2.1 Express Employment Agreements

• Library: Virginia Employment Practices and Forms (Virginia CLE) (2015 Ed.)

2.1 EXPRESS EMPLOYMENT AGREEMENTS

2.101 In General. The vast majority of employer-employee relationships are not derived from any formal employment agreement but arise instead in the traditional employment-at-will setting. In other words, the employee may leave whenever he or she chooses, for any reason or no reason at all, and the employer may terminate the employee's employment whenever it chooses, for any reason or for no reason at all. There is no fixed duration for the employment relationship.

In some instances, however, either one or both of the parties to an employment relationship may want to formalize the relationship in a written employment agreement. Generally, such employment agreements involve executives rather than lower level employees. When the parties are putting such an agreement into place, they are at the beginning of what both typically hope will be an enduring relationship. Consequently, many employment agreements are not drafted with an eye to what might go wrong. Counsel, in advising on the drafting of employment agreements, should assist their clients in anticipating the impact of the agreement if the employment relationship falters.

2.102 When Is an Employment Agreement Useful?

A. In General. A variety of reasons motivate both employers and employees to seek a formal employment agreement. Although both parties often give up certain rights in entering into such an agreement, the agreement can be mutually beneficial in a way that offsets the loss of those rights. Either the employer or the employee may derive the following benefits from the existence of a written employment agreement.

B. Security. An employment agreement provides security to the employee by setting forth the expected duration of the employee's employment or the grounds under which the employee's employment may be terminated by the employer.

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C. Recruitment Incentive. Written employment agreements are beneficial to the employer because, by providing the additional security to the employee, the employer may be able to attract talented employees who would not enter into an employment relationship without that security.

D. Defined Performance Expectations. The written employment agreement articulates the expectations of the employer with respect to many aspects of the employee's performance.

E. Defined Compensation Expectations. The written employment agreement articulates the expectations of the employee with respect to compensation during the course of employment and any severance payment that might be due to the employee after the termination of the employment relationship.

2.103 Typical Employment Agreement Provisions and Drafting Tips.

A. Duration.

1. In General. An employment agreement should define the expected duration of the employment relationship between the employer and the employee. This duration may be set forth in terms of the number of years for which the employer and the employee agree to be bound by the agreement. Typically, an employment agreement also contains provisions that allow the relationship to be terminated in accordance with its terms. In drafting such agreements, counsel should inquire whether the agreement is intended to last for a definite period or only until one of the parties is able to exercise one of the grounds under the agreement for terminating the employment relationship.

2. Agreements with a Finite Term. Placing a finite term in the agreement gives the employee the security of knowing the duration of the relationship. It benefits the employer by allowing the relationship to end without having to terminate the employee's employment prematurely. Agreements with specific terms should state whether, at the end of the term, the relationship will end, convert to an at-will relationship, or renew for a successive period.

3. "Evergreen" Clauses. Some agreements contain "evergreen" clauses under which the contract, while set to expire on a finite date, is automatically renewed for a successive period, which may be of the same duration as the original period or for a shorter time, if neither party gives notice of intent to terminate. A typical evergreen clause would read as follows: "After the expiration of the initial term, this Agreement shall be renewed for successive one-year terms unless either party gives notice of intent to terminate the

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Agreement at least 30 days before the expiration date of any such successive terms."

Counsel for employers should be aware that an evergreen clause may become a trap for the client. If the employer consents to the inclusion of an evergreen clause, it must ensure a mechanism by which it calendars each possible notice date, or the employer may unwittingly find itself subject to a renewed employment period under the agreement.

B. Position and Title. Most employment agreements, as noted above, are put in place for executives rather than lower level employees. Consequently, the employment agreement generally should set forth the title and position that will be filled by the prospective employee so there is no misunderstanding with respect to the job that the employee is accepting. But the employer should retain the unilateral right to change the employee's title, duties, and reporting relationship. The employee, on the other hand, should insist that any such change would place the employee in a position of similar responsibility and one that is commensurate with the employee's expertise.

C. Compensation.

1. In General. One of the most critical aspects of any employment agreement is the compensation structure that is being provided to the employee in the agreement. If the employee is merely receiving a certain base salary, then setting forth those terms of the agreement is not particularly complicated. Even if the agreement addresses only base salary, however, counsel should ask whether the parties intend for the base salary to be reviewed and adjusted with any regular frequency, such as at the time of an annual performance review.

2. Base Salary. Employers in Virginia (and other states) have long stated salary figures in monthly or weekly terms rather than annual terms for fear that a court might view the statement of the salary in annual terms as an implied contract to pay salary for a year. ¹ Several courts in Virginia have

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discounted this theory, ² but it is probably still good practice to state base salary in monthly or weekly as well as annual terms when drafting documents such as letters offering employment. In employment contracts, however, it is probably not as much a concern since the terms of the relationship and the rights of the parties upon termination are likely to be delineated specifically in the agreement.

In an express employment contract, it is particularly helpful to define "Base Salary" as a term in the agreement because it is likely that other provisions of the agreement (such as severance pay) will make reference to base salary.

3. Bonuses/Profit-Sharing/Incentive Compensation. In many agreements a bonus may be a component of the employee's compensation. There are numerous ways to design an employee bonus provision, but generally the earning potential is defined in one of the following ways:

a.	A set amount that is guaranteed to the employee regardless of results;
b.	A set amount that is contingent upon the employee meeting some goals or objectives;
c.	An amount equal to a percentage of revenues, profits, or some other measure; or
d.	An amount left solely to the discretion of the CEO or Board.

From the perspective of an employer, the preferred bonus provision would retain complete discretion over the awarding of the bonus in the employer, but it may be necessary to offer a greater incentive to the employee in order to retain the employee's services.

If the bonus is going to be tied to the achievement of results, the parties must decide if it will be based solely on the results achieved by the employee individually, the employee's department/division, or the company as a whole. In other words, the company must decide if it is willing to pay the employee the bonus even if the company has not performed well. Conversely, the

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employee must consider if he or she is willing to forego the bonus if, despite the employee's best efforts, the company has not met expectations.

When the bonus is based on the attainment of certain measures (whether individual, departmental, or company-wide), the most critical aspect of counsel's job in drafting the agreements is ensuring that the terms upon which the compensation is based are as well defined as possible. For example, when a bonus is tied to a general profit-sharing arrangement based on the profits of the company, the parties may differ on their understanding of "profit." ³

Thus, although the central term in this component of the employee's compensation, "profit," appears to be a generally understood accounting term, the definition of profit should be included in the employment agreement. For example, the agreement should specify whether the profit is pre-tax or after-tax profit. The parties should also consider making explicit reference to the document that will report the company's profit, such as the year-end audited financial statements. Of course, many of these details can be omitted from the agreement itself if the terms have been adequately addressed in a separate profit-sharing plan in which other executives or employees participate.

4. Commissions. If the employee is engaged in a sales-related activity, his or her compensation will often include commissions based on revenue generated by the employee or by other employees for whom he or she has responsibility. When commissions are involved, particularly commissions based on the work of other employees (often called override commissions), the parties should carefully define in the employment agreement the basis on which the override commissions will be...