How to Use Employment Contracts

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In such a litigious society, all business owners need to understand the necessity for employment contracts (such as confidentiality agreements), at-will termination agreements and noncompete agreements. Should you use them? What's the best way to do it?

OVERVIEW [top]In an ideal world, most CEOs would opt to run their businesses on good faith and handshakes. However, this is not an ideal world. Painful as the thought may be, companies need contracts — especially employee contracts — based on good legal advice. "For many people, employment contracts aren't viewed as life and death, so they just don't get around to doing it — and forestalling that is forestalling disaster," says Garry Mathiason, senior partner with the nation's largest labor law firm, Littler Mendelson in San Francisco. If your company has been "forestalling disaster," this Quick-Read Solution will clarify:
  • What a contract should include and why.
  • How to support a contract.
  • Potential negatives associated with contracts and where problems can arise.
SOLUTION [top] Who needs employment contracts? Every company needs employment contracts, but not every company needs the same types or terms. Developing a contract policy is critical for companies with limited product lines built around one or two key innovations (as is the case with most startups and emerging-growth companies). Contracts are most needed and most often negotiated with top-level executives and key engineering or marketing people, although increasing numbers of companies are requiring contracts of all employees. In a small growing company, losing a top salesperson and a couple support staffers to a competitor can be devastating. When do companies need an employment contract? "They need them as soon as they expand from one person to two or more," says Sandy Weinberg, who started six different biomedical companies before becoming entrepreneur-in-residence at Muhlenberg College in Allentown, Pa. "Once you have a second person, you're at peril." Why do companies need an employment contract? Good will is a good thing, but it won't stand up in court. "It's like a prenuptial agreement in a marriage," says Rob Kaufman, managing partner at Kaufman Chaiken Miller & Klorferin in Atlanta. "If there's a problem, people run to it. It's much easier to deal with it on the front end than on the back end." As much as anything, experts say, contracts reinforce for employees the gravity of the employer's interest in protecting business assets. What should a contract cover? A company's contract needs will vary by industry and the strategic value of different employees. A brick-and-mortar retail company, for instance, may be less concerned about nondisclosure agreements, and more concerned about noncompete agreements. Following are some types of agreements and the areas of major concern they may deal with:
  • Intellectual property — Defines ownership of ideas and inventions developed by employees and also applies to contractors.
  • Nondisclosure — Prevents release of key information.
  • Noncompete — Limits the ability of key individuals to take what they know to a competitor or to start a competing business. Tough to enforce, noncompete agreements work best when specifically defined and are limited to 6 months or less.
  • Arbitration — Spells out the process by which disputes will be resolved, and avoids more costly court litigation.
  • Termination and severance — Spells out whether an employee may be let go "at will" or "with cause," when each condition would apply and what compensation would be due.
  • Wage and hour release — Contractual employees can waive wage and hour claims. Employees can't waive protection under such laws.
To learn more about different kinds of contracts, see "How to Protect Your Business with Contracts." Four Contract Support Tips
  1. The more specifically worded the contract, the easier to enforce.
  2. The more consistently applied and enforced the employment contracts and personnel policies, the easier to defend contract clauses if and when a terminated employee protests in court or arbitration.
  3. If a contract defends intellectual property, make sure you can show that you have taken steps to protect that information. Treat information as confidential; stamp or label it; store it securely; and limit access. A court will look more kindly on rigorous document handling and tight internal security.
  4. Look also to your Web site. It is difficult, Kaufman says, to claim that information about key customers and technology is confidential if you have posted it on your Web site.
Possible negatives and problems
  • Contracts must be very specific, so they are difficult to draft properly. Consult your lawyer.
  • Employees may resist signing, and that may cause you concern. A candidate who refuses to sign may not be someone you want to hire anyway. Most candidates appreciate the security a contract provides.
  • Executive-level employees will want to negotiate contract points, often based on advice from their legal advisers. Going in, you should know what you are willing to negotiate and what you want to remain constant in all contracts.
  • When your staff size passes legal thresholds, the law may require contract changes. If your company has more than 50 employees, for instance, worker agreements must comply with provisions of the Americans with Disabilities Act and equal employment opportunity laws.
REAL-LIFE EXAMPLE [top] Before going to work at Ulticom in Mount Laurel, N.J., each employee is required to sign the same contract. It's been that way for years, says Mike Sweeny, who works for T. Williams Consulting in Collegeville, Pa., and handles Unicom's staffing through an outsourced arrangement. The telecom software company did $28 million in revenues in 1999, and the company wants to protect its claim to its ideas to keep those revenues growing. The contract includes nondisclosure, termination and intellectual property clauses. "With the engineers, the most important part is the nondisclosure," Sweeny says. "It's to keep them from learning valuable information here and leaving and starting a competing business elsewhere." In the last two years Ulticom has had no contract disputes, Sweeny says. DO IT [top]
  1. Get an attorney familiar with labor-contract law. Don't assume that every attorney knows this field well. A good corporate attorney may cover all the bases in setting up the business, but may also use boilerplate contracts, which can have holes.
  2. Provide the attorney with copies of any employee handbooks, policy manuals and memos defining how pay and benefits are determined or defining any other aspect of work that the employment contract might mention, to ensure that the new contract is aligned with the de facto contract comprised of such documents. This wil l be a good time to document your relationship with every employee in the employee's personnel folder. Unless changes have been agreed to by employees, each is covered by the written or de facto contract rules that were in effect when he or she was hired. If you want to change the rules to bring all contracts into alignment, the best time to get each employee to sign on is when you're offering him or her a pay raise.
  3. Make sure the contract has noncompete, intellectual property and termination clauses and provides for arbitration of disputes and the procedure for selecting an arbiter. Language clarifying who is and is not "exempt" from the wage and hour law will prevent back-wage claims.
  4. The more specific the language, the better. Sweeping generalizations or covenants that would prevent someone from earning a living after departure invite challenge and may not be defensible.
  5. Ask counsel to ensure that the contract protects individual managers from claims made by terminated employees.
  6. Be prepared to provide exiting employees with a copy of a letter from the corporate counsel, reminding them of all terms to which they agreed in signing the contract.
RESOURCES [top] Books Individual Employment Disputes: Definite and Indefinite Term Contracts by Donald W. Brodie (Quorum Books, 1991). Brodie emphasizes legal considerations. Perks and Parachutes: Negotiating Your Best Possible Employment Deal, from Salary and Bonus to Benefits and Protection by John Tarrant with Paul Fargis (Times Business/Random House, 1997). These discussions of contract options and negotiation tips for employees provide excellent perspective for employers too. Internet Sites "Companies expanding employment contracts to entry-level positions," Bizjournals.com Losing or Leaving a Job Alexander Hamilton Institute Employment Law Resource Center Article Contributors Writer: Stu Watson
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