Definition: An agreement entered into between an employer and an employee at the time the employee is hired that outlines the exact nature of their business relationship, specifically what compensation the employee will receive in exchange for specific work performed .
Hiring employees is a fairly straightforward task--at least, most of the time. Most states assume an "at will" relationship, under which you can terminate an employee at any time for any reason or no reason. (Or alternately, your employee can quit for any reason.) But there are circumstances under which 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.
Employment contracts also help protect critical trade secrets, and are especially critical in high-tech companies. An employment contract can prohibit employees from revealing company secrets, working for the competition or soliciting customers. Noncompete agreements can be difficult to hold up in court, so you must be careful in drafting them. Because it's anticompetitive to prohibit people from earning a livelihood in their field, 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. 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. 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.
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. 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.
Given the complexity and issues involved, you can understand why employment contracts are usually reserved for key employees. Certainly, always consult your attorney about clauses to include and avoid.