Drafting Severance Clauses in Australian Employment Contracts

If you employ staff (or you’re about to), chances are you’ve seen the words severance clause pop up in templates, negotiation emails, or even in a clause someone insists is “standard”.

But for small business owners, a severance clause can feel like a double-edged sword. On one hand, you want certainty and a clean exit path if a role changes or a relationship ends. On the other hand, you don’t want to accidentally promise more than the law requires, or draft something that increases risk and costs when things go wrong.

This guide breaks down what a severance clause is (in plain English), where it usually sits in your employment and contractor documentation, how it interacts with Australian employment laws, and what to include if you’re drafting one for your business.

What Is A Severance Clause (And Why Should Small Businesses Care)?

A severance clause is a contract term that sets out what happens if the working relationship ends - particularly what payments or benefits are provided on termination.

Depending on the context, it might cover:

• notice of termination and whether you can make a payment instead of requiring the person to work out the notice period
• redundancy or retrenchment-style payments (sometimes called severance pay)
• final pay items like accrued but unused annual leave, leave loading (where relevant), commissions, bonuses, or reimbursements
• conditions that must be met before a severance amount is paid (for example, returning property, complying with confidentiality, or signing a deed of release)
• any additional “ex gratia” amount (an extra payment you offer even though it’s not legally required)

Small businesses care about severance clauses because they can help you:

• reduce disputes by setting expectations early
• control costs by clearly limiting entitlements (where legally permitted)
• protect confidential information and customer relationships on exit
• avoid accidental promises that become enforceable obligations

Just as importantly, a well-drafted severance clause can help you terminate employment more smoothly when you’re under pressure - for example, during a restructure, a performance issue, or a change in business direction.

Severance Clause vs Notice, Redundancy And “Termination Payouts”: What’s The Difference?

In Australia, the term “severance” gets used loosely. To draft a good severance clause, it helps to separate the concepts that often get bundled together.

Notice Of Termination (Or Payment In Lieu)

Most employment relationships require notice to end the employment (unless there’s summary dismissal for serious misconduct).

Your clause should explain:

• how much notice is required (often aligned with the Fair Work Act minimums, and sometimes increased for senior roles)
• whether you can direct an employee not to attend work during notice (often called “garden leave”)
• whether you can make payment in lieu of notice (and what that payment includes)

For small businesses, clarity here matters because a termination often needs to be managed quickly, and the cost difference between “work out notice” vs “pay out notice” can be significant.

Redundancy Pay (Which Many People Call Severance Pay)

Redundancy is different to ordinary termination. It usually involves a role no longer being required, not a person being “let go” for misconduct or performance issues.

Redundancy pay may apply under the Fair Work Act (and/or an applicable modern award or enterprise agreement), but there are exceptions and variations. For example, some small businesses are exempt from redundancy pay under the NES, and awards or agreements can change the position. The calculation can be complex and changes based on length of service and coverage.

If redundancy is a realistic scenario in your business, it’s worth understanding how payouts can work before you rely on a clause. A good starting point is Sprintlaw’s redundancy calculator to get a practical sense of the numbers that can be involved.

Final Pay Items (Accrued Leave And Other Entitlements)

Even if your severance clause doesn’t offer “extra” money, an employee may still be entitled to final pay items such as:

• unpaid wages up to the termination date
• unused annual leave (and sometimes leave loading, depending on the instrument and contract terms)
• other contractual entitlements (for example, commissions already earned under a commission structure)

It’s common to include a short “final pay” paragraph in the severance clause so the contract clearly states what will be paid out and when.

“Severance” In Contractor Agreements

Contractors aren’t employees. That means most statutory employee entitlements (like redundancy pay and paid leave) generally won’t apply to genuine contractors.

However, contractor agreements often include termination and “exit” provisions that look severance-like, including:

• a notice period for ending the services
• a termination fee (sometimes used to compensate for committed time or to secure continuity)
• payment for work performed up to termination and any approved expenses

Be careful here: if the relationship is actually employment in substance, calling someone a contractor in the agreement won’t necessarily protect you. This is one reason your contractor documentation should be consistent with how the relationship actually operates.

How A Severance Clause Interacts With Australian Employment Law

This is the part many businesses miss: a severance clause does not exist in a vacuum. It sits inside a legal framework that can override or limit what you can agree to.

Minimum Standards Still Apply (Even If The Contract Says Otherwise)

Employment contracts can’t undercut minimum legal entitlements that apply to the employee. These minimum standards can come from:

• the Fair Work Act 2009 (Cth)
• the National Employment Standards (NES)
• a modern award
• an enterprise agreement

So if your severance clause says “no notice is required”, but the law requires notice (and no lawful basis exists for summary dismissal), the clause is unlikely to protect you.

You Can Offer More Than The Minimum (But Be Deliberate)

Many businesses choose to offer more than the minimum, particularly for:

• senior employees
• specialist roles where hiring is competitive
• roles where a clean exit is important to protect goodwill and client relationships

That’s where a severance clause becomes a commercial decision, not just a legal one. The key is ensuring you understand the cost exposure and that the clause is drafted to match how you want to operate.

Be Careful With “Automatic Payout” Language

One common pitfall is accidentally creating a promise that triggers in situations you didn’t intend.

For example, phrases like “if the employment ends for any reason, the employee will receive…” can unintentionally cover resignations, terminations for serious misconduct, or probationary exits - which might not align with your business expectations.

It’s usually safer to:

• define which termination scenarios trigger the payment
• expressly exclude scenarios where it won’t apply (for example, serious misconduct, resignation without notice, or termination during probation, if appropriate)
• make the severance payment conditional (for example, upon signing a deed of release)

Don’t Forget The Unfair Dismissal / General Protections Risk

A severance clause is not a free pass to terminate.

Even if you pay someone a severance amount, a termination can still create risk if the process is mishandled or the reason is unlawful. Paying extra may help facilitate an agreed exit, but it won’t automatically prevent an employee from bringing (or succeeding in) an unfair dismissal or general protections claim.

This is why severance clauses work best as part of a broader approach that includes:

• a fit-for-purpose Employment Contract
• clear performance management processes
• proper termination documentation when issues arise

When Should You Include A Severance Clause In Your Contracts?

Not every small business needs a complex severance clause.

In many cases, a standard contract that clearly covers notice, termination grounds, and final pay is enough. However, you should consider including (or negotiating) a more detailed severance clause where:

• you’re hiring for a senior role (for example, a general manager, head of sales, or executive)
• the employee is leaving another secure role and wants certainty if it doesn’t work out
• the business is scaling and you anticipate role changes, restructures, or reallocation of duties
• you’re acquiring or selling a business and you need clarity about termination costs and liabilities
• you want a clean “break” on exit (especially where the employee has access to sensitive information, pricing, or customer lists)

It can also be useful in fixed-term arrangements, maximum term arrangements, or project-based roles - but these require careful drafting because the termination rights and payout mechanics can become complicated fast.

What To Include In A Severance Clause: A Practical Drafting Checklist

If you’re drafting a severance clause (or reviewing one proposed by a candidate), here are the core elements to think through.

1. Define The Trigger Events Clearly

Start with the basics: When does the severance clause apply?

Common trigger events include:

• termination by the employer without cause
• termination due to redundancy
• termination following a change of control (more common in larger companies, but sometimes used in growing businesses)

Also consider what should not trigger severance, such as:

• resignation
• serious misconduct
• termination during probation (if you have a probation period)
• failure to comply with lawful directions or policies (depending on your circumstances)

If you’re unsure about probation risk and termination mechanics, it’s worth aligning this with your broader approach to termination during probation so the documents work together.

2. Set Out Exactly What Is Paid (And What Is Not)

A severance clause should be specific about the components of any payout. For example:

• Notice: what notice applies, or whether you can provide payment in lieu
• Severance amount: how it’s calculated (a fixed sum, a number of weeks’ pay, or a formula)
• Accrued entitlements: unpaid wages and accrued annual leave
• Bonuses and commissions: whether they are paid, pro-rated, or excluded (and how “earned” is defined)
• Benefits: whether a car allowance, phone allowance, or other benefit continues during the notice period

Small drafting choices can have big financial outcomes. For example, “weeks of base salary” is different to “weeks of total remuneration” (which may include allowances).

3. Address Timing: When Will You Pay?

For small businesses, cash flow is real, and termination costs can be lumpy.

Consider stating:

• the timeframe for final pay and severance payment (for example, within X days of termination)
• whether any additional severance component is paid in a lump sum or instalments (instalments can be workable in some situations, but should be documented carefully and you should still ensure minimum entitlements are paid on time)

If you want flexibility, it’s worth thinking through how that flexibility impacts enforceability and employee expectations.

4. Make The Payment Conditional (Where Appropriate)

Many severance arrangements are offered as part of a “clean break”. If that’s what you want, you can set conditions to manage risk.

Common conditions include:

• returning company property
• confirming all passwords and access credentials are returned/removed
• continued compliance with confidentiality obligations
• signing a deed of release/settlement (often used where there is dispute risk)

Be careful: conditions can’t be used to withhold minimum legal entitlements (like unpaid wages or accrued annual leave). Usually, conditions apply to the additional severance component, not to statutory minimum amounts.

5. Consider Post-Employment Protections

Severance clauses often sit alongside (or interact with):

• confidentiality obligations
• non-solicitation clauses (not poaching clients or staff)
• restraint of trade clauses (limited non-compete terms, where appropriate)

If you’re relying on these protections, it’s important they’re drafted carefully and proportionately - overly broad restraints are harder to enforce.

6. Ensure The Severance Clause Matches Your Other Documents

Inconsistency is a common problem for growing businesses.

For example, you might have:

• an employment contract that says 4 weeks’ notice
• a workplace policy that talks about different notice periods
• a severance clause that refers to “statutory notice only”

These mismatches create confusion and can make an exit more contentious than it needs to be.

If you’re updating or rolling out contracts across the team, it can be helpful to treat this as a broader employment compliance project rather than a one-off clause draft.

Common Severance Clause Mistakes Small Businesses Should Avoid

Even well-meaning businesses can run into problems when severance language is copied from overseas templates or pieced together from multiple sources.

Using US/International “Severance” Templates Without Australian Context

In Australia, severance arrangements operate within the Fair Work system, modern awards, and the NES.

International templates may refer to concepts that don’t map neatly onto Australian law (or ignore award obligations entirely). The result can be a clause that doesn’t do what you think it does.

Accidentally Creating A Redundancy Entitlement Beyond What You Intended

If your severance clause promises redundancy pay in circumstances where redundancy doesn’t legally apply (or promises a more generous redundancy scheme than you can sustain), you can unintentionally lock your business into a costly obligation.

This is especially risky if you use broad language like “if your employment ends due to business reasons” without defining what that means.

Not Clarifying Whether Superannuation Applies To The Severance Amount

Superannuation and tax treatment can depend on what the payment represents (for example, ordinary time earnings vs other kinds of termination payments) and how it is structured.

While you don’t need to turn your severance clause into a tax memo, you should avoid ambiguous wording that creates disputes about what’s included and what’s excluded, and consider getting tax/accounting advice for your specific situation.

Forgetting To Align With How You Actually Manage Terminations

If your clause assumes you will always provide working notice, but your real-world practice is to pay out notice and end access immediately, that mismatch can create operational and security problems.

It’s often better to include explicit rights around payment in lieu and directions during notice so the contract supports your practical business needs.

Ignoring The Broader “Exit” Paperwork

A severance clause is only one piece of the “exit” puzzle.

Depending on what happens, you may also need:

• a separation or release deed (if you’re negotiating terms)
• updated system access and confidentiality reminders
• final pay calculations and recordkeeping

If you’re unsure what should be included in your employment documentation suite more broadly, having a strong contract foundation upfront is usually the best place to start.

Key Takeaways

• A severance clause sets out what is paid (and under what conditions) when a working relationship ends, and it can be a useful risk-management tool for small businesses.
• In Australia, severance concepts often overlap with notice, payment in lieu, final pay and redundancy, so it’s important to draft the clause with those differences in mind.
• A severance clause can’t override minimum legal entitlements under the Fair Work Act, the National Employment Standards, and any applicable award or enterprise agreement.
• The most common drafting risks are vague trigger events, overly broad “automatic payout” wording, and clauses copied from non-Australian templates.
• A practical severance clause should clearly define trigger events, specify exactly what is paid, set payment timing, and align with the rest of your employment contract and termination processes.

Note: This article is general information only and isn’t legal, tax or accounting advice. Your obligations (including redundancy, notice, superannuation and tax treatment of termination payments) can vary based on the Fair Work Act, the NES, any applicable award or enterprise agreement, and your specific circumstances. If you’re unsure, get advice for your situation.

If you’d like help drafting or reviewing a severance clause for your Employment Contract (or contractor terms), you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.