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Employment Contracts Gain Ground in Corporate America

February 1, 1999
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Employment contracts, confidentiality agreements, and non-compete and non-solicitation clauses aren’t just for top dogs anymore.

As the social contract between employee and employer weakens, the employment contract has gained huge ground. A survey by Norwalk, Connecticut-based Exec-U-Net, an executive networking organization, found 26 percent of 412 executive search firms reported their candidates received written employment contracts, where five years ago the idea was virtually unheard of. A well-written contract can be a boon to both sides. Employees feel more secure, and the company knows it has set boundaries for hiring, firing, compensation and other sticky details.

Michael D. Karpeles, head of employment law for the Chicago-based firm Goldberg, Kohn, Bell, Black, Rosenbloom & Moritz Ltd., explains the types of contracts HR managers may consider—and how to make sure they do what they’re intended to do.

Why are employment contracts becoming more common?
We’re seeing more employers use employment agreements with middle managers as well as top executives. The trend seems to be going deeper into the organization now than it ever did in the past, as we move from a manufacturing economy to a service economy in which information is a large part of a company’s capital.

What are the goals of using such contracts?
Companies want employees to sign confidentiality agreements and non-compete agreements. Employees, in turn, are getting sophisticated about the advantages of equity ownership and the importance of locking in things like benefits and salary. So those [issues] are working together to create a situation in which more employers are using employment contracts for more of their employees than they ever did before.

How far will this increase in the use of employment contracts go?
I think it’s not likely to reach farther down past middle management in most companies, but it probably depends on the industry.

In the information technology field or other fields in which employees deal with sensitive financial information or trade-secret type information—such as patents, formulas or technology codes—you’ll see written confidentiality agreements signed by employees. But we’re seeing more of all kinds of contracts: confidentiality agreements, non-competes and employment agreements.

Can you explain the different uses for these contracts?
A confidentiality agreement typically will require employees to not disclose company proprietary information or trade secrets during their employment or after to anybody. A non-compete agreement—also called a restrictive covenant—typically prevents employees from competing with their employer after employment for a limited period of time and limited geographic area.

How does a contract prevent employees from doing that?
The non-compete agreement can include two non-solicitation agreements. There’s a non-solicitation of customers agreement, which means for a limited period of time after an employee leaves, he or she won’t solicit the former employer’s customers or prospective customers.

And then there’s a non-solicitation of employees, which means for a limited period of time after an employee leaves the company, he or she can’t attempt to hire away former fellow employees.

What is an employment agreement?
An employment agreement is a document that expresses the agreement of the employer and employee regarding wages, compensation, bonuses, vacations, medical leaves, possible stock options and termination provisions.

An employment agreement can include a confidentiality agreement, a non-compete and a non-solicitation. You can have all these within one global employment agreement.

So what does a good employment agreement have?
A good employment agreement describes the employee’s position, specifies the duration of the contract, and specifies wages and other compensation and benefits. It’ll say whether termination can be by either party at will, or whether the employment agreement will be for cause—that is, the employee can’t be fired for whatever period of time the agreement covers unless he or she has given cause, such as dishonesty or conviction of felony.

How are wages addressed in the agreement?
The agreement can include wages; for example, when the employee is eligible for a raise or bonus plan. If it’s a long-term contract, there may be built-in increase levels at certain time points. If you put in a timeline for bonuses or raises, you should also include criteria for those bonuses or increases.

Do you have advice about the terms used in the contract?
Employers shouldn’t mention permanent employment—that’s a buzzword sometimes used that’s a dangerous term and conveys to employees that they have a permanent job. And be careful not to use language that implies the employment is anything other than at-will.

What else does a good non-compete agreement include?
First, make sure your state law allows them—in some states they’re unenforceable, but in most states they’re enforceable as long as they’re reasonable and protect a legitimate business interest. They’ll need to be limited to a year or two years, and limited in geographic scope to the area in which the company is actually doing business. For a national company, that means describing the markets in which the company competes.

What else should a non-compete agreement clarify?
It should also be reasonable in the scopes of activities that are restricted. If a guy is a salesman for you and wants to work as a PR person for a competitor, that may not be a legitimate restriction. The agreement should indicate that a breach of the contract will lead to irreparable harm to the employer. It also will state that if a court finds the contract overly broad or unreasonable, it has the right to rectify the non-compete to make it reasonable and enforce the modification.

What about a confidentiality agreement?
These agreements usually list all the items a company wants to protect, and then state that by signing below, you agree not to disclose this information at any time.

Often there’s a provision that says once the information becomes public through legitimate means, then the obligation to maintain confidentiality is gone. Most of these kinds of contracts can be signed upon entering the employment relationship, during the employment relationship or even after the relationship is over.

Is there anything else employers should know about employment contracts?
Most contracts containing severance arrangements are going to be deemed ERISA welfare benefits plans. Many employers don’t know that.

How should an employer handle that situation?
If an employer is going to have a severance program that applies to more than one employee, it should have a written plan document that describes the particulars of the program and gives the employer discretion to interpret the plan and determine eligibility for the severance. It’ll give more protection if there’s ever a dispute later—the courts will be more deferential to their decisions if they have a written severance plan.

What else should the employer do about severance?
Employers ought to consult with an executive compensation specialist to determine what’s fair or appropriate in terms of severance—how senior the person is, and how much the company wants the person. It’s much better to negotiate upfront when both sides are feeling good about each other than after a separation when the likelihood of getting an agreement is less.

What are the benefits to an employer of using a contract?
The benefit to employers is that the obligations they have are clearly spelled out in writing. The disadvantage is that sometimes employment contracts eliminate some flexibility that a company might otherwise have or want.

Can you describe a situation in which the problem of flexibility is illustrated?
For example, a company says it wants an employee to sign a non-compete or a confidentiality agreement, and the employee says "Fine, but I want an employment contract that gives me guaranteed severance or a job for a certain period of time." Companies must make that judgment as to whether an employee is worth entering into such an agreement. n

This article is intended to provide useful information on the topic covered, but should not be construed as legal advice or opinion.

Workforce, February 1999, vol. 78, No. 2, pp. 99-101.

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