Other employers don’t take the time to carefully draft executive employee agreements. In the excitement of finding the right fit to lead a key position in their company, they overlook what might appear as the mundane task of circumscribing an executive’s duty, responsibilities, and performance expectations. After all, this is a highly motivated individual entrusted with a key organizational function, how much guidance do they need?
But more than just defining expectations, executive employment agreements outline key contractual obligations for both the executive and the employer. Likely you attracted this key member of your company by offering some combination of lucrative compensation and benefits, equity grants, and the security of a term of employment. What happens when things don’t work out as expected? Do the parties have an understanding on how promised compensation will be handled in the event of early departure or termination? If a dispute arises about performance or compensation, how will it be resolved? And, whether the executive completes the expected term of service, what post-employment restrictions are needed to protect the company, without unduly burdening the executive?
Whether executive employment agreements are necessary or beneficial depends on the nature of the employer’s business and the executive’s role. The benefits of entering into a written employment agreement include:
Listed below are ten issues that should concern both the hiring company and the key employee when putting together any executive employment agreement.
- DUTIES AND RESPONSIBILITIES
Perhaps the most overlooked and poorly defined terms of any executive employee agreement are the performance expectations of the executive. This section is often given short shrift. The company has been so focused on the compensation and benefits package and its bottom line; it forgets to outline what it will actually get for its money. Likewise, key employees seeking to maximize their independence are happy to receive broad and generic duty descriptions and performance goals. This may come back to bite them as well when the success they have worked so hard to achieve turns out not to be the success the owners were looking for. As the company owner, take to time to develop detailed performance objectives. These can often be tied to compensation bonus or equity offerings. As the key executive, if you have been offered performance goals in the interview process, seek to have these included.
- TERM AND RENEWAL
An executive’s employment agreement typically will set an effective date and state that the initial term of employment will be for a period of years subject to earlier termination under other provisions of the agreement. In contrast, “at-will” employment can be terminated by either party at any time, for any reason that is not unlawful, and without advance notice. The contract should address whether the relationship is for a term or at-will, and whether the term will end at the expiration of the initial term or automatically will renew for extension periods absent advance notice.
- COMPENSATION
While it’s unlikely that any executive employment agreement will be signed without outlining compensation terms, they may not be offered in clear terms. This can lead to disappointment and conflicts. If employment is based solely on base salary, there is little danger or confusion. Make sure how, and to who it will be paid. Some executives have been known to request payment be made to a company, rather than themselves directly in an attempt to shelter money for tax or other purposes. Remember that this is a personal services contract that must be paid to a person.
Other compensation terms may be complicated, and both parties should be sure they understand how they will be determined. For example, if you include formula-based incentive compensation, you may wish to include one or more examples of how that formula will work within the agreement itself. If some form of compensation is discretionary or conditioned upon objective achievements, make sure the agreement is clear as to which is which, and how the specific objective achievements will be measured.
- EQUITY AWARDS
Frequently equity awards as a significant source of compensation are included in an executive employment agreement. These awards, particularly with start-up, may eclipse base pay. Such incentives may include stock options, stock appreciation rights, restricted stock and restricted stock units. One important, and often overlooked, consideration is the vesting period for these types of awards. Too short a period may not provide the key employee enough incentive to plan for long term success. Too long a period may not offer enough incentive for the award to have the value you want to incentivize. Both sides should consider these factors, as well as whether the award will accelerate and become fully vested if the executive is terminated without cause.
- BENEFITS
In some cases, the fringe benefits offered to attract key employees can be quite complex. Standard packages, like insurance coverage and premiums, enrollment periods, and retirement plan service requirements, may be incorporated by reference to plan documents and policies. Other terms, such as vacation time, vehicle use, and funds allocated for professional licensing and continued education may require more specific considerations.
- EARLY TERMINATION
Any agreement for a term of years will likely include a termination for “Cause” provision. This allows the employer to terminate the executive’s employment immediately for certain acts or omissions against the employer’s interest. The employee will want this clause to be narrowly drafted and specific. The employer may seek broader language. The broader the language, the more important to include notice and opportunity to cure provisions. If an employee may be terminated without cause, the parties will want to negotiate terms for a period of advance notice, and severance terms.
- CLAWBACK PROVISIONS
If the agreement provides for immediate payment of signing bonuses and/or relocation expenses the parties should discuss an appropriate repayment provision if the executive does not complete the expected term of service.
- TAX CONSIDERATIONS
When structuring compensation packages, both employees and owners should be aware of Internal Revenue Code Section 409A, addressing nonqualified deferred compensation. Section 409A applies to compensation that an employee earns in one year, but that is paid in a future year, such as bonus payments, severance arrangements, equity awards, releases, and reimbursement arrangements. If the employee’s compensation package contains any deferred compensation that fails to meets the requirements of Section 409A, then it is subject to certain additional taxes, including a 20% additional income tax.
- POST-TERMINATION RESTRICTIONS
The enforcement of non-disclosure/confidentiality, non-competition, and non-solicitation provisions contained in an employment agreement vary as a matter of state law. Some states, like California, will not enforce non-competition agreements, except under certain circumstances. Most states, including California will enforce reasonable post-employment restrictions that are necessary to protect the employer’s customer relationships or trade secrets/confidential information. Both parties should be aware of the current law in their state.
- GOVERNING LAW AND JURISDICTION
Most executive employment agreements, as with most other business contracts, will specify the law that a court or arbitrator will apply to interpret the contract and resolve future disputes. The agreement may also provide for that any dispute be first submitted to a mediator or be adjudicated by arbitration, or both.
Takeaway
Careful consideration is given to which provisions should be included in the employment agreement, and both parties should have a clear understanding of the terms before signing. A well-drafted executive employee agreement can be a valuable recruitment tool and minimize confusion and conflict between the parties about their mutual obligations. Most companies tend to create a standard agreement and stick with it. This has the advantages of uniformity and consistency in contracts. If you need assistance drafting an executive employment agreement, or updating an existing one, Contact CASHMAN LAW today for a free consultation to see how we might assist.
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