Employment Contracts: More Than Just a Handshake

By G.A. Finch, Michael, Best & Friedlich, Chicago -- Consulting-Specifying Engineer, 6/1/2005

Coach Mike Ditka once said, "Success isn't permanent, and failure isn't fatal." I often think about this quote when considering employment agreements, but in the context of employment, I would add one important point: It sure helps to have a contract.

With the increasing rate of turnover in employees and executives, the prudent firm—and its executives and professional staff—will seriously consider entering into an employment contract to protect the interests of all concerned. Like parties to a marriage who sign a prenuptial agreement, by using employment agreements, A/E firms and their employees are not anticipating an imminent divorce. They do, however, desire clear expectations of, and reasonableness in, the terms for their parting of the ways, if that should turn out to be the case.

In recent years, we have seen a marked increase in the number of top-level executives and key employees who are demanding employment contracts before taking positions with new firms—or deciding whether to stay with their existing employers. It's safe to say that many of these individuals feel economically insecure. They may not trust employers' loyalty, or they might fear office politics. But whatever their reasons, with current executive scandals, merger mania, profit performance pressures and downsizing, their fears are not unjustified.

And for their part, employers increasingly want some assurance that an employee is committed to sticking around and not walking off with proprietary information, client lists or other valuable employees to set up a competing shop next door. For all of these reasons, more and more professional service firms are utilizing employment contracts.

Whether you are the employer or the employee, here are some basics you should know. For starters, most states apply the legal concept of "at will." At-will employment means, as a general rule, an employer can fire an employee for no reason. The exceptions to this rule include the following:

• a union contract;
• an individual contract with a termination-for-cause provision;
• an implied contract, e.g., employee handbook;
• a public policy being violated such as being fired for jury duty, serving as a military reservist, filing a workers' compensation claim, refusing to perform an illegal act or for whistle blowing;
• violation of civil rights laws concerning age, race, national origin, sex, sexual orientation, disability, marital status, religion, disability, or the like.

When it comes to the employees' benefits, they may use an employment contract to negotiate any of the following:

• a minimum employment term;
• termination for cause only (specifically defined);
• job title;
• higher guaranteed salary;
• less contingent bonuses based on performance;
• stock options.

And, of course, these agreements offer the best vehicle for guaranteeing a host of additional benefits. The list could go on and on, but might include such items as: additional medical and life insurance, tuition reimbursements, car allowance, club memberships, moving expenses, cell phones, laptops, parking, housing and entertainment allowances, low- or no-interest loans, income tax preparation, severance pay and outplacement.

An employee will sometimes negotiate the right to outside employment, but what is an even more critical issue with employees is the non-compete clause that restricts their post-employment ability to work in the same business and same geographic area for a period of time. In fact, my experience has been that in addition to emphasis on salary, stock options and severance payment, most executives will focus on non-compete clauses in their employment contract negotiations.

Most employers focus their negotiation efforts on at-will provisions—such as termination without cause—no-severance provisions, performance-based compensation and bonuses, job description, confidentiality, intellectual property rights, non-disparagement, arbitration and non-compete clauses. Because the value of intellectual property rights, such as copyrights, patents and trademarks, has soared in tandem with the U.S. maturation into a predominantly knowledge-based service economy, employers are almost uniformly demanding ownership over these rights arising from the employee's efforts related to or similar to the kind of business in which the employer is engaged.

A court will view the enforceability of a non-compete agreement through the lens of the "reasonableness" of the restriction used to protect the legitimate interests of an employer. The analysis will be whether a geographic area is too large and whether the length of time is too long for the industry or the profession in question. Because of the time and expense of litigation, employers are pleased that courts are increasingly willing to enforce arbitration clauses involving employment disputes.

But how do the various types of firm ownership come into play here to affect employment agreements?

Closely held corporations and partnerships will often have their principals, or employees who are shareholders and partners, execute employment agreements in conjunction with their shareholder/partner agreements. The reasons are manifold: The principals may want to have an objective mechanism to set out the expectations in terms of duties, compensation, conduct and termination by which to manage the employment relationships and keep control of the company. There may be a legal question as to whether and to what extent a shareholder of a closely held corporation, after resigning as an officer and director, owes a continuing duty not to compete with the corporation. Hence, a corporation may wish to establish a contractual basis for non-competition. Employers should carefully consider severance provisions in employment agreements. These provisions can often generate goodwill from a departing employee, thereby reducing lawsuits and binding the employee to confidentiality and non-disparagement clauses. Employment lawsuits are expensive and generate bad public relations for a company. The amount of severance pay will vary from industry to industry and will depend on the employee's level and length of service. Also, sometimes a neutral letter of reference, assuming there has been no criminal or unethical behavior by the employee, may be part of the severance provision.

Neither the employer nor the employee should underestimate the utility of intellectual-property, confidentiality and nondisclosure provisions. Proprietary business information is a critical, but underappreciated, asset of many companies. Some methods, processes, depictions, etc., may indeed be eligible for protection under intellectual property laws. A typical state trade secret statute protects a company's information that is treated as secret and has economic value, because it is not generally known to other persons. This information includes technical or non-technical data, a formula, pattern, compilation, program, device, method, technique, drawing, process, financial data or list of actual or potential customers or suppliers. A confidentiality agreement protects the employer's trade secrets and informs employees what information they are permitted to use post-employment. Of course, employees should understand at the time of signing an employment agreement that much of the intellectual capital and information they create for the firm may not go with them or be used by them when they leave the company.

The two most important things to remember about employment contracts are: Everything is negotiable; and put it in writing. Both parties should remember that a so-called "offer of employment" letter may constitute an employment contract. Also, each side should understand to which commitments, if any, each party has agreed.

Because of the rights, duties and liabilities that are at stake, the company or the individual would be penny-wise and pound-foolish to enter into an employment contract without the advice of legal counsel.