I.

INTRODUCTION

Not so long ago, most high-level managers and executive officers were hired with a firm handshake or, at most, a friendly, vaguely worded offer letter. But times have changed, and the wise company avoids this congenial yet ill-advised approach.

Executive and managerial employees frequently possess special skills and experience that significantly enhance a company’s ability to compete in a tough marketplace. At the same time, however, their employment presents a company with special risks. While senior managers and executives are less likely than lower-level employees to sue for wrongful termination after they leave, they are uniquely positioned to compete directly within your industry, solicit your employees and/or use or disclose your confidential and proprietary information to your detriment. In addition, if they were forced out of the company, they often are sophisticated enough to demand a lucrative severance package. Finally, if they do bring a lawsuit against you, their sophistication, financial resources and knowledge of your company can drag you through protracted and expensive litigation.

Given these realities, many of our clients are increasingly considering the use of employment agreements to (1) clarify the respective expectations and (2) minimize the risk that disputes will occur during and after the employment relationship. While in years past this approach was neither necessary nor particularly desirable, we believe that, in today’s employment atmosphere, it is imperative for companies to develop and utilize effective and acceptable employment contracts for their executives.

In this article, we focus on the essential clauses that should be considered for inclusion in all executive employment agreements. These clauses are designed to protect your company from the risk of expensive employment disputes while remaining palatable to even the most sophisticated executives and the most seasoned attorneys representing them.

II.

GENERAL DRAFTING CONSIDERATIONS

An old adage claims that "expectations are ninety-nine percent of satisfaction." Put differently, if you raise someone’s expectations to a certain level and then fail to meet them, he or she will never be satisfied. When hiring talented high-level employees with significant compensation packages, a company must pin down the basic ground rules of the employment relationship in clear, written form.

An employment contract is designed so that both sides understand their respective expectations and obligations at the very beginning. The document can and should be written in plain English so that both sides understand its terms and conditions. It also should be carefully crafted to cover all key terms and conditions of the executive’s job.

What lawyers call an "integration" clause should be included at the end of the contract in order to verify that the document represents the entire understanding of the parties and that it supersedes all prior representations and agreements, both written and oral. This alleviates the possibility of misunderstandings based on oral promises and side commitments that can occur, particularly during the recruiting and interviewing process.

III.

ESSENTIAL CONTRACT PROVISIONS

Ordinarily, the most critical issues to address in executive employment contracts include: the term of the employment, and how that term can be extended or cut short; a description of the executive’s duties and authority; a detailed list of the compensation and benefits to be provided, including how pay increases and bonuses will be awarded; and the circumstances under which the executive can be terminated and the consequences of that decision (e.g., notice period, reasons for termination, and termination payments, if any). The employment agreement is also an ideal opportunity to address and prevent post-employment competition problems by including a variety of provisions restricting the employee’s activities in the industry.

A.

Term Of Contract

The term, or duration, of an executive employment agreement ordinarily depends on the unique circumstances involved in any given hiring. In many cases, a company wants an open-ended relationship that can be terminated by either side with a specified amount of notice. Such an approach may be in the executive’s best interests as well, because she does not have to worry about whether the company will renew her contract. From the company’s perspective, an open-ended contract is attractive because it keeps the relationship going when the executive is performing well, without worry about renegotiating the contract (at a higher

salary) or ending the relationship altogether. The downside, of course, is corporate inertia. If the executive is not performing to the company’s expectations, an open-ended contract, unlike one with an express term, may not provide the necessary impetus to force the company to decide whether it wants to renew the executive’s contract or begin recruiting her replacement. These same pros and cons exist, albeit to a lesser degree, for contracts with an express long-term duration.

It frequently will be in the company’s interest (and the executive’s as well) to provide for a short-term contract. Such a contract, which usually can be renewed by the parties at the expiration of the term, gives both sides desirable flexibility. Alternatively, the agreement could set forth a longer term and simply provide the parties the option to terminate the contract either at the conclusion of some specified period or at any time upon some specified notice.

In addition to providing for a specified duration, companies will often want to reserve the right to terminate the employment relationship on an at-will basis, i.e., for any legal reason or no reason at all before the intended expiration of the contract. Any intention to preserve an employee’s at-will status should be clearly stated in the contract. Given the courts’ seemingly relentless attacks on the legal viability of at-will employment, the sufficiency of an at-will provision in the agreement will be fortified if the contract also cites business reasons for the provision — for example, the company’s need for flexibility in upper management or need to respond to competition in the marketplace.

Describe the executive’s duties and responsibilities in broad terms to maintain flexibility and reflect the realities of running a business. In the event of litigation over the executive’s performance of a particular duty, however, a court may be asked to determine whether that duty existed and, if so, whether the executive’s performance of that duty was up to the company’s standards. For this reason, incorporate into the contract, as much as possible, specifications of the executive’s primary duties and the standards of performing of those duties. Of course, it is impossible to anticipate and describe all of the duties inherent in an executive’s position; nevertheless, a court would be well-guided by an illustrative list of the more important duties followed by a broadly worded "catch-all" description.

It is rarely necessary to specify the scope of an executive’s authority to any great detail in the employment agreement. The executive’s title itself usually provides sufficient indication of his authority. However, the company’s by-laws or other corporate documents may also provide some guidance. If so, they should be referred to in, and/or attached to, the agreement.

C.

Compensation And Benefits

Executive compensation packages vary greatly, depending in large part on the following considerations: tax consequences to the executive and the company; financial obligations and constraints of the executive and company; the executive’s role in the company (that is, as CEO, CFO, general counsel, etc.); the company’s strength and position in the industry; and the company’s mission within its industry.

Executive compensation (current and deferred) is too complex a subject to discuss in substantive detail here. Suffice it to say that companies can and should utilize compensation experts to draft personalized compensation plans to attract the most qualified executives, provide them with the work incentives desired by the company and minimize tax consequences to them and the company.

Give particularly careful consideration to the tax consequences of compensation. If an executive’s salary is largely fixed, consider including provisions for projected inflation through a cost-of-living escalation clause or an automatic basic salary increase clause. If incentive compensation based on profit-sharing is combined with a base salary, the employment agreement should include a provision on point. Many companies provide an incentive compensation plan that covers a number of employees. The executive may be covered by that sort of general "bonus" plan or may have his own separate incentive compensation arrangement. Either way, the terms of the incentive compensation should be set forth in the employment agreement.

The offer of such equity incentives as stock options is an increasingly common and important component of executive compensation packages. Expensive lawsuits can be generated over misunderstandings and disagreements concerning such equity incentives. All stock option arrangements should be summarized in the employment agreement (even though they will be set forth in much greater detail in a separate incentive stock-option or stock purchase agreement that the employee will sign). The employment agreement should also explicitly state that stock options are subject to a vesting scheme governed by a separate written agreement and the company’s stock option plan documents. This prevents disputes over whether the company promised an outright grant of stock as opposed to stock options subject to vesting.

The employment agreement should also describe other available benefits, such as health insurance, pension and profit-sharing plan participation, disability payments, vacation, auto allowances and expense reimbursement.

D.

Successorship Provisions

With the frequency of corporate mergers and acquisitions in today’s business world, executives are extremely apprehensive about the effect of such business combinations and reorganizations on executive employment agreements. A company, therefore, must consider whether its executive employment contracts should survive if the company’s business is merged into an acquiring one.

The executive ordinarily wants a specific provision for survival of the agreement. The company ordinarily wants to terminate the agreement because an outstanding employment contract may trouble a prospective acquiring company and impede a desirable acquisition. On the other hand, a survivorship provision could be an effective sales pitch in recruiting highly sought-after executives. One way to accomplish both of these competing objectives (i.e., attracting top-notch employees and not impeding advantageous acquisitions) is to include a clause allowing the company to terminate the contract in the event of an acquisition but requiring the company to provide the executive with a lucrative separation package — the proverbial golden parachute. (This clause could be included as part of a general termination without cause provision.)

E.

Non-competition During Employment Term

A company usually expects its executives to work full-time on the company’s behalf and to refrain from engaging in any enterprises that compete with the company. Spell out these expectations clearly in the employment agreement or you may be hard-pressed to prevent an employee from engaging in competitive outside activities.

In some situations, an executive may want to work only part-time for the company or may be loath to give up pre-existing outside interests in other, non-competitive enterprises. If the company chooses to allow the executive to pursue or continue non-competitive outside activities, describe the specific activities permitted and require the employee to obtain the company’s consent before pursuing additional outside activities during the term of the agreement.

F.

Non-competition After Employment Term

Many companies are tempted to include broadly worded non-competition provisions in their employment agreements. Resist that temptation. Companies employing workers in California need to be aware that under the Business and Professions Code Section 16600, covenants not to compete are generally unenforceable in the state.

In jurisdictions that allow covenants not to compete, a company must make sure that such a clause is reasonably drafted so that it is not overly broad in duration, territory and prohibited activities. A draconian non-compete clause runs the risk of being held invalid by a court and, perhaps more importantly, may scare away qualified recruits (thus, impeding a company’s ability to compete in the marketplace).

A company legitimately concerned with protecting itself against post-employment competition from an executive may address this concern through other provisions that will be acceptable to the executive and enforceable in the courts.

1. Consulting services clause

For instance, a company’s employment agreement might include a provision for consulting services. The primary purpose for a consulting agreement is to encourage the executive to assist the company in achieving a smooth transition of duties to the successor. However, a consulting agreement can also be an effective vehicle to prevent the employee from competing with the company. Retaining a departing employee as a consultant may make economic sense if the company can avoid lost profits or litigation expenses that may result from a highly skilled individual starting or going to work for a competing business.

In general terms, a consulting services provision simply provides that the departing employee will work as a consultant for the company for a certain period of time, and that she will refrain from working for, or providing any services to, the company’s competitors during that period. Of course, the individual would be free to work for a competitor, but the company would simply terminate the consulting agreement and not pay any more compensation under it. A consulting services provision should spell out exactly which companies the departing employee will not work for or provide services to, and which other competitive activities he must refrain from engaging in. It also should clearly set forth the specific terms relating to the individual’s duties and responsibilities during the consulting period.

A consulting provision may also achieve other purposes — such as providing for deferred compensation. If this is the case, the employment agreement should clearly indicate that the individual is an employee, not an independent contractor, by specifying that the individual cannot work for any competitor and that the company maintains the right of control over the individual’s work in the industry.

2. Unfair competition clause

California courts will not hesitate to restrain a former employee from engaging in unfair competition with a former employer. An agreement by an employee not to engage in unfair competition is enforceable and should be included in an employment agreement. Unfair competition includes the use of a company’s trade secrets, confidential and proprietary information, information about its services, products and/or customers and its methods of doing business.

To be effective, however, an unfair competition clause should be narrowly tailored to protect the company’s interests. It should proscribe only that conduct which truly amounts to unfair competition and should be limited in duration, territory and job position. Overreaching may scare off top recruits. It also may not be enforceable and may put the entire provision at risk.

A company has a legitimate interest in preventing its workforce from being raided by a former employee who has gone to work for a competitor or started a competing business of her own. Although it generally is legally permissible for a former employee to solicit other employees to leave a company for a competitor (as long as the current employee is not under contract), it is unlawful for that former employee to use or disclose trade secrets or confidential information in connection with such solicitation. Knowledge of which employees are the top performers is arguably protected confidential information or a trade secret. A competitor could benefit unfairly by cherry-picking the best employees based on information provided by a former employee.

A contractual provision prohibiting employee solicitation will be enforceable so long as it is reasonable in scope. For example, a provision in an employment agreement that the employee will not disrupt, damage, impair or interfere with his former company by affirmatively soliciting its work-staff for one year after his departure from the company will probably be enforceable.

Proprietary information/confidentiality provisions protecting and preserving trade secrets and other valuable confidential information are typically contained in employment agreements. These provisions are valid and enforceable — but a company is well-advised not to overreach. Such a provision should be reasonable and necessary to protect only legitimate

trade secrets and confidential information. Such a provision cannot magically create trade secret status where it does not exist under the law but, rather, simply reflects existing law on what constitutes a trade secret. However, designating certain information as a trade secret in an employment agreement provides additional evidence that the information constituted a trade secret.

G.

Termination

Take particular care in determining the circumstances under which the executive will be discharged prior to the end of his term. Ideally, there should be two forms of termination: termination for cause and termination without cause. If the executive is terminated for cause, no severance pay is typically provided. When the executive is terminated without cause (as, for example, when there is a change in the direction of the company’s business) severance pay and other benefits are normally provided. If the termination provision is properly written, the only issue to be decided is whether the company terminated the executive with or without justification, as that term is defined by the contract. Courts will typically honor the contract and limit any damages to those required by the contract.

H.

Arbitration

Litigation surrounding the termination of a company executive is time-consuming and expensive. Perhaps even more importantly, it generates a lot of publicity that can adversely impact both the corporation and the individual. Typically, it is in everyone’s best interest for the executive to depart on as amicable a basis as possible and, where disputes arise, to have those disputes resolved in as confidential and expeditious a manner as possible.

To resolve disputes efficiently, confidentially, and in a cost-effective manner, companies should consider putting into their employment agreements a final and binding arbitration provision. Under such a provision, all disputes, whether based upon a wrongful termination, breach of contract, discrimination, or any other tort or statutory claim, are resolved on a binding basis before a neutral arbitrator. Great care must be given to how this provision is written to ensure that the clause is enforceable and that it covers all possible disputes surrounding the executive’s employment and termination. This provision should be written in a balanced way so that the company is not perceived as having an undue advantage. In essence, the only thing that should change is the forum for the dispute. All rights and remedies available to each side in court should remain available in arbitration.

However, arbitration provisions are under increasing attack in the courts and the last word has not yet been written on their current and future viability. Nonetheless, we advocate the inclusion of such provisions in executive employment agreements. Because the legal debate over arbitration clauses centers on a company’s ability to take away an employee’s

statutorily protected rights and remedies under state and federal anti-discrimination laws, a carefully tailored arbitration provision in an executive employment agreement will, at the very least, be enforceable with respect to disputes not involving claims under those anti-discrimination statutes.

For a detailed discussion of why an arbitration clause remains advantageous, and of how to draft one in a way most likely to survive a legal attack, please see Drafting Arbitration Agreements That Will Survive An All Out Attack, in these Symposium materials..

IV.

CONCLUSION

The specific terms of any given employment contract will depend in large part on the particular circumstances involved — the industry standard, the degree of competition for qualified applicants, and the company’s and prospective executive’s respective positions in the market are just a few of the relevant variables. Not all of the provisions discussed above will be possible — or even desirable — in all contracts. They should, however, be considered in the negotiation process of every contract. It will be up to you to decide which provisions can and should be included to strike the appropriate balance between protecting yourself and maintaining your ability to compete for the most qualified executives available.

The Appendix below provides a checklist for executive employment agreements, itemizing the essential provisions that a company should consider for inclusion in every such contract.