<PAGE>   1
                                                                   Exhibit 10.37

                               SEVERANCE AGREEMENT
                         AND GENERAL AND SPECIAL RELEASE

This Severance Agreement and General Release ("Agreement") is entered into as of
this 6th day of October, 1999 by and between William Schmidt ("Executive"), on
the one hand, and Oakley, Inc., a Washington corporation ("Company"), on the
other hand (collectively, the "Parties").

                                    RECITALS

               WHEREAS, Executive has been employed by the Company as Chief
Executive Officer, pursuant to an employment agreement with the Company dated
May 1, 1999 (the "Employment Agreement");

               WHEREAS, Executive wishes to voluntarily terminate his employment
with the Company effective October 6, 1999;

               WHEREAS, pursuant to the terms of the Employment Agreement the
Company is not obligated to pay and Executive is not entitled to receive any
severance payment whatsoever upon his resignation from the Company; and

               WHEREAS, the Company has determined that it would be in the best
interest of the Company and its shareholders to offer Executive a severance
package, in exchange for Executive's full release of claims against the Company
and the other covenants and agreements contained herein.

               NOW THEREFORE, in consideration of the promises and mutual
covenants contained herein, and for other good and valuable consideration, the
receipt and sufficiency of which are expressly acknowledged, the Parties agree
and promise as follows:

               1. EXECUTIVE'S TERMINATION.

                      Pursuant to this Agreement, Executive's employment with
Company is terminated effective October 6, 1999 (the "Separation Date").

               2. SEVERANCE PAYMENT.

                      a. In consideration of Executive's release of claims and
Executive's other covenants and agreements contained herein, except as provided
in clause (B) below, ten (10) days after the later to occur of (i) the
Separation Date, and (ii) Executive's execution of this Agreement and delivery
to the Company, and provided that Executive has not exercised any revocation
rights as provided in Section 4, below, the Company shall pay Executive as a
severance benefit (the "Severance Benefit") (A) his First Year Base Salary (as
defined in the Employment Agreement) through May 1, 2001, in a lump sum payment,
less all applicable federal, state or local taxes and other normal payroll
deductions, (B) a bonus (the "1999 Performance Bonus") equal to either (1) 60%
of his First Year Base Salary if the Company's diluted net income per common
share ("EPS"), as determined by the Company's independent accountants in
accordance with generally accepted accounting principles, for the calendar year
ended December 31, 1999, equals or exceeds $0.45 per share (without giving
effect to any rounding to the nearest whole cent) or (2) $64,898 (which amount
equals the product of $100,000 and a fraction, the numerator of which is 159
(the number of days between May 1, 1999, and the Separation Date) and the
denominator of which is 245 (the number of days between May 1, 1999, and
December 31, 1999)) if the Company's EPS is less than $0.45 per share, which
bonus shall be paid as soon as practicable following March 31, 2000, and (C) a
one-time lump sum payment of $5,000, which amount shall be used at Executive's
discretion to obtain outplacement services for Executive's benefit. In addition,
as a Severance Benefit, the Company



                                       1
<PAGE>   2

shall continue to make lease payments of $1,168.48 per month for Executive's
leased automobile for a period of three months from October 6, 1999, provided
that within three days following the end of such three month period Executive
shall deliver the automobile to the Company in similar condition to when he
first received the leased the automobile in September 1999.

                      b. Except for (i) the Severance Benefit pursuant to
Section 2(a) above, and (ii) Executive's salary and all other compensation
through the Separation Date, including any earned but unpaid vacation pay,
Executive shall not be entitled to receive any other compensation or benefits of
any sort including, without limitation, salary, vacation, bonuses, stock
options, short-term or long-term disability benefits, or health care coverage
(except as provided under applicable state or federal law), from the Company,
its affiliates, or their respective partners, principals, officers, directors,
shareholders, managers, employees, agents, representatives, or insurance
companies, or their respective predecessors, successors or assigns at any time;
and

                      c. Executive acknowledges and agrees that the Severance
Benefit provided under Section 2(a) above, constitutes consideration which, but
for the mutual covenants set forth in this Agreement, Company is not otherwise
obligated to provide, nor is Executive otherwise entitled to receive.

               3. MUTUAL RELEASE. In consideration of the payment made pursuant
to Section 2, above, and the Company's and Executive's other covenants and
agreements contained herein, the Parties hereby release and discharge each
other, and Executive hereby releases and discharges the Company's past and
present shareholders, and the officers, directors, managers, employees, agents,
attorneys, servants, affiliates, predecessors, successors and assigns of each of
them, and its and their insurers, employee welfare benefit plans, and pension or
deferred compensation plans, along with their respective trustees,
administrators, and fiduciaries (collectively, the "Released Parties") from any
and all claims, charges, complaints, liens, demands, causes of action,
obligations, damages and liabilities, known or unknown, suspected or
unsuspected, that the Parties had, now have, or may hereafter claim to have
against the Released Parties, arising out of or relating in any way to
Executive's hiring by, employment with, or separation from the Company or
otherwise relating to any of the Released Parties from the beginning of time
through the later to occur of (i) the Separation Date, and (ii) the date on
which Executive actually receives the Severance Benefit. This release
specifically extends to, without limitation, claims or causes of action for
wrongful termination, impairment of ability to compete in the open labor market,
breach of an express or implied contract, breach of any collective bargaining
agreement, breach of the covenant of good faith and fair dealing, breach of
fiduciary duty, fraud, misrepresentation, defamation, slander, infliction of
emotional distress, disability, loss of future earnings, and claims under the
California constitution, the United States Constitution, and applicable state
and federal fair employment laws, federal equal employment opportunity laws, and
federal and state labor statutes and regulations, including, but not limited to,
the Civil Rights Act of 1964, as amended, the Fair Labor Standards Act, as
amended, the National Labor Relations Act, as amended, the Labor-Management
Relations Act, as amended, the Worker Retraining and Notification Act of 1988,
as amended, the Americans With Disabilities Act of 1990, as amended, the
Rehabilitation Act of 1973, as amended, the Executive Retirement Income Security
Act of 1974, as amended, the Age Discrimination in Employment Act of 1967, as
amended, and the California Fair Employment and Housing Act, as amended; and

               The Parties expressly waive all rights afforded by Section 1542
of the Civil Code of the State of California ("Section 1542") with respect to
the Released Parties. Section 1542 states as follows:

               A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR
               DOES NOT KNOW OR SUSPECT TO EXIST IN HIS FAVOR AT THE TIME OF
               EXECUTING THE RELEASE, WHICH IF KNOWN BY HIM MUST HAVE MATERIALLY
               AFFECTED HIS SETTLEMENT WITH THE DEBTOR.



                                       2
<PAGE>   3
Notwithstanding the provisions of Section 1542, and for the purpose of
implementing a full and complete release, each of the Parties understands and
agrees that this Agreement is intended to include all claims, if any, which each
of the Parties may have and which each of the Parties does not now know or
suspect to exist against the Released Parties and this Agreement extinguishes
those claims.

               4. REVIEW AND REVOCATION PERIOD. Executive acknowledges that the
Company has advised Executive that he may consult with an attorney of
Executive's choosing prior to signing this Agreement and that Executive has
twenty-one (21) days during which to consider the provisions of this Agreement,
although Executive may sign and return it sooner. Executive further acknowledges
that Executive has been advised by the Company that Executive has the right to
revoke this Agreement for a period of seven (7) days after signing it and that
this Agreement shall not become effective or enforceable until such seven
(7)-day revocation period has expired. Executive acknowledges and agrees that if
Executive wishes to revoke this Agreement, Executive must do so in writing, and
that such revocation must be signed by Executive and received by the Company no
later than 5:00 p.m. Pacific Daylight Time on the seventh (7th) day after
Executive has signed this Agreement. Executive acknowledges and agrees that, in
the event that Executive revokes this Agreement, Executive shall have no right
to receive any benefits hereunder, including the Severance Payment. Executive
represents that Executive has read this Agreement and understands its terms and
enters into this Agreement freely, voluntarily, and without coercion.

               5. NO DISPARAGEMENTS. Executive and the Company agree that
neither Executive nor the Company shall make any oral or written, public or
private, statements that are disparaging of Executive or the Company, its
affiliates, or their respective partners, principals, officers, directors,
shareholders, managers, employees, agents, representatives, or their respective
predecessors, successors or assigns at any time; provided, however, nothing in
this Section 5 shall preclude Executive or the Company from making truthful
factual statements regarding Executive or former officers, directors or
employees of the Company.

               6. RETURN OF THE COMPANY'S DOCUMENTS AND PROPERTY. Executive
agrees to return all records, documents, proposals, notes, lists, files and any
and all other materials including, without limitation, computerized and/or
electronic information that refers, relates or otherwise pertains to the
Company, its affiliates, and/or their respective partners, principals, officers,
directors, shareholders, managers, employees, agents, representatives, or
insurance companies, or their respective predecessors, successors or assigns at
any time. In addition, Executive shall return to the Company all property or
equipment that he has been issued during the course of his employment or which
he otherwise currently possesses. Executive shall deliver to the Company at its
offices in Foothill Ranch, California on or before the Separation Date at
Executive's expense all of the Company's records, documents, proposals, notes,
lists, files and materials and property and equipment that are in his
possession. Executive is not authorized to retain any copies of any such
records, documents, proposals, notes, lists, files or materials. Nor is he
authorized to retain any other of the Company's property or equipment.

               7. PROPRIETARY INFORMATION. Executive acknowledges that Executive
has had or may have had access to proprietary information, trade secrets, and
confidential material of the Company or its affiliates, including, but not
limited to, all ideas, information and materials, tangible or intangible, not
generally known to the public, relating in any manner to the business of the
Company, its personnel (including partners, principals, employees and
contractors), its clients or others with whom it does business that Executive
learned or acquired during the period of Executive's employment with the Company
("Proprietary Information"). Proprietary Information includes, but is not
limited to, manuals, documents, computer programs, source code, users manuals,
algorithms, compilations of technical, financial, legal or other data, client or
prospective client lists, names of suppliers, specifications, designs, business
or marketing plans, forecasts, financial information, work in progress, and
other technical or business information. Executive agrees, without limitation in
time or until such Proprietary Information shall become public other than by
Executive's unauthorized disclosure, to maintain the confidentiality of such
information and to



                                       3
<PAGE>   4

refrain from divulging, disclosing, or otherwise using said Proprietary
Information to the detriment of the Released Parties, or for any other purpose.
Executive further acknowledges and agrees that he continues to be bound by and
will abide by any and all prior confidentiality and/or non-disclosure agreements
entered into by and between Executive and the Company, and that nothing in this
Agreement in any way alters, amends, or waives any such duties and/or
obligations Executive has or may have under such other agreements.

               8. COOPERATION IN LITIGATION. Executive shall cooperate with the
Company, its affiliates, and each of their respective attorneys, barristers,
solicitors or other legal representatives (collectively, "Attorneys") in
connection with any claim, litigation, or judicial or arbitral proceeding which
is now pending or may hereinafter be brought against the Company or its
affiliates by any third-party. Executive's duty of cooperation shall include,
but not be limited to, (a) meeting with the Company's and/or its affiliates'
Attorneys by telephone or in person at mutually convenient times and places in
order to state truthfully his knowledge of matters at issue and recollection of
events; (b) appearing at the Company's, its affiliates' and/or their Attorneys'
request (and, to the extent possible, at a time convenient to Executive that
does not conflict with the needs or requirements of his then-current employer)
as a witness at depositions or trials, without necessity of a subpoena, in order
to state truthfully Executive's knowledge of matters at issue; and (c) signing
at the Company's, its affiliates' and/or their Attorneys' request declarations
or affidavits that truthfully state matters of which Executive has knowledge.
The Company and/or its affiliates shall promptly reimburse Executive for his
actual and reasonable travel or other expenses that he may incur in cooperating
with the Company, its affiliates, and/or their Attorneys pursuant to this
Section 8.

               9. NON-ADMISSION OF LIABILITY. Nothing in this Agreement shall be
construed as an admission of liability by Executive or the Released Parties;
rather, Executive and the Released Parties are resolving all matters arising out
of their employer-employee relationship and all other relationships between
Executive and the Released Parties, as to each of which each of the Released
Parties and Executive deny any liability.

               10. CONFIDENTIALITY. Executive covenants and agrees that neither
he nor his attorneys or representatives shall reveal to anyone, except his
spouse, accountants for income tax and audit purposes, and attorneys for
purposes of the enforcement of this Agreement, any of the terms of this
Agreement, except as may be mutually agreed upon in writing or otherwise
required by law or court order.

               11. BINDING EFFECT. This Agreement shall be binding upon the
Parties and their respective heirs, administrators, representatives, executors,
successors and assigns, and shall inure to the benefit of the Parties and their
respective heirs, administrators, representatives, executors, successors and
assigns.

               12. SEVERABILITY. While the provisions contained in this
Agreement are considered by the Parties to be reasonable in all circumstances,
it is recognized that some provisions may fail for technical reasons.
Accordingly, it is hereby agreed and declared that if any one or more of such
provisions shall, either by itself or themselves or taken with others, be
adjudged to be invalid as exceeding what is reasonable in all circumstances for
the protection of the interests of the Company, but would be valid if any
particular restrictions or provisions were deleted or restricted or limited in a
particular manner, then the said provisions shall apply with any such deletions,
restrictions, limitations, reductions, curtailments, or modifications as may be
necessary to make them valid and effective and the remaining provisions shall be
unaffected thereby.

               13. ENTIRE AGREEMENT; MODIFICATION. This Agreement constitutes
the entire understanding among the Parties and may not be modified without the
express written consent of the Parties. This Agreement supersedes all prior
written and/or oral and all contemporaneous oral agreements, understandings and
negotiations regarding the subject matter hereof. Notwithstanding the foregoing,
the provisions of the Employment Agreement shall remain in effect, except as
otherwise modified herein.



                                       4
<PAGE>   5

               14. GOVERNING LAW. This Agreement shall be governed by and
construed and enforced pursuant to the laws of the State of California
applicable to contracts made and entirely to be performed therein.

               15. VOLUNTARY AGREEMENT; NO INDUCEMENTS. Each Party to this
Agreement acknowledges and represents that he or it (a) has fully and carefully
read this Agreement prior to signing it, (b) has been, or has had the
opportunity to be, advised by independent legal counsel of his or its own choice
as to the legal effect and meaning of each of the terms and conditions of this
Agreement, and (c) is signing and entering into this Agreement as a free and
voluntary act without duress or undue pressure or influence of any kind or
nature whatsoever and has not relied on any promises, representations or
warranties regarding the subject matter hereof other than as set forth in this
Agreement.

               IN WITNESS WHEREOF, the Parties have set their hand as of the
date first written above.

                                    EXECUTIVE:


                                    /s/ William O. Schmidt
                                    ---------------------------------------
                                    WILLIAM SCHMIDT



                                    OAKLEY, INC.:


                                    By: /s/ Link  Newcomb
                                        ----------------------------------
                                    Its: C.O.O.
                                         ---------------------------------



                                       5