Contracts Part VI: Employment Contracts- 10 Insights

Employment contracts are some of the most common contracts that business owners encounter and some of the most misunderstood. 

Editor’s note: This is Part IV in the contracts series. Prior pieces in this series: Part I:  Small Business Contracts Part I: A Different Perspective, Part II Contracts Part II: Laying the Groundwork ,Part III: Contracts Part III: The Role of Legalese in Contract Drafting Part IV Supplier Contracts- What Small Business Owners Need to Know and Contracts Part V: 7 Unique Features of Distribution Contracts.

Among the agreements that business owners most frequently encounter are employment agreements.  Not all employment relationships require a written agreement, but, in certain instances, not having an agreement is an invitation to misunderstanding, bad feeling, and, sometimes, litigation.

1.   In State Jurisdictions where the Rule is Termination at Will, the First Question to Answer is Whether an Agreement is Necessary

The governing rule in most states (with many exceptions) is that an employee may be terminated “at will” for any reason or no reason, as long as the reason is not a discriminatory reason.

Because the default common law rule is, generally, more favorable to employers, businesses are less likely to enter into employment agreements with their first tier (employees in the field) and second tier (first line supervisors) personnel. 

The reason for this is that an employment contract risks constraining the employer’s common law right to decide whom it wants to work for it.

2.   But Even without a Contract, Statutory Law May Impose Some Restrictions on the Employer-Employee Relationship

Even though under the common law of most states employers have considerable power over their employees, statutory law on both the state and federal levels has carved out for employees certain rights of their own. 

Both state and federal law, for example, mandate a minimum wage, overtime pay for certain classes of employees, family leave under certain conditions, and then there is a potpourri of discrimination laws, including city and state human rights laws and the federal civil rights laws that constrict an employer’s ability to terminate employees for disciminatory reasons.

Thus, even where contracts of employment are not used, a superstructure of local, state, and Federal laws have substantially restricted the discretion of employers to fire workers at will. 

Moreover, these statutory standards cannot be waived even in the case of an employee who is willing to waive them.  

3.   The Role of Employment Manuals in Defining Employment Relationships

Employment manuals can also supplement employment contracts or supply terms where an actual written agreement does not exist or is skeletal.

For example, procedures may be contained in an employment manual that prescribe a list of sanctions, short of termination, from warnings, to suspensions, to demotion, which can serve to restrict the employer’s right to terminate an employee at will.  

Indeed, in some states, the commitments undertaken by an employer pursuant to an Employment Manual, or well-established policy, can rise to the level of contractual obligations.

4.   When Should an Employer Enter into an Employment Contract with a Prospective Employee

Employment contracts are entered into with company executives or critical employees whose expertise and experience cannot be easily found in the market place, or are otherwise considered essential.

One of the purposes behind entering into such an agreement is that the counterpoise to employment-at-will is that employees can also terminate their employment at will, creating uncertainty for the employer. Thus, while employment agreements necessarily impose constraints on employers’ conduct vis a vis employees, the advantage is that it can secure commitments from essential employees to work for a certain term of years.

The more essential the employee is by virtue of her experience, knowledge, skills, and/or quality and quantity of her business relationships, the greater the leverage such employee may have in negotiating advantageous terms, including restrictions on the employer’s right to terminate, monetary incentives, such as participation in bonus and profit sharing plans, generous vacation or leave of absence concessions, and more leeway to exercise the authority of her position.

5.   Important Terms

Beyond the most straight forward terms of an employment agreement, e.g. term of employment, description of duties, and compensation and benefits, employers should review carefully termination provisions, restrictive covenants, such as non-competition and non-solicitation provisions, non-disparagement provisions, confidentiality restrictions, work made for hire provisions, and cost shifting provisions.

Next- #6 Termination Provisions through #10 Non-Disparagement Provisions