You are the person in management at your company who is responsible for hiring the head of a new company division. You finally located the individual that you believe to be “the right one” for the job. However, you want to make certain that your new employee understands what the company expects from her and what the company will provide in return. Maybe there should be something in writing between the new employee and the company. You could always confirm the terms of the position in a letter to the employee, but what exactly does that accomplish? Does it give the company any protection? Does it obligate the company? Is it a contract? Maybe you should have an employment agreement with your new hire. You could take your own employment contract, make a few changes and use that document, but what changes to make? Does this new employee need the same provisions contained in your employment agreement? Do you really need anything in writing at all?

This scenario, its questions and its issues are faced by companies every day. When it comes to employment agreements, inertia is king. Those companies that have historically used employment agreements oftentimes follow past practice and continue to enter into employment agreements with new employees, even if doing so is not really necessary or advisable. On the other hand, companies that have historically not used employment agreements may tend to theorize that since they have not been “burned” in the past by not using them, why start now? Typically, employers fall into one of three categories: (1) companies that never use employment agreements (but should); (2) companies that use employment agreements with almost every employee (but shouldn’t); and (3) companies that tend to dredge out their old “Standard Employment Agreement” and simply change the employee’s name, title and salary on the form on the computer, without really considering alternative ways to structure the operative document that will define the essential terms of the employment relationship. In this article we discuss when employment agreements should be used, key provisions to consider and ways to ensure that your agreements actually work for you — not against you.

Why should employers use employment agreements?

Why would an employer enter into an employment agreement with an employee? There are several reasons. An employment agreement can provide clarity with respect to the parties’ expectations for the employment relationship. A well-drafted employment agreement can ensure that both the employer and the employee understand what the other expects concerning duties and responsibilities, compensation, benefits, and grounds to terminate the relationship. In addition, an employment agreement can clearly define an employee’s incentives to perform, such as requirements for bonuses, commissions, evaluations, performance goals and objectives and consequences for failure to meet those goals and objectives. An employment agreement can also confirm the status of employment — will employment be at will, or for a specified term, and how long will that term be? With an employment agreement, the employer can define minimum commitments and obligations for both the employer and the employee and, if well drafted, can minimize disputes based upon the termination of the employment relationship by clearly setting forth the terms under which the employer and employee may separate. Finally, in today’s workforce, in order to recruit certain executives, salespeople, or research and development personnel, the employer may have to provide the employee with some guarantees in writing in order to persuade that individual to enter into the employment relationship.

On the other hand, there are reasons not to have employment agreements, and most of those reasons concern the employer’s ability to end the employment relationship. Employment agreements restrict and limit an employer’s flexibility in terminating the employment relationship. Most employment agreements require “cause” as defined and agreed upon between the parties in order to terminate the relationship. In many agreements, if the employer seeks to terminate the contract, the termination must occur within a specified period of time prior to the end of the term of the agreement. Employment agreements usually require the employer to pay the employee some compensation at termination if the employment relationship is not terminated for “cause.” If the employment agreement is not terminated properly or if the employer deviates from its terms, the employer may face a claim for breach of contract and wrongful termination.
Therefore, while employment agreements can be useful tools, they are not arrangements to be entered into without careful thought, planning and consideration.

WHAT IF AN EMPLOYEE DOES NOT HAVE AN EMPLOYMENT AGREEMENT?

True or false? Absent a written or oral agreement of employment which specifies the duration or specific period for employment, an employer can terminate an employee at any time, for any reason or for no reason, with or without notice. Many employees will respond that any such statement is false because an employer cannot terminate an employee without good cause and some notice. However, the statement is absolutely true in the majority of states. Under the “employment at will” doctrine, in most states, as long as an employer does not terminate an employee for an illegal reason (e.g., discrimination, jury service, workers’ compensation claim, etc.) either party can terminate their employment relationship at any time for any reason and the employee has no claim for wrongful discharge.

There are some exceptions to the employment at will doctrine. Obviously, an employer with a unionized workforce under the terms of a collective bargaining agreement cannot terminate an individual’s employment in violation of that agreement. Some states have laws which provide that a period of compensation — for example, a monthly, semimonthly or weekly salary — creates a guaranteed period of employment for at least the time period provided by the compensation. There are federal and state laws that prohibit discharge from employment based upon discrimination, pursuing rights under wage and hour laws, service on a jury, or military service obligations. In addition, many states have statutes and regulations prohibiting discharge of employees due to the filing of a workers’ compensation claim, reporting an employer for illegal activities, political orientation or sexual preference. Although some states have some notice requirement prior to termination even absent an employment agreement, in the majority of states, provided that there is no employment agreement and provided that the reason for termination is not illegal, either the employer or the employee can terminate the employment relationship at any time for any reason or for no reason, with or without notice, and the employer will not face liability for a claim of wrongful termination or wrongful discharge.

Who should have an employment agreement?

Many employers operate under the belief that all employees should have employment agreements. This practice is particularly evident with European-based parent companies which, based upon employment laws in their countries, assume that each employee in their American subsidiary needs an employment agreement. Consequently, employers often have workforces where everyone from the president down to the receptionist has an employment agreement. Practically speaking, an employer’s use of employment agreements should be limited. The use of employment agreements should be reserved for employees whose absence would damage, limit or impair the company’s ability to conduct business, for employees who possess unique skills, knowledge or abilities, and for employees who would be extremely difficult to replace. Typically, employment agreements are best used for high-level executives, such as chief executive officers, chief financial officers, chief operating officers, presidents and vice presidents, heads of divisions or other members of upper management, significant research and development or information systems personnel and highly compensated or high-producing sales personnel. Generally, mid-level and lower-level employees and routine office personnel such as receptionists, administrative assistants, accounts receivable and accounts payable clerks, bookkeepers and even office managers should not have an employment agreement, so that employment may be terminated and the individuals replaced as needed without having to pay for a notice period or pay any form of severance pursuant to the terms of a contract.

A caveat on offer letters

Many employers use letters to extend an offer of employment and to outline the terms of that employment relationship. Unfortunately, many employers do not realize that offer letters can frequently form the basis for an enforceable agreement, especially when an employer asks the individual to sign the offer letter if accepted, date it and return it to the employer. Therefore, employers should carefully consider and review offer letters for any promises that might be construed as a guaranty of a particular length of employment, or that employment may only be terminated for “cause.” An employer should consider putting “at will” language in an offer letter. Such language should indicate that employment with the company is “at will” and may be terminated by the employer or the employee at any time, for any reason or for no reason, with or without notice. While such language may seem legalistic or cold, it can avoid having an offer letter construed as a contract for some specific term and avoid a great deal of confusion, hostility and legal fees.

What should be in an employment agreement?

Employment agreements are governed primarily by state laws, and the laws applicable to the construction, validity and enforcement of employment agreements differ from state to state. Generally speaking, for an employment agreement to be enforceable, it must contain the basic elements of a contract for services. That means that whether the contract is in writing or is an oral agreement or implied understanding between the parties that constitutes a contractual arrangement, there must be some identification or designation of the employee’s place of employment, a specific time period or fixed term for the period of employment, a description of the services that the employee is to provide and the amount of compensation the employee is to receive for the performance of those services. In addition, at least two parties must have entered into the contract — the employer and the employee.

Generally, the terms of any agreement must be sufficiently clear to be understood and enforced. A written employment agreement will be construed in favor of the party who was not involved in drafting the document and will be construed against the party who prepared the document. Therefore, employers should have their legal counsel review their employment agreements before such agreements are put into use.

A general rule of thumb is to avoid the use of any industry-specific or company-specific words or phrases. The agreement should be written so that a third party could easily read and understand the document. If the agreement is unclear, vague or ambiguous, it will provide fertile ground for misinterpretation and disputes between the parties and may very well render certain provisions or the entire contract invalid. If you must use an industry or company-specific word or phrase, make certain that the phrase is clearly defined in the contract. Do not assume that the term or phrase is understood by those who will be bound by the agreement.

Key Elements Of An Employment Contract

1. Description of Duties.

An employment agreement should contain a clear description of the employee’s job duties. Such a description should include the name or title of the position as well as the essential job functions or duties of the position, and any limitations on authority. In addition, the agreement should include language that requires the employee to put forth his or her best efforts on behalf of the employer, to focus all of the employee’s time, energy and effort on the interests of the employer during working hours, and to refrain from engaging in any activities or conduct that would damage or impair the company’s business. A description of job duties should include the place or location where the duties will be performed and the expected hours of employment or operating hours for the office or site of employment. The employer should make certain that the reporting relationship is described — from whom will the employee take direction and to whom will the employee report? An employer should make certain that the employment agreement states that the employee will perform the duties described for the position and any other duties that may be assigned to the employee from time to time by the employer.

2. Term of the Agreement.

One of the most important terms of the contract is the length of the agreement. While the importance of stating the term of the agreement should be self-evident, unfortunately, many employers tend to overlook or minimize the significance of this provision. The importance of the provision becomes painfully clear later on when the employer attempts to terminate the contract. An employment agreement should clearly set forth the term of the agreement. The written agreement can indicate that employment is “at will,” meaning that the employment relationship can be terminated by either party at any time with or without cause and for any or no reason, with or without notice, or by providing some minimum form of notice, such as written notice seven or fourteen days prior to termination. Keep in mind that when an employment agreement requires a notice period, the employee must be paid for that notice period. The agreement may be for a fixed term, such as one or two years. With a fixed term, the parties should clearly indicate what happens at the end of the term. In other words, the parties should decide whether the agreement will simply end or whether the agreement will continue, such as with a one-year extension of the agreement, unless one party provides notice to the other that there will be no extension of the contract.

3. Compensation.

An employment agreement should clearly set forth the terms of the employee’s compensation. An agreement should address any form of base compensation such as salary, hourly wages or commissions. For employees paid a salary, the compensation should be identified in two ways: by the amount that the employee will draw per pay period (weekly, biweekly, semimonthly), and by the total of those payments on an annualized basis. With an hourly rate, the agreement should clearly indicate at what intervals the employee will be paid, the expected hours of work per week, and whether overtime must be approved prior to its accrual.

Commission payments can be a matter of great contention between an employer and an employee. Therefore, an employer must make certain that any requirements for commissions are clearly spelled out in the employment contract, including when a commission is earned, how and when a commission is paid, whether the employee will receive a draw against commissions, whether the employee is required to repay any unearned draws if employment terminates, and the effect of employment termination on any pending deals, sales, contracts or projects. That last point is particularly significant in order to avoid situations in which employees claim that they are entitled to commissions even though their employment has terminated. For example, if a sale is “in the works” but the company has not yet been paid by its client at the time the employee leaves, will that employee be entitled to a sales commission, or must the company have actually received payment itself by the time the employee leaves for the employee to be entitled to a commission?

In addition, with regard to compensation, any incentive programs or arrangements should also be addressed and the terms set forth in plain language. For example, if the employer pays a bonus, the employer should indicate in the agreement whether the bonus is discretionary and who makes the decision. If there are certain performance criteria for a bonus, those criteria should be plainly identified along with how the criteria are met, who determines that the criteria have been met, and when the bonus is earned and paid. The agreement should also indicate what happens to eligibility for any incentives if employment terminates and if different reasons for termination impact the payment of the incentive. For example, will the company pay a bonus to an employee whose employment is terminated due to some form of misconduct, such as fraud, theft or sexual harassment?

The provisions that address compensation should also indicate whether the employee is to be reimbursed for any reasonably incurred business expenses and what the employer’s requirements are for reimbursement of those expenses. If an employee is provided with a car, meal, travel or living allowance, the terms for those allowances should also be included in the employment contract. Finally, the employment contract should indicate how and when the employee’s salary may be adjusted, either up or down. If an employee’s salary is altered after a written employment agreement has been entered into, an amendment should be prepared for the agreement so that the individual’s correct level of compensation is clearly documented.

4. Benefits.

A written employment agreement should also address any benefits to be provided to the employee or for which the employee may be eligible during the term of employment. If the employer provides health, dental, vision, life or disability insurance to its employees, those benefits should be identified in the employment agreement, but any provision concerning those benefits should indicate that the employee will be eligible to receive those benefits provided that the employee meets and satisfies the requirements for coverage pursuant to the employer’s benefit plans.

If the employer will also provide some form of professional liability insurance for the employee, that provision should also be documented in the employment agreement as well as any requirements for coverage. If the employer intends to reimburse an employee for professional license fees or memberships in professional organizations or associations, or to reimburse the employee for educational training courses that would increase the employee’s value to the company, the parties should document their understanding in the employment contract. An employee’s entitlement to paid vacation, holidays and sick leave should also be outlined in the employment agreement, along with any requirements for or restrictions on the use of paid leave. Any entitlement or eligibility for stock options, profit sharing plans or pension plans should also be identified in the employment agreement, and if the company utilizes other documents that govern those entitlements, those documents should be identified in the employment contract.

5. Performance Targets.

If the employer has any specific performance goals or benchmarks that it expects the employee to achieve, obviously, those terms should be clearly set forth in any written employment agreement. For example, if the employee is expected to achieve a certain volume of sales, meet a specific level of production, limit or reduce overhead expenses or reach a certain skill level, it is essential that those performance terms be identified in the employment contract. Oftentimes employers leave performance targets rather vague, e.g., “Employee will be paid a bonus if sufficient sales are achieved.” Such vague terms often leave unanswered many vital questions, e.g., How much bonus? When will it be paid? What level of sales is required? The more specific an employment agreement is in defining performance targets, the less likely disputes are to arise.

6. Termination.

A vital provision in any employment contract is the one that deals with the termination of the agreement and of the employment relationship itself. If an employment relationship is not “at will,” then a termination provision must address under what circumstances the employment contract can be terminated, who can terminate the employment contract, and whether the employee is to receive any form of compensation upon termination. A termination provision should plainly address any grounds for termination. For instance, the agreement should set forth what happens if the contract merely expires at the end of a term. The agreement should also address what happens if the contract is terminated by the employee or the employer.

With regard to the employee, the agreement should state that the employment contract terminates upon the death of the employee. The parties should document what payments would be made to the employee’s designated beneficiary or to the employee’s estate upon the employee’s death. The employment agreement should also address whether the employment agreement will terminate in the event of the employee’s disability. The Americans with Disabilities Act, 42 U.S.C. § 12101, provides that an employer may not discriminate against an employee based upon a disability if the employee is able to perform the essential functions of a job with or without reasonable accommodation. Therefore, in order to comply with the Americans with Disabilities Act, employment agreements that address termination in the event of an employee’s disability usually state that, due to the significance of the employee’s position and responsibilities, employment will terminate if the employee is unable to perform the essential functions of the job due to a mental or physical disability for some extended period of time in a 12-month period, such as 120 or 180 consecutive days. Typically, such provisions are reserved for employees in significant management, research or product development roles, and should be reviewed by legal counsel.

An employment contract should provide some means for an employee to end the employment relationship without cause or reason. Generally, such a provision states that an employee may terminate the employment relationship without cause or reason by providing some specified written notice to the employer, such as 14 days or 30 days written notice.

Some employment contracts provide that an employee may terminate the employment contract for “good reason.” “Good reason” is often defined as a substantial change in the employee’s duties or responsibilities without the employee’s consent; a change in the employee’s compensation without the employee’s consent; a requirement that the employee relocate to another city or state; or the employer’s breach of any term of the employment contract. Obviously, such provisions should not be included in every employment agreement. Typically, such provisions are found in employment contracts where the employee is of significant value to the company and the employer has negotiated such a provision with the employee in order to obtain the employee’s services. For an employer, such a provision should never be entered into without careful consideration as most such provisions provide that the employee is entitled to some form of severance if the employee terminates the agreement for “good reason” as defined by the terms of the contract.

As for the employer, the employer should also have a provision in the employment contract that allows the employer to terminate without cause or reason. Again, such provisions typically provide that the employer may terminate the employment contract without cause or reason by providing some advance written notice to the employee of the termination. An employer would be wise to include in any such provision a clause that allows the employer to relieve the employee of duties and responsibilities during the notice period and to pay the employee for the notice period rather than have the employee remain in the workplace.

Employers should also have a carefully drafted provision that allows the employer to terminate the agreement for “cause.” Unfortunately, many employers simply use the word “cause” and assume that the term “cause” must be defined by law. Generally, that term is not the subject of some specific legal definition and if it is, it generally requires some extraordinarily bad conduct on the part of the employee in order to justify a termination for “cause.” Some employers so poorly define the term “cause” that termination of the employment contract and relationship requires some criminal act, gross negligence or reckless conduct on the part of the employee, rendering termination for poor performance virtually impossible. Therefore, an employer should make certain that any provision which provides for termination for “cause” not only includes criminal acts or conduct, fraud, misrepresentation, theft or dishonesty, but also includes factors such as poor performance to be judged in the company’s sole discretion, criminal convictions or the entering of a plea of “guilty” or “nolo contendere” to any crime, a violation of company policies and procedures, and any act or omission that results in a breach by the employee of the employment agreement.

The employment contract should also indicate what compensation, if any, will be paid upon termination of employment. One of the pitfalls that traps many employers is the use of an employment agreement that does not spell out precisely what the employee will, and will not, receive when the agreement is terminated. Unless your contracts have such definite terms, do not be surprised to see an employee who is terminated one year into a three-year employment agreement try to claim entitlement to a lump-sum payout of the remaining two years under the agreement. To avoid such a situation, differing compensation options are usually provided depending upon whether the agreement is terminated “with” or “without” cause, by voluntary resignation, etc. For example, many employment agreements provide that if an employee resigns, the employee will be entitled to receive only that compensation which has been earned up to and including the date of termination. However, if the employer terminates the agreement without cause, the employee will receive some form of severance in addition to any accrued but unused vacation, bonuses or other incentive compensation to which the employee may be entitled.

Typically, employment agreements provide that if the employer terminates the agreement for “cause,” however that term may be defined in the agreement, the employee will receive only the amount of compensation earned up to and including the date of termination. Obviously, what happens upon termination is important to both parties and its impact upon any compensation due the employee should be clearly set forth in the employment contract.

7. Restrictive Covenants.

Many employers want their employment agreements to contain restrictive covenants. Restrictive covenants are provisions that provide that during the term of employment and for some period of time thereafter, the employee will not compete with the employer, solicit customers or solicit employees of the employer. The goal of restrictive covenants is to protect the employer’s assets, goodwill and relationships with its customers and employees. If artfully drafted, restrictive covenants can serve this purpose. However, restrictive covenants are governed by state laws and those laws differ greatly from state to state. For companies operating in several states, a restrictive covenant contained in an employment agreement may be enforceable in one state and invalid in another. Most state laws require that restrictive covenants be reasonably related to and necessary for the protection of the legitimate business interests of the employer and require that the covenants be reasonable in geographic scope, time and the nature of the activities prohibited.

Restrictive covenants comprise a volatile, complex and ever-changing area of the law. Suffice it to say that the restraints and limits of this article do not provide for an adequate discussion of restrictive covenants in employment agreements. However, employers should make certain that any restrictive covenant provisions are reviewed by legal counsel and they should have such provisions reviewed on a periodic basis in order to ensure that such provisions remain valid and enforceable.

Dispute Resolution

In an attempt to decrease litigation expenses and reduce exposure to uncertain jury awards, an increasing number of employers are now including arbitration clauses in their job applications, employee handbooks and employee contracts. By agreeing to arbitrate instead of litigate, employees give up their rights to have their claims heard by a jury in a court of law. Arbitration provisions can be an effective, efficient and economical way of disposing of employment disputes. However, such agreements are not without their faults.

Why arbitrate? Studies show that many potential jurors tend to have a “pro-labor” mind-set that favors terminated employees. Many jurors tend to feel that employees should be the top priority of a company, not its profits. It is not surprising to find out that employees win the majority of all employment lawsuits that go to trial. When they rule in a plaintiff’s favor, juries can award large damage verdicts, and punitive damages that can easily reach into six figures and beyond are often awarded.

With these risks in mind, it is not surprising that many employers are turning toward mandatory arbitration provisions in their employment contracts, handbooks or even job applications, whereby aggrieved non-union employees agree to waive their rights to a jury trial, to take all common law and statutory claims out of the judicial arena, and to arbitrate those disputes privately. Arbitration provisions are not limited to traditional “discrimination” claims, such as those based on race, sex, age, disability, etc. In actuality, the majority of employment-related lawsuits allege state common law claims such as breach of contract, intentional infliction of emotional distress and similar allegations, and such claims are ripe for arbitration. Courts in most judicial circuits will generally find an arbitration provision to be enforceable, so long as certain procedural safeguards are in place. To be enforceable, an employee’s agreement to arbitrate claims must generally be “knowing and voluntary.” In other words, an employer cannot try to slide an arbitration provision into a contract or handbook. The arbitration provision must be conspicuous and should be in plain language.

Making the Employment Relationship Work

The main purpose behind employment agreements is to clarify the parties’ expectations. When a new employee is hired, it’s always “milk-and-honey” — neither side expecting the employment relationship to end, and neither side focusing on all the “bad things” that can happen months or years down the line. By using a written agreement addressing these issues, employers may spell out exactly what an employee will receive and what she can expect, both during the term of employment and upon its eventual termination. There is no bright-line test for which employees should and should not have employment agreements. There is also no magical form or template for an employment agreement that will provide a document that can be used in every situation. Simply because an agreement worked for one employee does not mean that the same agreement is appropriate for another. Often employment contracts are the subject of intense negotiations between the employer and the employee which result in compromises from both parties. Employment agreements can be a tremendous asset for employers and of great benefit to employees, but vague, ambiguous or poorly drafted contracts can severely damage the working relationship through misunderstandings, misinterpretations or unfulfilled expectations. Thus, from an employer’s perspective, while using employment agreements certainly offers many benefits, such agreements should be entered into carefully and with proper consideration given to the obligations of both parties to the contract. As Ralph Waldo Emerson observed, “Nothing astonishes men so much as common-sense and plain dealing.”