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Building a successful company requires a visionary, a dream, a business plan, and, eventually, a great team of employees to assist the visionary in executing the business plan and realizing the dream. Often, a handshake brings the first several employees on board. However as the company matures, it may enter into written employment agreements with key senior executives that address compensation, severance pay, and other significant terms of employment. This is particularly true when the labor market is tight, as has recently been the case, or when a company is trying to hire an employee away from a secure or lucrative job or to relocate from another part of the country. Also, an employment agreement may be appropriate from the company’s perspective if the company wants to retain key employees using "golden handcuffs" that make it costly for the employee to leave.
The employer and the employee should consider a variety of business and legal issues when they are negotiating an employment agreement. Among the business issues are: the term of the agreement; the employee’s title, duties, and responsibilities; the employee’s compensation (e.g., base salary, bonus, and equity compensation); and employee benefits (e.g., health insurance, disability and life insurance, and vacation). Among the legal issues are: the reasons for early termination by the employer (e.g., death, disability, for "cause," and without "cause"); the reasons for early termination by the employee (e.g., for "good reason," or without "good reason"); the effect of a change in control; the effect of early termination of the agreement or a change in control on bonuses and unvested equity compensation; the nature and amount of severance payments under various termination scenarios; the nature and scope of restrictive covenants such as a covenant not to compete; and dispute resolution.
Like most states, North Carolina follows the employment "at-will" rule. Under this rule, absent an employment agreement to the contrary, either the employer or the employee may terminate the employment relationship at any time, for any reason (as long as the reason is not discriminatory or otherwise illegal), and without any notice. This often comes as a surprise to many people, who believe they only can be terminated for "cause" (i.e., if they do something "wrong").
Employment agreements are used to override the "at-will" rule and establish specific boundaries to the employment relationship. Generally, employment agreements are for an initial term of two or three years and automatically renew annually unless either party gives notice to the other party of its intention not to renew the agreement. Ultimately, the term of the employment agreement is not as important as under what circumstance the employment agreement may be terminated by the employer and the employee and the consequences of such termination.
Employment agreements should identify the employee’s job and title as specifically as possible. In addition to the employee’s job title, the employment agreement should describe the employee’s duties, responsibilities, and authority and identify to whom the employee reports. Often, the employee’s job is described in a very detailed exhibit that is attached to the employment agreement which may help to avoid ambiguity. Also, the employee’s job description may contain a catch-all provision such as "and such other duties as reasonably requested by the (board of directors of the company or a specific officer of the company)." This allows the employment agreement to be flexible and the employee’s duties to evolve as the company changes; however, this provision can also create uncertainty and could result in a dispute between the employer and the employee. Defining the employee’s job with specificity helps to ensure that the employer does not demote the employee or diminish the employee’s duties and responsibilities without the employee’s consent, which could give the employee the right to terminate the employment agreement for "good reason." However, the more specific the job description, the easier it may be for the employee to establish such action.
While the amount of the employee’s compensation is a business matter, counsel may be able to provide guidance regarding whether the compensation is consistent with comparable positions in similar companies. Employment agreements generally provide for a base salary that cannot be decreased without the employee’s consent. In addition, employment agreements generally provide for annual performance reviews that presumably will result in annual increases in the employee’s base salary. These increases may be fixed, based upon a formula, or determined by the company’s board of directors.
If the employee receives equity compensation such as stock options, the employment agreement will describe the general terms of such compensation. However, the actual grant of the stock options will be in a separate stock option agreement that will be governed by the employer’s stock option plan. Often, the employer and the employee desire to have the stock options vested based upon the employee achieving certain performance milestones rather than based upon the passage of time. This may cause accounting issues for the company, and the company should consult with its auditors.
The employment agreement may also provide that the company will pay bonuses to the employee if the employee achieves certain performance goals. These bonuses may be in the form of cash or additional equity compensation. In order to avoid disputes regarding whether the employee earned the bonus, it is advisable that the employment agreement provide specific objective criteria and goals against which to measure the employee’s performance. Examples include meeting certain revenue or profit levels, achieving certain budget percentages, or meeting certain sales goals. The employment agreement should also address how bonuses will be handled (and presumably pro-rated) for partial years at the beginning or the end of the period of employment. Often, it is necessary to redefine these criteria and goals annually. The employment agreement should provide a mechanism for this and address what happens if the employer and employee cannot agree.
The termination and severance provisions may be the most important and extensively negotiated portions of an employment agreement. If the employee retires, dies, or becomes permanently disabled, the employment agreement generally will provide that the employer will pay the employee or his estate his accrued and unpaid salary through the termination date. It may also provide for the payment of accrued and unused vacation and a pro-rated portion of unpaid bonus. Employment agreements generally define permanent disability as the employee’s inability to perform his job for a certain number of consecutive days or a certain number of days within a specified period of time. Upon retirement, the employee may also be eligible for certain retirement benefits.
If the employee is terminated for "cause," the employer’s obligation generally is to pay the employee accrued and unpaid salary and vacation through the termination date. "Cause" usually is defined as: conviction of a felony or other crime involving moral turpitude; failure to perform duties; breach of company policies; or breach of the employment agreement. The employee may request that the company give him notice and an opportunity to cure if it desires to terminate him for "Cause" based on a failure to perform his duties or a breach of the employment agreement. The Company may resist this request since it will desire to terminate the employee immediately and deal with any dispute with the former employee later.
An employee may request a provision in his employment agreement that gives him the right to terminate his employment for "good reason." If the employee is terminated without "cause" or the employee terminates the agreement for "good reason," the employee will desire to receive severance payments and perhaps acceleration of vesting of stock options as a result of such termination. "Good reason" may include: a decrease in the employee’s title, duties, responsibilities, or compensation; a requirement to relocate beyond a specified area; the company’s breach of the employment agreement; a significant change in the board of directors of the management of the company; or a change in control.
Employment agreements generally include restrictive covenants that prohibit certain actions by the employee during and after employment by the company. Among these restrictive covenants are: confidentiality and non-disclosure agreements; non-solicitation agreements that apply to other employees of the company and the company’s customers and prospective customers; and non-competition agreements. Restrictive covenants should be balanced to protect the employer, but not to limit detrimentally the employee’s ability to earn a living. In addition, the duration and scope of the non-competition agreement may be tied to the reason for termination and whether or not the company will pay severance to the employee after the termination.
Employment agreements involve a mix of business and legal issues that can have significant ramifications for the employer and the employee. Legal counsel can help structure employment agreements that address these sometimes complex issues.
This article was published in the August 2001 issue of the Triangle TechJournal.