Making the most of employment contracts

Well-written, enforceable contracts eliminate ambiguities - and lawsuits.

How do you prevent once-valued employees from becoming major liabilities when they no longer work for your company?

An employment contract is your best bet. While some people believe that employment contracts limit the ability to terminate or manage employees, well-written, legally binding employment contracts can provide greater flexibility to employers. They can be used to prevent former employees from using business secrets for personal gain; stop employees from working for a competitor for a certain period of time; and enforce the use of arbitration agreements that avert expensive lawsuits arising from employment disputes.

In addition, employment contracts can be used to reward certain high-level employees with benefits in exchange for the employees' promise of tenure with the company. Employers may customize contracts for individual employees or use the same contract for all employees. In either case, employment contracts can help to defray many of the "what it"' worries that arise when employers and employees part ways.

AN OUNCE OF PREVENTION

Here are some of the benefits that employers can derive from using employment contracts as a standard part of the hiring process:

Defense against claims of wrongful termination. Terminated employees have argued successfully that oral statements from a supervisor, a phrase in an employee handbook or a written policy created a contract protecting an employee from being fired without just cause.

The common thread in these cases is that alleged oral or inadvertent written statements undermined the employer's ability to determine and set the terms of employment. A written contract, however, will trump most arguments based on alleged oral statements or personnel policies. Here is an example of a statement that companies may add to an employment contract to describe the at-will nature of the employment:

The Company agrees to employ (employee's name), and Employee agrees to provide services to the Company as (job title), or in such other capacity as the Company may direct, under the terms and conditions set forth below. This employment may be terminated by either party at any time and for any reason upon giving 30 days advance written notice or, at the Company's option, 30 days base salary in lieu of notice.

Protection of the company's confidential information. An employment contract should include a provision to protect the company from unauthorized use or disclosure of proprietary information during or after employment. To discount the argument that the employee did not believe a particular item was confidential, it is important to specify what constitutes confidential information. Generally, "confidential information" is any business or technical information possessed by the company that is not known to the public and that gives the company an advantage over its competitors. It can include technical information, such as secret formulas and processes, or business information, such as customer lists.

Protecting this information from disclosure by former employees is important and can be achieved by ensuring that reasonable measures are in place to safeguard confidentiality. These measures may include labeling documents "confidential," limiting their distribution, requiring that documents be maintained in locked file cabinets and establishing a written policy relating to the protection of confidential information.

Confidential information should only be provided to employees on a "need to know" basis. Also, secret processes and methods should be hidden as much as possible from public view so as to avoid inadvertent disclosure, not only to employees generally but also to visitors to the workplace.

Contracts also should include a provision that any inventions or other intangible improvements made to the company's current or planned lines of business belong to the employer - regardless whether such inventions were made on company or personal time.

Protection against competition from former employees. Noncompete agreements and prohibitions of post-employment solicitation of customers and employees ensure that a former employee cannot work against your company after he or she no longer is employed by the company. The courts have thrown out noncompete agreements that they considered too broad in that they unfairly restricted the employee's ability to make a living.

It is important to limit the noncompete restrictions to certain geographical areas, industries and time periods. For example, a noncompete agreement could provide that the former employee may not work for a direct competitor within the state or solicit the former employer's current customers or clients for one year.

Lowering the risk of expensive litigation and runaway jury verdicts by arbitration provisions. Arbitration of employment disputes provides a number of advantages over judicial resolution. Arbitrations are confidential - not matters of public record, like lawsuits. They typically move to resolution much more rapidly than do lawsuits. And they are enforceable under the Federal Arbitration Act, provided that the agreement to arbitrate is in writing and irrevocable.

The courts will scrutinize the provisions of the arbitration agreement for its overall fairness and preservation of fundamental rights of due process. Thus, the arbitration agreement should provide for the following:

* A description of the claims that are within the scope of the agreement.

* A procedure for initiating and notifying the parties of the arbitration demand.

* A provision for selecting the arbitrator(s).

* Mandatory informal mediation as a prerequisite to arbitration.

* Procedures for conducting the hearing and pre-hearing fact-finding.

* Allocation of costs,

* A statement that an arbitration agreement does not enhance or diminish the at-will nature of employment.

* A choice of which laws will be applied (usually the laws of the place of employment).

* A confidentiality requirement regarding the arbitration and its final outcome.

* A provision reserving the right of the employer to prospectively terminate or modify the arbitration agreement.

* A provision that determines where the arbitration will occur.

ADDITIONAL BENEFITS

Alignment of employee and shareholder interests. Employee contracts can be written to reward an employee's performance with stock or bonuses based upon profits. By including such provisions in an employee's contract, employers are able to customize these incentives to the individual, rather than writing a company-wide policy.

These provisions allow a business to offer bonuses based on the price of the company's stock. These so-called "phantom shares" reward the employee with an increase in share price without actually providing ownership of the shares. Thus, the employer can avoid the problem of employees obtaining the rights of shareholders. An employment contract is not required to issue "phantom shares," but it could ensure that the employee could not misinterpret his rights.

Promotion of long-term loyalty among high-ranking employees. Businesses can encourage top-level employees to stay with the company for a certain period of time by offering deferred cash or retirement benefits. An employment contract can spell out what is required for the employee to realize the deferred cash or benefits, as well as ensure that the deferred payment does not inadvertently become subject to regulations of the Employee Retirement Income Security Act of 1974 (ERISA).

Compensation plans for a "select group of management or highly compensated employees," known as "top hat" compensation plans, are exempt from many ERISA requirements. These requirements usually subject the benefits to participation, vesting, funding, fiduciary duty and other rules that restrict a company's flexibility.

Unlike rank-and-file workers, top hat employees are not subject to these requirements because the law assumes that these select employees, by virtue of their special status, have enough influence over plan design that they don't require the protection of ERISA regulations. ERISA's reporting and disclosure requirements, however, do apply to top hat employees.

For example, a top hat benefit could provide monthly payments to a senior vice president upon retirement, provided that he remains with the company until the age of 65. If his employment ends before that time, the employee forfeits the payments.

The company has discretion in determining which of its senior executives will be given these benefits and the amount that they will be paid. The Internal Revenue Service requires that top hat employees make at least $80,000 per year. The Department of Labor is more limited in its requirements for this status.

If a company wishes to offer a deferred cash benefit to someone who is not part of a top hat group, care must be taken to avoid subjecting it to the requirements of ERISA. The arrangement must not provide retirement income to employees or result in a deferral of income by employees for periods extending to or beyond the termination of covered employment. Generally, a company can comply with this requirement by allowing the employee to have access to the money at a specified time prior to the end of employment.

CONCLUSION

Employment contracts can be useful tools to provide incentives to employees, protect employers from unintended legal obligations, safeguard trade secrets and manage the employment relationship in a more predictable way.

Editor's note: This article should not be construed as constituting legal advice or pertaining to specific factual situations.

John J. Myers, David V. Radack and Paul M. Yenerall are attorneys in the Pittsburgh office of Eckert Seamans Cherin & Mellott, LLC.

COPYRIGHT 1998 Society for Human Resource Management
COPYRIGHT 2004 Gale Group