Stay-In Contract

Drawing up employment contracts can help retain key employees and protect your trade secrets-but beware of the drawbacks.
Magazine Contributor
4 min read

This story appears in the August 2001 issue of Entrepreneur. Subscribe »

Should you enter into employment contracts with your employees? Not if you don't want to alter the "at will" relationship assumed in most states, under which you can terminate an employee at any time for any reason or no reason. Still, there are circumstances when employment contracts make sense.

First, the advantages. An employment contract can help you attract and retain key employees. While you can't force employees to stay, a contract can ensure that they'll provide reasonable notice prior to departure-typically 60 to 90 days.

Especially in high-tech companies, employment contracts help protect critical trade secrets. "Suppose you have people doing research and development, and you're worried about an employee leaving and disclosing what you're working on to the competition," says Pat Lowry, an employment attorney with law firm Steel Hector & Davis in West Palm Beach, Florida. An employment contract can prohibit employees from revealing company secrets, working for the competition or soliciting customers.

"You have to be very careful in drafting these, because courts hate them," cautions Glenn Dowd, an employment attorney with law firm Day, Berry & Howard in Hartford, Connecticut. Because it's anticompetitive to prohibit people from earning a livelihood in their field, he says, courts generally will enforce noncompete agreements only if they're reasonable. You can't prohibit employees from ever working for a competing business anywhere in the country, but you might be able to enforce an agreement that they not work for a competing business within a 30-mile radius of your company for two years, or that they not solicit your company's customers for a year.

Employment contracts are also useful when you're buying or selling a business to make sure key people don't leave. "An employment agreement assures the new owners that the key players are committed for a given period," Lowry says. You can offer employees a retention bonus for staying or let them know they'll be forfeiting a valuable severance package if they leave.

Contracts also clarify individual jobs by spelling out employees' responsibilities, compensation, bonuses, stock options, rights to any inventions and patents, expense accounts and more. You can include an "evergreen" clause stating that the contract automatically renews on a given day each year if neither side provides notice of termination. (Put the dates on your calendar.) And an arbitration clause can ensure that any employment-related dispute will be subject to binding arbitration rather than played out in court, which can be expensive and time-consuming. (See "Arbitration Update")

Now the downside. Employment contracts change the "at will" relationship, restricting your ability to terminate employees who aren't working out. Typically you agree only to terminate "for cause" unless you're at the end of the contract term, which opens your decision to second-guessing by the courts as to whether your cause was adequate.

If you draft an employment contract, pay special attention to the termination section. You might want a clause denying certain benefits if you terminate for cause-such as committing a felony or acting in a way that's clearly harmful. "This gets the employer out of having to pay severance packages after misbehavior," Dowd says. Some employees might negotiate "double trigger" clauses, in which they can resign "for good reason" (such as being reassigned to another department) and still be entitled to a severance package.

"I would not make a practice of making employment agreements except for key employees," Dowd says. "It introduces a level of complexity and legality to the relationship that you don't need." Certainly, consult your attorney about clauses to include and avoid.

Arbitration Update:

Many employers require employees to sign documents stating that any dispute with the company will be resolved through arbitration. On April 28, the U.S. Supreme Court ruled that such agreements are legally binding. The decision affirms the legal right of employers to avoid expensive litigation by submitting discrimination claims and other employment matters to arbitration.

The case in question concerned a Circuit City employee who filed a discrimination claim against the company. The company argued that the dispute must be resolved through arbitration because the employee's signed job application included a provision agreeing to submit any and all claims to binding arbitration.

A federal judge sided with the company. But the 9th Circuit Court of Appeals overturned that ruling, pointing to the wording of the Federal Arbitration Act, which excludes employment contracts of seamen, railroad employees and other workers engaged in interstate commerce. That means all employees, the 9th Circuit irrationally ruled. Obviously not so, said the U.S. Supreme Court. Except for transportation workers, all employees who sign an arbitration clause must submit disputes to arbitration.

Steven C. Bahls, dean of Capitol University Law School in Columbus, Ohio, teaches entrepreneurship law. Freelance writer Jane Easter Bahls specializes in business and legal topics.

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