damages received (whether by suit or agreement and whether as lump sums or as periodic payments) "on account of personal physical injuries or physical sickness." However, section 104(a) specifies that "emotional distress shall not be treated as physical injury or physical sickness" except for "damages not in excess of the amount paid for medical care … attributable to emotional distress." As a result, jury awards and settlements for employment discrimination and wrongful dismissal claims are fully taxable to the extent that they are based on emotional distress. Church leaders must determine whether severance pay is taxable so that it can be properly reported (on a W-2 and 941 forms), and taxes withheld. Failure to properly report severance pay can result in penalties for both a church and the recipient.
13. Housing allowances. Can a church designate any portion of a minister's severance pay as a housing allowance? This question has never been addressed by either the IRS or any court. However, an argument can be made that a church can designate a portion of severance pay as a housing allowance if the severance pay is treated as taxable compensation rather than as damages in settlement of a personal injury claim. If the severance pay represents taxable income, as the IRS will almost certainly insist in most cases, it is because the amount paid represents compensation based on services rendered. Since a housing allowance must be designated out of compensation paid to a minister for services rendered in the exercise of ministry, a reasonable case can be made that a housing allowance can be designated with respect to taxable severance pay. Of course, a housing allowance can only be designated for ministers. And, designating severance pay as a housing allowance will be of little value if a minister transfers immediately to another church that designates a timely housing allowance. But a designation of a housing allowance will be useful in the case of a minister who is not immediately employed by another church or religious organization.
14. Arbitration. Some employers include a clause in severance agreements that requires any dispute associated with the agreement to be resolved through mediation or binding arbitration.
Case study. An Indiana court ruled that a lawsuit brought by a dismissed pastor against his former church was barred by the First Amendment guaranty of religious freedom, and by the fact that the pastor's acceptance of a 90-day severance check amounted to an "accord and satisfaction" of all claims against the church. An accord and satisfaction is a binding settlement of a disputed claim that occurs when one party offers less than the disputed amount to the other with the understanding that its acceptance will constitute a settlement of the entire claim, and the other party accepts the lower amount. Under these circumstances, the party who accepted the lower amount cannot later claim any additional amount.

Miscellaneous Issues

Overview
HERE ARE A VARIETY OF MISCELLANEOUS ISSUES THAT MAY AFFECT YOU AND YOUR CHURCH: National Labor Relations Act

The National Labor Relations Act gives employees the legal right to form labor unions. Some religious organizations are exempt from the provisions of this law.

Reference letters

A reference letter evaluates the qualifications and suitability of a person for a particular position. Churches, like other employers, often use reference letters to screen new employees and volunteers. Churches often are asked to provide reference letters on current or former workers. The law generally provides employers with important protections when responding to a reference letter request. However, liability may still arise in some cases, such as if the employer acts with malice in drafting a reference letter.

Church leaders often are reluctant to provide a reference letter containing negative information because of a fear of legal liability. Some churches and secular employers have been sued by former employees or volunteers because of negative information shared in a reference letter. Liability generally is based on defamation, the infliction of emotional distress, or "interference with contract." While it is possible for churches to be sued, and found liable, for information contained in reference letters that they provide to other churches or employers, there are precautions that church leaders can take to reduce this risk.

Evaluations

Many churches perform periodic evaluations of their employees. In many cases, supervisors give inflated evaluations in order to avoid conflict. This common practice can expose a church to an increased risk of liability for employees who are protected by a state or federal employment discrimination law. How can a church avoid such a scenario? By insisting that all employee evaluations be objective assessments of clearly defined goals or standards.

Interviews

Employers must be familiar with what questions they can and can't ask at different stages of the interview process. Many pre-offer interview questions can be deemed as discriminatory, especially as they relate to disabilities. Be sure you know how to conduct interviews correctly.

Arbitration

By adopting an arbitration policy, a church can compel members to arbitrate specified disputes with their church rather than pursue their claim in the civil courts.

Handbooks

Employee handbooks can provide employees with valuable information on the terms and conditions of their employment. However, they may also expose a church to an increased risk of liability. Have an attorney prepare or review your employee handbook before it is adopted.

Privacy

Do employees have a "right of privacy" in their workspace? Are the contents of their desk off limits to prying staff? Can church leaders dismiss an employee if they find pornographic files on his office computer? Or, would this amount to an invasion of the employee's privacy or a violation of wiretap laws?

Courts have ruled on these questions and determined that employees may have a limited right of privacy in their workspace that may extend to the contents of their desk and cabinet drawers, and employer-provided computers. This right of privacy can be superseded by a policy that clearly authorizes the employer to inspect these items.

Insurance

Employment disputes are one of the most common sources of litigation involving churches. However, many churches are not insured against this risk, because most church general liability insurance policies exclude employment practices. This means that many churches face a potentially significant uninsured risk.

How can church leaders respond to this potentially uninsured risk? Two ways: 1. Implement an effective risk management program that addresses the most common types of employer liability. 2. Purchase employment practices liability insurance (EPLI). Often, EPLI insurance can be purchased as a special endorsement to a comprehensive general liability (CGL) policy.
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