Employment agreements are enforced under state law. So it is vital to understand which state law is applicable to the contract. One way to avoid uncertainty on the issue is to state in the agreement what particular state law governs, but it is necessary to select a state law that has a defensible nexus to the employment relationship. This outline will discuss drafting considerations that might be used in drafting effective executive employment contracts.
Drafting the Employment Agreement
1. In General. The terms of a contract should be in writing understandable to and understood by the parties.
2. The Preamble. Employment agreements are contracts that establish a legal relationship between the employer and employee who enter into the employment relationship. The essential elements of a contract are: (i) offer; (ii) acceptance; and (iii) consideration. The preamble, or preliminary statement at the beginning of the employment agreement, establishes the existence of contract essentials, and the parties’ mutual assent to the terms of the employment agreement.
3. Term: Avoiding Automatic Renewal. The purpose of a clause establishing the term of employment is to define the beginning of and, more importantly, the end of the employment relationship. This can be a trap for unwary employers who fail to expressly provide for termination
of the employment relationship on a date certain unless extended in writing by the agreement of the employer and employee.
(a) This qualifying language is essential because employment agreements do not necessarily expire on the termination date. Under common law, if an employee hired for a specified term of one year or more continues to work in the same job after the term expires the employment contract is presumed to extend for successive terms. 2 Williston on Contracts §6.42, at 452 (Lawyers Cooperative Pub. 4th ed. 1991); see also 17A Am. Jur. 2d Contracts §605 (1991).
(b) This common law rule is valid today and has been upheld in New York and other states including California and Maryland. See, e.g., Cinefot Int’l Corp. v. Hudson Photographic Industries, 196 N.E.2d 54 (N.Y. 1963); Otten v. San Francisco Hotel Owners Assoc., 168 P.2d 739 (Cal. Ct. App. Dist. 1946); Kropfelder v. Snap-On Tools Corp., 859 F. Supp. 952 (D. Md. 1994); See also 27 Am.Jur.2d Employment Relationship §31 (1996).
(c) The presumption of automatic renewal may be overcome by proof that the parties intended otherwise, or proof of a new agreement. The following provision expressly states the parties’ mutual intention to end the employment relationship at the close of the employment term.
4. Employment Duties: Reserve the Right to Reassign and Require Compliance with Company Rules and Policies. Many employees only want to do particular tasks (e.g., the duties of an executive). Employers will most often want to retain the flexibility to use the employee where needed, especially if conditions change during the term of employment. The employer and employee should understand and agree upon the duties that the employee will be responsible for performing. The description of job duties could be specific but may be broadly stated to permit the employer to reassign the employee to another position with different responsibilities. This may become a matter of intense negotiation.
(a) A general statement of duties and the right to reassign may avoid constructive discharge, or breach of contract claims resulting from a change of duties or position. A reduction in rank or a change of the duties that the employee is engaged to perform may be a violation of an employment contract that is specifically drawn as to duties, and the basis of an action for damages for breach of contract.
(b) Significantly, an employee’s refusal to perform assignments amounting to a reduction in rank or change of duties, in defense of his contractual rights may not constitute insubordination in some states. The employee’ refusal to perform duties contemplated or expressly required in the employment agreement, on the other hand, may constitute insubordination, violate the employee’s contractual duty, and justify discharge without liability to the employer. See, David J. Oliveiri, Annotation, Reduction in Rank or Authority or Change of Duties as Breach of Employment Contract, 63 A.L.R.3d 539 (1975) (collecting cases).
(c) In any event, the description of job duties should also include abiding by the employer’s rules and policies as part of the employee’s responsibilities.
5. Conflicts of Interest and Best Efforts. Employers want assurance that their employees are not distracted from maximal performance because they are “moonlighting” in other jobs, or involved in any other activities that detract from their ability to devote their time and energies to the employer, or may be detrimental to the employer’s business and reputation.
Employers also want assurance that their employees are giving their best effort; after all, the employer hired them to do the job well, not just go through the motions.
(a) Employers should carefully consider the effect of state laws on their ability to limit the off-duty activities of the employee. At least 28 states and the District of Columbia have statutes that forbid employment discrimination based on off-duty tobacco use.
(b) New York State, in particular, has a “legal activities” law that prohibits adverse employment actions based on an employee’s legal, off-duty recreational and political activities, and use of consumable products such as tobacco. (N.Y. Law. Law §201-d). Colorado and North Dakota also attempt to protect “legal activities” of employees. Col. Rev. Stat. §2434-402.5 (West Supp. 1997); N.D. Cent. Code §14-02.401. Employers and their legal counsel should consult these laws to determine their applicability before drafting a conflicts of interest and best efforts clause.
(c) Additionally, employers may use this provision to emphasize the fiduciary duty that high-ranking employees with decision-making authority owe the employer. An important element of this fiduciary duty is the duty not to take personal advantage of potential business or so-called “corporate opportunities,” and to present those opportunities to the employer. See Steven H. Winterbauer, The Corporate Opportunity Doctrine: What Employers Should Know, 18 Employee Re. L.J. 391 (1992).
6. Employee Compensation and Benefits. The employment agreement should definitively state how much and when the employee will be paid. State law will have to be consulted to see whether salary may be paid by direct deposit or check and how often salary must be paid. The easiest method of accomplishing this is to provide for salary payments in accordance with the employer’s regular payroll practices.
(a) Bonuses. Bonuses come in many varieties including a sign-up bonus, a regular periodic or annual bonus, a stay bonus, and incentive bonus. The key is to make the determination to pay and the amount of any bonus subject to the employer’s sole discretion. Statements that the employer will exercise its discretion “in good faith” should be avoided because they lead to costly litigation to interpret the meaning of “in good faith.” The best bonus provisions simply provide that the employee may be eligible for additional compensation as determined by the employer.
(b) Many companies have executive bonus plans. The contract should spell out whether the employee is to benefit from such plans.
7. Employee Benefits. The employment agreement should make the employee aware of the benefit plans available from the employer. Employee benefit programs, such as health and life insurance, 401(k), and pension plans are subject to frequent modifications and changes of providers. Therefore, the most efficient way to address this issue in an employment agreement is to offer the employee the same benefits in effect for other executive-level employees. This avoids the necessity of amending the employment agreement every time there is a change in an employee benefit plan.
8. Vacation and Expenses. The employment agreement may refer to the employer’s practice for other executive-level employees, but it is preferable to state how much vacation the employee is eligible for, when it may be taken, and whether the employee will be paid for unused vacation. The employment agreement should also specify the business related expenses that will be reimbursed to the employee.
9. Withholding from Salary and Benefits. The employment agreement should provide for deductions from salary and benefits for applicable federal, state, and local taxes, and required employee contributions to benefit plans.
(a) Most states limit the deduction that employers may take from an employee’s pay. Deducting employee debts, advances, or loans is also problematic especially when a bank seeks to deduct loan repayments against salary or an employee account. In New York, for example, other than very limited circumstances, the Department of Labor disallows such deductions from salaries. (N.Y. Labor Law §193 (McKinney 1986)).
10. Termination of the Employment Agreement. The employment agreement should state the obvious: the contract terminates upon the death of the employee. This is important so the employee’s estate does not claim it is entitled to compensation, with the exception of accrued salary, benefits, and life insurance proceeds.
(a) Disability. The employment agreement should anticipate that the employee may be unable to perform his or her responsibilities because of a disability. The employment agreement, however, does not supersede the employer’s obligations under the ADA and the FMLA, which must be carefully considered in dealing with employees.
(i) In general, the ADA prohibits discrimination against a person with a disability (real or perceived) who can perform the essential functions of the job with or without reasonable accommodation.
(ii) The FMLA mandates 12 weeks of unpaid leave for employees in any 12- month period, including medical leave for the employee’s serious health conditions, and restoration to the employee’s former position upon completion of leave. The FMLA contains a limited exception for highly compensated employees. The employer may deny reinstatement to an employee (upon written notice to the employee) who is in the highest paid 10% of the employer’s work force, if returning the employee to work would cause “substantial and grievous economic injury” to the employer’s business.
(iii) ADA and FMLA requirements, in addition to applicable state and local laws, should be consulted before the employer exercises its rights under the disability termination provision of the employment agreement.
(b) Notice (Without Cause). Most employment agreements reserve the right of either party to terminate the employment relationship after a specified notice period. The notice termination provision should expressly provide for the termination of the employer’s obligations (except for accrued salary and benefits) and the continuation of the employee’s obligation to comply with any noncompete clause or other restrictive covenant.
(i) It is particularly difficult to enforce noncompetition clauses and other restrictive covenants when the employer terminates the employee’s services. Therefore, many employment agreements provide additional consideration for the employee’s compliance. Severance payments may also serve as consideration for a waiver and release of the employee’s claims against the employer arising out of the employment relationship, or the termination of employment.
(c) Termination for Cause. Employment agreements often specify “cause” for discharge to avoid uncertainty over the circumstances under which the employer, employee, or both may terminate an employment agreement without continuing liability for the balance of the agreement’s terms.
(i) If the parties to the employment agreement do not specify what constitutes cause, the decision will be left to the court if one party believes the other has done something inimical to its contractual obligations. The majority of courts have adopted the Restatement Second, Agency approach which provides in pertinent part:
A principal is privileged to discharge before the time fixed by the contract of employment an agent who has committed such a violation of duty that his conduct constitutes a material breach of contract, or who without committing a violation of duty, fails to perform or reasonably appears to be unable to perform a material part of the promised service because of physical or mental disability.
Restatement Second, Agency §409(1)(1958); see Trachten, Formal Employment Contracts; Wrongful Termination Claims, 558 PLI/Lit 87 (1996) (discussing the “cause” standard in employment agreements).
(ii) Employers must specify what conduct constitutes “cause” to avoid the vagaries of a court under this ambiguous standard. Significantly, many courts require good faith and fairness as an essential component of “cause” although the employment agreement may not. The list of specific grounds for termination should include a provision that “cause” includes any unforseen circumstances that amounts to a breach of duty, contractual or otherwise, that the employee owes to the employer.
11. Noncompetition Agreements and Restrictive Covenants. Every employer dreads the prospect of a trusted, executive-level employee departing to work for a competitor or to start a competing business.
(a) A well drafted noncompetition provision includes agreements by the departing employee:
- Not to compete either during or for a specified time period after employment;
- Not to induce other employees to leave the employer; and
- Not to divulge the employer’s trade secrets or confidential information.
(b) The enforceability of noncompetition and confidentiality provisions are matters of state law. Some states, including Montana and North Dakota, prohibit covenants that restrain employees from engaging in a lawful profession, trade, or business. Mont. Code Ann. §28-2-703 (1977); N.D. Cent.Code §9-08-06 (1987). California is well known for its statutory and case law purporting to hold noncompete agreements void and unenforceable; however, limited restraints on departing employees may be enforceable. See Mainland, Contracts Limiting Competition by Former Employees: A California Perspective, 340 PLI/Pat 119 (1992).
(c) Other states, including Louisiana and South Dakota void any covenant extending more than two years after the employment relationship ends. La.Rev.Stat.Ann. §23:291C; S.D. Codified Laws §53-9-11 (Michie 1990).
(d) Still other states, notably New York, do not have specific statutes but determine the enforceability of noncompetition agreements by balancing the respective interests of the employee (in making a living) and the employer (in protecting its business) focusing on public policy disfavoring competitive restrictions.
(e) The standards for enforcement of confidentiality and trade secret provisions are equally varied. For example, 42 jurisdictions have adopted all or portions of the Uniform Trade Secrets Act, 14 U.L.A. 150 (West Supp. 1997), as amended and approved by the National Conference of Commissioners on Uniform State Laws in 1985. New York, on the other hand, is among the states that have relied on the definition and formulation of trade secrets and confidential information contained in the Restatement, Torts §757, Comment d (1939).
(f) Employers and their legal counsel may wish to consult the following sources for preparing enforceable noncompetition agreements and restrictive employment covenants. Richey, Covenants Not to Compete: A State-by-State Survey, Section of Labor and Employment Law, American Bar Association (BNA, 1991 and Supp. 1995); Victoria A. Cundiff, The Departing Employee Toolbox: How to Construct Contracts that Meet Real Business Needs, 20 Employee Rel. L.J. 481 (1994) Schneider and Arnold, Trade Secrets and the Peripatetic Employee, 196 PLI/Pat 237 (1985); James E. McKinney, Noncompetition Clauses in Executive Employment and Severance Agreements, 16 Employee Rel. L.J. 29 (1990).
(g) Despite these differences, it is universally true that noncompetition and confidentiality provisions that are drafted with the particular employee’s duties in mind, and are carefully tailored to protect the employer’s legitimate business interests, are the most likely to be enforced in court. Blanket use of boilerplate language obscures the interests that the employer is entitled to protect. Even worse, it could leave the employee seriously confused about what information is subject to protection, or cause the court to conclude that the employer is overreaching and deny enforcement of the provision. Even if state law and the employment agreement permit the court to modify or “blue pencil” the provision so it is enforceable, it is still best to try to limit restrictions to the reasonable range.
12. Inventions and Improvements. Employment agreements for employees such as writers, architects, engineers, or designers should include a provision making any invention or discovery conceived by the employee the employer’s property, and require the employee to cooperate in securing the employer’s property right to the invention, discovery or writing. The potential for employer overreaching is a problem here as well. Several states including California, Minnesota, and Washington have laws prohibiting employment contracts that require employees to sign over their inventions and discoveries in areas outside the employer’s business interests. Cal. Lab. Code §2870 ( West Supp. 1998); Minn. Stat. Ann. §181.78 (West 1993); Wash. Rev. Code Ann. §49.44.140 (West 1990).
13. Protection Against the Employee’s Obligations to Former Employers. The employee’s former employers may be just as concerned about protecting their confidential information and other legitimate business interests as you are about protecting yours. An appropriate clause will remind the employee about his or her obligations, if any, and potentially avoid costly and
damaging litigation if the new employer improperly, albeit unknowingly, benefitted from the former employer’s confidential information.
14. The Employee’s Post-Employment Duties. The employer should require the employee to return all the employer’s property and business-related materials prepared by the employee when the employment relationship ends. The employer should also require the employee to make himself available for any litigation the employer may become involved in that would require information from the employee.
15. Alternative Dispute Resolution—Arbitration. Many employers include arbitration provisions in their employment agreements requiring employees to submit any employment dispute that may arise to arbitration.
(a) Arbitration is an attractive alternative to the present system of protracted and expensive litigation of employment disputes. However, arbitration may encourage litigation by its speed and relatively low cost. Now that most discrimination claims are jury trials, employers are rightly concerned that runaway jurors might not understand business needs and impose their own standards when they disagree with the employers’ judgments. Consequently, many employers are imposing alternative dispute mechanisms for resolution of employee disputes, especially those involving claims of violations of law (statutory, contractual, or tort).
(b) Since the U.S. Supreme Court’s decision in Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20 (1991), the overwhelming majority of courts have upheld the enforceability of written arbitration agreements requiring submission of employment disputes to arbitration under the FAA. The FAA established a strong federal policy favoring arbitration that extends to discrimination as well as other employment claims. However, potential plaintiffs still seek to avoid arbitration and invoke juries.
(i) Enforcement of arbitration agreements is subject to defenses that apply to contracts in general including unconscionability, fraud, and lack of consideration. Some courts have refused to enforce arbitration agreements when the individual seeking a jury trial signed an agreement without knowing its terms. See e.g., Prudential Ins. Co. of America v. Lai, 42 F.3d 1299 (9th Cir. 1994), cert. denied, 516 U.S. 812 (1995) (plaintiff’s claim of sex discrimination and sexual harassment held not subject to arbitration because she did not “knowingly” agree to arbitrate employment disputes).
(ii) Further, the EEOC with its backlog of cases, reaffirmed its long-standing opposition to mandatory arbitration of employment discrimination claims in its “Policy Statement on Mandatory Arbitration” issued July 10, 1997 (DLR 7/11/97 at AA-1). Citing “inherent limitations” that cannot be cured by improving systems of mandatory arbitration such as “lack of public disclosure,” severe limitation of judicial review, and “structural biases” against employees, the EEOC confirmed that it will continue to challenge the legality of mandatory arbitration agreements. The EEOC, however, reaffirmed its support for voluntary post-dispute arbitration at the employee’s election.
(c) Therefore, if an employer favors arbitration it is imperative that the employer clearly and unambiguously require binding arbitration of all disputes in any way relating to the employment relationship or the termination of that relationship. Arbitration clauses are generally enforceable in court so long as the procedure is fair, the outcome can be the same as a jury trial, and the employee knew that he or she was agreeing to final and binding arbitration.
16. Applicable Law. Employers should specify the state law that will be applicable to resolving disputes under the employment agreement. Choice of law provisions in written employment agreements are routinely upheld by courts if there is a nexus to the employment. See State Labor Law Developments, 8 Lab. Law. 618 (1992) (and supplements collecting cases).
(a) If the employment agreement does not specify the laws of a particular state, the courts will apply choice of law rules to determine which state law controls, and could potentially defeat the employer’s ability to enforce the employment agreement—particularly the noncompetition provisions and confidential information.
(b) Therefore, employers and their counsel should specify the applicable state laws with full enforcement of the employment agreement in mind.
17. Judicial Forum. Employers should use the employment agreement to select a judicial forum for litigation of disputes concerning the interpretation of the agreement and enforcement of the noncompetition provision and restrictive employment covenants. The forum should be conveniently located for the employer and offer familiar court rules and procedures to the employer’s legal counsel. A convenient and familiar forum allows counsel to expedite court injunctive proceedings to prevent disclosure of trade secrets or confidential information, or breach of other restrictive employment covenants.
18. Assignment. The employer should reserve the right to assign the employment agreement so a successor employer may benefit from the employee’s services in the event of a merger, consolidation, asset purchase, or other business transaction. The employment agreement should not be assignable by the employee, however, because the employee’s unique ability to do the job is not transferable.
19. Non-Waiver of Rights. The non-waiver clause prevents the employee from arguing that the employer’s past actions or inactions under the employment agreement bind the employer or limit the employer’s ability to exercise its rights in the future. Essentially, this provision permits the employer to exercise its rights under the employment agreement without regard to whether the employer has or has not previously done so.
20. Notices. The employment agreement should provide addresses so the employer and employee may send written communications concerning the agreement to each other. This provision should also state when written notice is effective (e.g., upon mailing or personal delivery) for triggering termination on notice or other contract requirements.
21. Modifications. Amendments to the employment agreement should be in writing and signed by the parties. This clause prevents entanglements that result when a party claims a contract was modified by an oral agreement or understanding.
22. Complete Agreement. This provision accomplishes two goals.
(a) First, it establishes that the written employment agreement is the only contract between the parties. This is particularly significant if the parties were involved in negotiations concerning the agreement’s terms. It prevents misunderstandings that might otherwise blossom into litigation based on correspondence or conversations during negotiations.
(b) Second, it unequivocally conveys the employee’s understanding of and voluntary commitment to the agreement’s terms. The employee’s understanding is reinforced by the provision for consultation with the employee’s legal counsel. High-level employees who are asked to sign employment agreements typically consult their lawyers before doing so. Therefore, the employer does not lose anything by including this provision.
The Alabama State Bar requires the following disclosure: No representation is made that the quality of legal services to be performed is greater than the quality of legal services performed by other lawyers.