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Employment Contracts For The New Economy

Employment contracts revolve around four unifying concepts: compensation and benefits; duration, title and responsibilities; and premature exit and severance. Contract law is designed to create a set of predictable rules governing the creation, enforcement, interpretation and termination of contractual relationships. The existence of these rules, and the sanctity of contracts, especially in a “new economy,” is critical to the ordering of economic relationships.

At the same time, contracts, particularly employment contracts, are “made to be broken,” with no moral opprobrium attaching to either side in the event of breach — only hopefully, predictable legal consequences. Careful drafting of employment contracts can create greater predictability, certainty and benefit.

Case Study
John Jones enters into what he believes is a five year contract with Admirable Media Co. as Executive Vice President for sales and marketing, reporting to the CEO. The contract prohibits Jones from joining “any competitor in the same industry” for one year after he leaves Admirable. Shortly after the contract commences, Admirable, a software company for the media and advertising industries, decides to downsize and consolidate its executive ranks. Admirable tells Jones that his position is being eliminated, but that the company is prepared to retain him for the duration of his contract at the same salary, provided he agrees to report to the Chief Operating Officer, with whom Jones had previously been co-equal in rank. Jones views this as a demotion as well as a breach of his employment contract and wishes to claim “constructive discharge,” allowing him to leave Admirable immediately.

Jones is considering a job offer from Admirable’s chief competitor, which would pay him only 50% of his regular salary, but provide a percentage ownership in the company. Jones questions whether, if he turns down the new position at Admirable, a court would nevertheless find Admirable in “material breach” of the contract because of Admirable’s change in the terms and conditions of his employment. Of equal concern to Jones is whether, even if Admirable is found liable for a breach of contract, the court will award him damages, in light of his new position.

Both Sides Might Have Avoided Uncertainty:
If the scope of Jones’ job responsibilities and reporting had been clarified in the contract. Admirable would have benefited, particularly in uncertain economic times, from insisting on a flexible description of job responsibility and reporting lines — one that anticipated a restructuring. Jones would have been in a better position if the contract had specified that any change in Jones’ reporting relationships or job responsibilities constituted grounds for him to terminate the contract for “good reason” with a specified severance (or payout on the contract) to follow.

If the contract was more explicit in specifying damages to be assessed in the event of breach and the scope of Jones’ obligations, if any, to “mitigate” (i.e. reduce) his contract damages for the period left on his contract. Employees have, in the event of termination, a legal obligation to make reasonable efforts to seek comparable, gainful employment. Employees often seek but only occasionally obtain a “no-mitigation” clause, entitling them to the full amount “guaranteed” left on their contract, irrespective of the income earned by the employee following his departure. Where, as here, the contract does not excuse the mitigation requirement, Admirable is likely to claim that Jones failed to exercise reasonable efforts to mitigate his contract damages by not obtaining comparable employment at a similar rate of compensation. The only certainty arising from this uncertainty is that litigation (or at least negotiation) will ensue.

If the contract had been more specific concerning grounds for termination and severance. With most employment contracts, particularly in boom economic years, the parties choose not to contemplate, or provide in great detail, for the “what ifs” of termination, believing that such negative “worst case” thinking was a turnoff and destructive to the future relationship. Times have changed however. The benefits, particularly to an employer who has greater leverage in today’s economic environment, of spelling out in greater detail the circumstances in which termination may rightfully occur, with specified economic consequences, are apparent. One might even fairly argue that, in public companies, the failure to prevent or weed out “sweetheart” executive contracts may constitute a breach of the fiduciary obligation owed by each of the directors on the board.

If the post-employment restrictive covenant in the contract had specified the names of the competitors with whom Jones was precluded from working, as opposed to describing them generally as “companies engaged in the same business and having similar customers” as Admirable. The narrower and more detailed the restrictive covenant, the more likely it is to be enforced. Assuming Admirable has a legitimate interest in protecting real trade secrets, one approach would have been to provide, irrespective of reasons for termination, for Jones to continue to receive salary, either as an employee or a consultant, for all or a portion of the non-compete period, essentially placing Jones on “garden leave.”

If particular attention had been given to severance. Of all of the provisions deserving of a contract drafter’s attention, few are as important as severance. Some “five year” contracts are illusory, and in essence reduce to one year agreements, where the employer retains the right to terminate the contract for specified reasons, and the employee receives a guaranteed severance. It may not be unreasonable to tie the attainment of performance benchmarks to the yearly renewal of the contract.

In today’s competitive environment, the “tried and true” standard form of employment agreement may well prove to be antiquated, as well as a blueprint for unnecessary litigation. At least for the moment, the pendulum of negotiating leverage has swung back to the employer, who can craft and tailor agreements to meet their needs for flexibility. With some forethought, and sound drafting, both sides can assure greater predictability of outcome and hopefully avoid costly and ultimately unproductive litigation.

This article was first printed in the October 2009 "Legal Perspectives" supplement to The Delaney Report.