Part 1: Introduction

Severance payments: A guide for the public sector.

This guide is intended to help public sector employers when considering making a severance payment to a departing employee. It replaces our 2012 publication, and has been updated to reflect more recent case law and changes in accounting standards.

In this Part, we discuss:

Why severance payments are sometimes made

Public sector employers are expected to follow good human resources practices to avoid employment relationship breakdowns, and to follow proper processes to avoid or reduce risk. Their overriding duty under the Employment Relations Act 2000 is to act in good faith. But even the best practices cannot completely prevent problems. When employment difficulties arise, they need to be resolved in the best interests of the public organisation and the employee.

Severance payments are unlikely to be warranted when:

  • problems are resolved and the employment relationship can continue;
  • the parties agree to end the employment relationship on the ordinary contractual terms; or
  • there is sound legal justification for the employer to terminate the employment relationship, proper process has been followed, and the termination is justified.

However, sometimes there is no readily available solution or process to follow, or the parties might disagree on the issues or the process. The problem might not be one that legislation or employment agreements have provided for. The employer might be in a situation where the relationship has broken down, or there is a complete lack of faith or confidence, but there are no valid grounds for ending the person’s employment or where there may otherwise be a lengthy formal process. Alternatively, the employer might be facing a personal grievance claim. In circumstances when an employer and an employee are in dispute, or one or both are dissatisfied, an exit on agreed terms (including a severance payment) can be a sensible and appropriate solution.

Common situations that might lead to the parties considering an agreed exit include:

  • the employer being dissatisfied with the employee’s performance, or issues arising in the course of the performance management process;
  • disciplinary processes;
  • the employee raising a personal grievance about a workplace issue and/or claiming that they have been constructively dismissed;
  • the board or senior management being dissatisfied with the chief executive or senior employee, resulting in a loss of trust and confidence in each other;
  • a change of board members or senior management, and assessment that an employee’s skills are not those required in the role;
  • a dispute over renegotiation of position description, remuneration, or terms of employment;
  • relationship difficulties affecting the functioning of a role or the well-being of staff;
  • claims of bullying or harassment;
  • stress claims;
  • a restructuring situation leading to a dispute about the process or outcome; or
  • a personality clash between an employee and their manager, or between managers, particularly at a senior level.

Typically, discussions between the parties on such matters will involve either direct negotiation between the parties and their advisers or the mechanisms available under the Employment Relations Act. These mechanisms include raising an employment relationship problem, seeking mediation assistance, and submitting a statement of problem to the Employment Relations Authority.

A major failing of trust and confidence can occur at any level but is more common at senior levels. Breakdowns in relationships between boards or stakeholders and chief executives or senior managers can be particularly intractable. Employers might not consider it appropriate or practicable to run a performance management process for a chief executive or senior manager. The issue might not be one of clearly identifiable poor performance or serious misconduct, but might still be causing serious risk to the public organisation or a significant distraction from the organisation’s core business or operations.

Although the general requirements for a fair disciplinary process are well known, employers can find these processes difficult and risky and they can have a significant effect on the employee. The high-level requirements of a fair process are described in legislation (s103A(3) of the Employment Relations Act), and there is also established case law to provide guidance. The procedural requirements focus on ensuring fairness to the employee involved and, as such, can be challenging for the employer in some circumstances. They have traditionally required careful attention to detail as the process unfolds. The required standard of substantive justification for dismissal is high, and the expectations of the Employment Relations Authority and Employment Court of public sector employers are arguably higher than their expectations of private sector employers.1 One of the contextual tests for considering the fairness and reasonableness of an employer’s actions is “the resources available to the employer” (s103A(3)(a) of the Employment Relations Act). A public organisation, even a relatively small agency, will be presumed to have access to resources.

Employees called to account for their performance or conduct can challenge the substance or process at any stage. At times this might be tactical or designed to cause delay, and make the process resource-intensive and time-consuming. This can further strain the employment relationship and risk adversely affecting how the public organisation functions and day-to-day working relationships.

Even a well-planned and well-implemented process can go awry and face unexpected delay or, if challenged, fail to meet the high expectations of justification or fairness and be ruled unjustified. Therefore, reaching an agreed severance arrangement can be a cost-effective and low-risk option, especially where the risk of successful legal action by the employee is assessed as high or the effects on the public organisation are becoming significant.

Sometimes, employees ask for exit packages that include a severance payment. This can be during the course of, or at the end of, a performance management process or a disciplinary process. The employee would rather leave on agreed terms than go through a long process or risk dismissal, and/or the employer might be willing to include a severance payment to avoid the risk, stress, and cost of the process and any legal challenge. However, this should not be the normal approach. The particular circumstances need to be carefully assessed to decide whether this is a justifiable response. Some of the factors to consider are described in the next Part (see paragraph 2.22).

Difference between contractual entitlements and severance payments

Employers need to clearly distinguish between the different types of payments made to an employee when their employment ends. The relevant considerations and disclosure rules will vary depending on the type of payment (and the seniority of the employee – see Part 3).

Contractual entitlements

Any payment that is required to be made under an employment agreement is a contractual entitlement, not a severance payment. Contractual entitlements can include:

  • any specified period of notice, which can be paid out instead of worked (usually at the employer’s discretion);
  • any payment due if an employee’s position becomes redundant;
  • annual leave that has been earned but not taken at the time of termination;
  • any benefits that are part of the employee’s remuneration package and which they have become entitled to by the time they leave (for example, a bonus or incentive payment, or long-service leave);
  • any obligation to pay out the remaining period of a fixed-term agreement (if it is ended early); and
  • any disengagement payment (sometimes referred to as a “golden handshake”), if the agreement provides for it.2

If a departing employee is contractually entitled to any of these payments, the employer is under a legal obligation to make the payment and must do so. The payments cannot usually be withheld or negotiated.

An employer can pay a contractual entitlement where it has not yet accrued, or make a small payment that it is not legally obliged to make. This might be on compassionate grounds or because it is what a “fair and reasonable” employer would do in the circumstances. Long service, illness, or other personal circumstances might warrant such a gesture.

For example, an employee might resign because of family illness when she is two months short of the 20 years required for long-service leave of four weeks. The employment agreement specifies that if the employee resigns or is dismissed before 20 years, she is not paid anything for long service. The employer might decide to pay the employee’s long-service leave or part of it, because the employer considers a payment to be fair and reasonable in the circumstances. There is a sound basis for the payment, but in formal terms it is a discretionary severance payment.

Certain contractual payments for senior managers might have to be disclosed as severance payments

We do not usually regard contractual entitlements under an employment agreement as severance payments. However, in some situations, contractual payments related to a person’s departure might need to be disclosed under the broad heading of severance payments. In particular, accounting rules require the disclosure of some contractual entitlements paid to key management personnel as “termination benefits”. Disclosure requirements will depend on the particular definition applying to the public organisation and situation (see Part 3).

Severance payments

A severance payment is any payment that is made in addition to the employee’s contractual entitlements as part of an agreement to end their employment. Severance payments are made to help resolve an unsatisfactory employment situation or might be agreed to bring the employee’s employment to an end for other reasons. Sometimes, the payment might not be monetary (for example, the employer might agree that the employee can keep their laptop, mobile phone, or the work car that they have been driving).

The role of the auditor

Where a public organisation has made a severance payment to a departing employee, the auditor will consider whether the organisation has met public sector good practice expectations (including by looking into issues of probity
and waste).

In particular, the auditor will need to access information to assess:

  • whether the organisation has followed the correct approval process before deciding to offer a severance payment, including:
    • ensuring that approval is given by the right person within their delegated authority;
    • that the organisation has documented the process; and
    • that the organisation has taken legal advice, where appropriate; and
  • whether required disclosures have been made, as well as those required under the relevant accounting standards.

It is not generally the auditor’s role to examine the particular circumstances of the employment relationship, or the reasons for the severance payment, to assess whether the severance payment paid by a public organisation is appropriate. However, if a severance payment appears excessive, or not in keeping with public sector norms, it is likely to attract greater scrutiny, and the auditor might include a comment on the severance payment in their audit report or report to governors and management of the organisation.

1: See the comments of the Employment Court in Rankin v Attorney-General [2001] ERNZ 476.

2: Public sector employers should have prepared a reasonable business case for including such entitlements in employment agreements. Entitlements not in keeping with usual provisions in the sector can be subject to considerable public scrutiny and attract criticism. The payments are contractual, so they must be made – even if they are overly generous.