When Crafting a Severance Agreement, Should You Follow the Guidelines of the State the Employee Resides/Works in or the State Where the Company is Incorporated?

May 29, 2024

Before addressing the specific question about which state’s laws would apply for the enforcement or consideration of a severance agreement, it is important to address the importance of such agreements in the first place. Certainty is important in all business operations, and discharging employees is no exception.

When you are discharging an employee from your company, in many instances it it may be beneficial to the employer to provide a severance package to the departing employee.  While the employee may have no potential employment law claim against your company (i.e., for discrimination or otherwise), providing a severance package can provide you with certainty that the employee is foreclosed from bringing any action.

To that end, the severance agreement should contain a general release of claims in exchange for the employee’s receiving compensation. Note, most departing employees are not entitled to any severance at all, so providing compensation in exchange for a general release of claims is an important step for the certainty you’re seeking. There are also federal, state, and potentially local provisions that should be incorporated depending on the location of the employer, employee, and age of the employee.

A severance agreement is a contract. Generally speaking, the law of the state where the contract is enforced is the law that would apply.  Many companies are incorporated in states far from where the employee lives or works, therefore the general rule would be that the law of the state where the employee lives or works would apply.

Further, since the severance agreement is a contract, one could include a choice of law provision in the terms. That is, the agreement itself could dictate which state’s laws would apply. However, a choice of law provision could be defeated.  While parties to a contract generally have the freedom to choose the governing law, this freedom is not absolute. If applying the chosen state’s law would significantly conflict with a fundamental policy of a state whose law would otherwise apply, the choice of law provision could be stricken. Fundamental public policy considerations of a state can take precedence over the choice of law provision in a contract.

The bottom line is that the determination of which state law applies in the enforcement of a contract is a nuanced issue that depends on several factors, including the specifics of the contract and the circumstances of its enforcement. Employers should consult with experienced employment counsel with respect to drafting severance agreements to be in compliance with all applicable laws.

This article, slightly modified to note recent updates, was featured online in the Wisconsin Employment Law Letter and published by BLR®—Business & Legal Resources. Reproduced here with the permission of BLR®—Business & Legal Resources.