A Mathematical Formula for Calculating a Fair and Reasonable Severance Payment

July 17, 2012

Author: David Rice

Thousands of non-union employees are “laid off”, “downsized”, “let go”, “packaged out” or “early retired” each year.  While all of them have contracts of employment – written or partly written and partly oral – very few of these contracts state the length of notice, or severance pay in lieu, to which the employee is entitled in the event of termination of the contract without cause by the employer. 

In the absence of such a provision the common law states the contract contains an implied term that the employee is entitled to be given “reasonable notice” of termination.  What constitutes reasonable notice is determined by reference to several factors including the length of service, the age of the employee, the nature of the position, etc.  Hundreds and hundreds of reported decisions, countless employment law texts, and several computer analyses have considered these factors – usually categorized by job type.  Collectively they provide considerable guidance as to what a court will award an employee suing for damages for wrongful dismissal.  Given that, is there any magic formula that will give an employer and an employee confidence that a particular settlement figure is fair given the uncertainty and expense of a trial, the stress and antagonism that can result, and the difficulty in assessing a settlement offer when the re-employment prospects are uncertain? 

Although no such formula exists, consider the following:

                                    S = 5/8 CA
                                    Where “S” = Severance and “CA” = Court Award

There is no magic in the fraction “5/8”.  A case can be made for any number between 60% and 66 2/3%.  Obviously the amount of the potential court award will depend on the circumstances of the case. 

Assume that the middle of the range of the length of notice a court is likely to award the dismissed employee is 10 months.  The “formula” would generate a severance payment of 6 ¼ months. 

From the employee’s perspective the 6 ¼ months up front lump sum payment:

  1. eliminates the time, uncertainty and expense of a trial;
  2. allows the employee to “double dip” if she or he obtains another job;
  3. allows the employee the use of the money sooner than after a trial that might be months and months away; and
  4. avoids the stress and acrimony resulting from protracted negotiations or a trial. 

The 6 ¼ month payment should include the full range of benefits and other entitlements to which the employee would be awarded at trial such as commissions and bonuses, not just salary. 

From the employer’s perspective an amicable settlement based on “the formula”:

  1. avoids the expense of a protracted negotiation and/or a trial;
  2. avoids the uncertainty of a trial;
  3. avoids the exposure to a large severance payment (either negotiated or court-imposed) should the employee be unable to find another job; and
  4. provides a certain measure of comfort to other employees as to how they could be treated.

Some may argue that any discount to the contractual right to notice is unfair to a long-term, faithful employee.  Others will say, the majority in my experience, that discounting in this fashion is a fair compromise to address uncertainty – especially uncertainty in terms of the employee’s re?employability – and that a manager’s obligation to the owner/shareholder dictates such an approach.  


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