One of the toughest decisions a business owner or manager will ever face is terminating employees. While sometimes necessary due to performance or conflict, employee layoffs and terminations can sometimes expose companies to costly lawsuits, government investigations, and reputation-related damage. This risk escalates during a recession or hard economic times, when workforce reductions become more common and disputes over wrongful termination or discrimination claims increase.
For small and mid-sized businesses, knowing how to handle laying off employees is critical - not only to protect the company legally and financially but also to navigate the process with professionalism, empathy, and fairness.
The Legal Risks of Employee Layoffs
When letting an employee go, the decision must be legally sound and carefully documented to avoid potential lawsuits. Many employers assume that since their business operates under “at-will” employment laws, they can terminate employees at any time without issue. However, numerous federal, state, and local regulations still apply, and failing to follow them can result in expensive legal consequences.
Some of the most critical laws to consider include:
- Discrimination Protections – Employers must be careful to avoid terminating employees based on race, gender, age, disability, or other protected characteristics, even if the decision is business-driven.
- Wrongful Termination Claims – Employees who feel they were let go unfairly may claim they were fired without just cause or in violation of an employment contract. Even if the claim is baseless, legal fees alone can be costly to all parties involved.
- WARN Act Compliance – If a company has 100 or more employees, federal law requires 60-day notice before mass layoffs or plant closures. Some states have additional layoff notification requirements that you need to be aware of.
- Final Paycheck & Benefits Laws – State laws vary widely when it comes to final paycheck deadlines, accrued PTO payouts, and COBRA continuation coverage. Employers must follow state-specific rules to avoid penalties.
Ignoring these legal requirements can result in lawsuits, government penalties, and lasting damage to a company’s reputation. Business owners should consult experienced HR professionals to confirm that terminations are handled lawfully and ethically.
The Financial Impact of Employment Lawsuits
For many businesses, the real cost of a termination isn't just about severance pay—it's about the potential financial fallout if an employee files a lawsuit (especially if they win).
A wrongful termination lawsuit can cost a company easily anywhere from $50,000 to $100,000 or more, and that doesn’t include the indirect costs of lost productivity, reputational damage, and workplace morale issues. Even if a business wins the case, the time and money spent on legal defense can be overwhelming to say the least.
Legal disputes over layoffs and terminations can also create long-term cultural and operational consequences:
- Productivity drops as employees worry about job security and leadership decisions.
- Company culture suffers when employees perceive layoffs as unfair or mishandled.
- Hiring and retention challenges arise when job seekers see negative press or employee reviews about terminations.
The best way to mitigate risk is to approach terminations with a structured plan, clear communication, and legal safeguards in place to protect your company and reputation.
How Severance Agreements Can Reduce Legal Risk
One of the most effective ways to minimize post-termination disputes is by offering severance pay in exchange for a signed severance agreement. A properly drafted severance agreement protects businesses by ensuring that departing employees:
- Waive their right to sue for wrongful termination or discrimination claims.
- Agree to confidentiality clauses to protect sensitive company information.
- Refrain from making negative statements about the company, managers, or leadership.
Beyond the legal benefits, severance agreements also provide financial support to departing employees, allowing them to transition more smoothly into new job opportunities. This not only helps protect a company from legal battles but also fosters a sense of goodwill among former employees.
Real-World Consequences of Skipping Severance Agreements
In my 30+ years in HR, I or someone on my team has terminated over 1,000 employees. In nearly all cases, we offered severance agreements, and I have never had an employee sue us after signing one.
However, there were two instances where we didn’t offer severance agreements, and both resulted in costly legal battles:
- In one case, we won - but spent over $50,000 in legal fees just to defend ourselves.
- In another, a terminated employee claimed age discrimination. While I don’t believe age played a role, a jury disagreed, and the company had to pay over $1 million in damages.
In both situations, I strongly advised management to offer a small severance package in exchange for a signed agreement, but the recommendation was ignored. The result? Major financial and legal consequences that could have been avoided.
What to Do When You Need to Reduce Your Workforce
Workforce reductions are never easy, but companies can take steps to handle layoffs carefully and responsibly. You can also protect yourself from future situations that may happen again:
1. Plan & Document the Decision
Before making termination decisions, document the business reasons for the layoffs, whether it’s declining revenue, restructuring, or headcount redundancy. This documentation serves as protection if a former employee challenges the decision in court.
2. Review Legal & Compliance Requirements
Labor laws vary by state, and missteps in final paychecks, benefits, or notification requirements can result in costly penalties. Employers should consult HR professionals or legal counsel to verify compliance depending on where your company (or employees) are located.
3. Offer a Thoughtful Severance Package
Severance isn’t just about avoiding lawsuits—it also helps maintain morale and reputation. A well-planned severance package can:
- Reduce legal risk by securing a signed agreement from both parties.
- Provide financial stability to laid-off employees as they transition to a new role.
- Show professionalism and empathy, preserving the company’s reputation.
4. Communicate Transparently & Professionally
Layoff conversations should be clear, direct, and compassionate. Business leaders should always:
- Meet with employees privately to explain the decision.
- Provide details on severance, benefits, and outplacement support.
- Offer an opportunity for employees to ask questions if they desire.
5. Support Remaining Employees
Workforce reductions don’t just affect those being let go—they also impact remaining employees in many different ways. Leadership should communicate why the layoffs occurred and provide ongoing support to reassure the team about the company’s future.
Navigating Layoffs with Professional HR Support
For many businesses, handling employee layoffs properly requires HR expertise that may not be available in-house. Our Outsourced HR Services can help businesses:
- Reduce legal and financial risk with professional termination strategies.
- Handle workforce reductions with professionalism and empathy.
- Maintain compliance with employment laws at the state and federal levels.
Final Thoughts
Employee layoffs and terminations are never easy, but when handled strategically and legally, they can be less risky and less damaging to existing company culture. The key is to approach workforce reductions thoughtfully, communicate openly, and seek expert HR guidance from experts that know the ropes.
If your business is facing workforce reductions, Preferred CFO can help you navigate terminations safely and effectively. We handle the ins and outs of this difficult process to guide you through a difficult situation.
Need expert guidance on this or other HR topics and services? Contact us today to discuss your HR needs.
