Employment contracts are written agreements between an employer and an employee that detail the workplace duties and responsibilities of the employee and the compensation that the employer provides in return. Employment contracts typically lay out the wages, bonuses, vacations, medical leaves (including maternity/paternity), stock options and other benefits and compensation that the worker receives for fulfilling his/her obligations to the employer. These obligations are also specified in the contract, as is the duration of the worker-employee arrangement, the authority of the employee, ownership of intellectual property, and dispute resolution mechanisms. 

In recent years, employment contracts – and the perks, bonuses, and stock options often provided in such contracts – have become common and necessary for high-tech, software, online, and multi-media startups operating out of extra bedrooms, garages and sub-leased office space. The success of many such companies is now well documented, as are the riches by talented individuals who have tied their compensation to the success of these companies and obtained millionaire status without having to don a business suit.

Some business experts, however, contend that employment contracts can have a negative impact on long-term business health. According to this point of view, employment contracts undercut employee trust, loyalty, and dedication towards employers because they are seen as cold and impersonal documents that send an “everyone needs to look out for oneself” message. The new employment contract inherently demotivates employee spirit and, over the long-term, will sub-optimize organizational performance, becoming a self-destructive business strategy. Where employee buy-in and ownership is lacking, so too will be the discretionary effort critical to success. As a consequence, “work-to-rule” performance standard will evolve, and mediocrity will prevail. 

Critics contend that the emotional detachment that accompanies employment contracts will lead to increased turnover in important positions, especially since demographic trends and the ascendancy of the information-based economy are expected to increase the competition for experienced workers. 


Crafting an Employment Contract

Business owners who are considering introducing employment contracts into their operations should consider the following:

  1. Employment contracts that are imposed unilaterally, rather than by genuine mutual agreement between worker and employer, are at substantial risk in the courts. If the employee is found to have entered into the contract under duress, the agreement will be struck down.
  2. Employment contracts are an effective means of mitigating the risk of business damage at the hands of ex-employees. A carefully drafted employment agreement containing non-complete, non-disclosure and/or non-solicitation clauses can be useful in protecting the employer’s justifiable interests in its trade secrets and customer relationships. However, if the court believes that it is overboard, or will unreasonably prevent an employee from practicing an occupation, the agreement may be struck down in whole or in part, depending on state law.
  3. Consider collaborating with the employee in order to create a comprehensive contract. Both parties should put great thought into clearly defining the duties and authority of the employee to avoid confusion and misunderstandings as to expectations. Although it is almost always impossible to clearly outline all duties inherent in a particular position, objective specification of duties and standards of performance are desirable not only to avoid confusion but also to avoid litigation.
  4. Determine whether termination of the contract  is “at will” meaning that either the employer or the employee can end it at any time, or “for cause” meaning that the agreement between  the parties can be terminated only if the employee is found to have committed a legal offence  or other stipulated  act of dishonesty, fraud, etc. Consultants typically urge businesses to make certain that the language of the contract conveys “at will” message throughout, thus avoiding legal potential entanglements that can arise if the arrangement is seen as a permanent job.  One key in this regard is to limit the contract to a set period of time (contracts for one or three years are most common).
  5. Examine the regulatory/legal environment in which your company operates. Make sure that the employment contract adheres to pertinent laws before you introduce such agreements. Not all states provide the law for such agreements.
  6. Use employment contracts only for legitimate business relationships. Compensation for services rendered should be reasonable and should be distributed only when they are in fact completed. This element is of particular relevance to family-owned enterprises, which sometimes turn to employment contracts as part of their overall succession plan. Where the older generation founder really does intend to stick around for a while, and the younger-generation new owner can deal with any ego problems and make good use of the father’s advice, experience, and skills, such arrangements can make good economic sense. 
  7. Employee contracts are not “one-size-fits-all.” Employers should recognize that managers and executives can and should be rewarded in different ways, depending on their contributions to the company.
  8. Severance arrangement should be reviewed on a regular basis to determine the suitability for inclusion in employment contracts.  If an employer is going to have a severance program that applies to more than one employee, it should have a written plan that describes the particulars of the program and gives the employer discretion to interpret the plan and determine eligibility for severance. It will give more protection if there is ever a dispute later – the courts will be more differential to their decisions if they have a written severance plan.
  9. Dispute resolution mechanisms are often incorporated into employment contracts. This arbitration language is sometimes limited to certain specified issues within the contract (authority of employee, divisions of intellectual property, bonus calculations, etc.), thus leaving other aspects of the contract to the courts. 

Other employment agreements, however, include “blanket” arbitration clauses that provide for arbitration of all disputes between the employer and the employee under contract.

If you find this article useful, please share and subscribe to our newsletter.