About a year ago, you began adding sales and executive-level employees. After you let a sales manager go recently, he filed a lawsuit claiming that you and your company owe him $5 million. What?
Your partners want to know what's going on. You recall meeting with the sales manager at a restaurant a couple of times before hiring him. You talked about your new business and your vision for success.
You offered to pay him only a market salary but said that he would be eligible for any benefits or bonuses that the company might offer in the future. There were no promises, and nothing was put in writing. He took the job, but he just didn't work out. You had to let him go and, even though he was with you less than a year, you gave him a severance payment.
The complaint claims that you breached a contract with the sales manager. He claims that you promised to pay him $5 million for his contribution to the business and that he relied on that promise. He further claims he gave up other job opportunities and even purchased his own health insurance for his family.
Even worse, he claims that your statements were "fraudulent misrepresentations" and has named you as an individual defendant. You confidently tell your partners, "Don't worry, our lawyers will get this thing thrown out right away. I never made those promises, and there's nothing in writing, not even notes on a bar napkin." Are you right? Probably not.
Claims by employees or former employees for exorbitant compensation are being brought with increasing frequency against new businesses. Some employees may legitimately misconstrue the positive terms you use to describe your business. They feel that by joining your new venture they will share in the business' success or the profits of a sale, even though they did not contribute capital or work for a salary that was below market value.
Others are more opportunistic and feel that they are entitled to compensation simply for being employed as your business became profitable. Whatever the motive, the question is whether you and your company can mount an aggressive defense resulting in a quick dismissal.
In this case, your version of the facts and your assertion that no one would pay a sales manager $5 million for a year of lackluster performance are true. The problem is that you will likely have to go all the way to a jury trial to prove it. Courts can dismiss cases early on, but that is only when there are no issues of material fact which must be resolved under applicable law.
A contract for employment or for the payment of future compensation can be created verbally. Whether a contract was formed and whether there were misrepresentations made to the prospective employee are questions of fact that most often preclude early dismissal of a case.
The solution? Obviously, you should take great care during discussions with prospective employees concerning employment. You should not make promises regarding duration of employment or compensation unless you intend to be contractually bound. The fact is, however, that parties to a conversation never quite remember it exactly the same way, particularly when they are on opposite sides of a lawsuit.
An offer letter can preclude years of litigation. Issued to employees at the outset of employment, an offer letter describes in clear and exact terms what the compensation structure will be during employment.
If the employee is to receive benefits, the letter can simply reference the applicable benefits plan. Likewise, if the employee is eligible for stock options or other equity compensation, the letter can detail any applicable criteria such as vesting periods.
Being cautious about what you say and the administrative costs of preparing an offer letter far outweigh the cost of litigation and the prospect of a jury trial. Your words can come back to haunt you for a long, expensive time.