THE NUTS & BOLTS OF EXECUTIVE EMPLOYMENT AGREEMENTS (click here for video)
A video created by Dignitas Wealth Management – Family Office – Wealth Management.
THE NUTS & BOLTS OF EXECUTIVE EMPLOYMENT AGREEMENTS (click here for video)
A video created by Dignitas Wealth Management – Family Office – Wealth Management.
Indemnification By Employer
In my law practice covering executive employment contracts, I see too infrequently a provision requiring an employer to indemnify an executive for any costs, expenses, liabilities, and losses incurred by the executive in the performance of his duties with the company. Usually, the indemnification arises in the context of litigation costs. It should apply to any kind of claim or proceeding including an action, law suit, arbitration, investigation, or administrative proceeding. It should also apply to both civil and criminal actions, investigation, and proceedings.
The costs, expenses, liabilities and losses should include, but not be limited to, reasonable attorneys’ fees, judgments, interest, expenses of investigation, fines, excise taxes or penalties and amounts paid or to be paid by executive in any settlement.
A well drafted indemnification provision will require the employer to advance to the Executive all his costs and expenses concerning a claim or proceeding.
An indemnification provision may have qualifying language that, as a precondition for indemnification, the Executive must be properly performing his obligations in good faith.
Claw Black of Indemnification Payments
Some indemnification provisions will have a mechanism allowing the employer to claw back the amounts advanced to an Executive if a determination has been made that the Executive was not entitled to indemnification for the subject costs and expenses.
The most comprehensive indemnification provision I have seen used reads as follows: “Employee shall be held harmless and fully indemnified by Employer to the fullest extent permitted by [State X] law without qualification or limitation.”
A companion provision that would be prudent for the Executive to include in his employment agreement is that the employer be required to keep in place directors and officers’ liability insurance coverage for the Executive during his employment with the employer and for four years afterward.
Executives get investigated, prosecuted, and sued all the time. An Executive’s having indemnification and insurance provisions will offer the Executive some peace of mind.
Indemnification By Employee
Employers sometimes require an Executive to indemnify the Company.
One kind of Executive’s obligation to indemnify involves the Executive’s indemnifying, defending, and holding his company harmless from any uninsured portion of any claim, loss or expense arising from any action by the Executive that contravenes the rules and policies of the company, any applicable laws or that arise from intentional misconduct by the Executive.
New Employer’s Protection from Old Employer’s Restrictive Covenants
Another kind of Executive’s obligation to indemnify involves the Executive warranting that Executive is not under any legal or contractual obligations that contravenes the new employer’s employment agreement and execution of the employment agreement will not breach any other agreement by the Executive. If there is such a breach, then the Executive must indemnify the new employer and must hold the new employer harmless from and against any and all loss, damage, and expense emanating from the claim against the Executive or the new employer arising from Executive’s relationship with his previous employer. The breaches would typically involve non-compete provisions, non-solicitation provisions, and confidentiality provisions.
Employers must protect themselves from new employees who know they have valid legal obligations to previous employers like confidentiality agreements. One additional way to protect themselves is for the employers to require the prospective employee to provide copies of all employment and separation agreements containing restrictive covenants like non-compete, non-solicitation, and confidential information.
Employers should also be able to be made whole from the bad conduct of their employees giving rise to uninsured liability.
The scope and kind of indemnification by an employee must be appropriately negotiated by each side. Obviously indemnification amounts can be quite burdensome and even financially catastrophic for an employee.
Employment contracts may have a termination-for-cause provision. This kind of provision may include the term “moral turpitude.” The following are two different examples of a termination-for-cause definition clause containing moral turpitude:
These typical for-cause termination clauses that the use term “moral turpitude” do not define the concept.
The term turpitude means vile, depraved, shameful, or base. It has a grave meaning, and even the sound of the word suggests a perverseness. You add the word “moral” before “turpitude” and it suggests an egregiously bad act or conduct. While we have a textbook definition of “moral turpitude” as being reprehensible conduct, what can it mean in practice? Who knows? However, an executive should care.
The term is too vague and subjective. Crimes come in varying degrees of wrongdoing. Felonies involve varying degrees of criminality. Some are worse than others. In order to avoid arbitrary results and inconsistent employer or judicial application, we ought to discard this hidebound term altogether. When representing executives or organizations seeking to enter into employment contracts, I discourage the use of this term. I prefer an itemized list of causes for termination and plain language like the following clause:
This clause makes it readily understandable, among other acts, what kind of crime would be cause for termination, i.e. a felony. In the moral turpitude clauses above, the term crime or felony is modified by the term “moral turpitude” and, consequently, makes the felony or crime more vague and difficult to determine its applicability.
The use of term moral turpitude is anachronistic and should be eliminated from employment contract termination-for-cause provisions.
A not uncommon provision in employment agreements, separation agreements, or stand alone agreements containing restrictive covenants (e.g. non-competition and non-solicitation) is a “prevailing party” provision. This kind of provision grants the prevailing party in any litigation over an agreement the right to be reimbursed its, his or her legal fees and costs.
A typical prevailing-party provision will read like the following: “If litigation arises under this Agreement between the Company and the Executive, the prevailing party in such litigation shall be entitled to recover its or his reasonable attorneys’ fees, court costs and out-of-pocket litigation expenses from the non-prevailing party.”
The prevailing-party provision serves as a disincentive for an individual employee to assert his legal rights or to take a risk of violating an agreement. From the outset, the employer ordinarily would have more financial resources to litigate, and this added provision of saddling the non-prevailing party with all the litigation costs has a chilling effect on the employee’s seeking vindication of his rights. From the employer’s standpoint, this is precisely the sobering reminder that an employer wants to send to its ex-employees who may choose to test the validity of the employer’s restrictive covenants, especially non-compete clauses.
In any event, the prevailing-party provision is one that must not be overlooked by either the employee or the employer.
Executive employment agreements will ordinarily have termination of employment provisions. Executives will assume the termination provisions go one way, i.e. that the employer is always doing the terminating. What about the executive terminating his own employment?
Termination for Good Reason
The sophisticated executive or professional will negotiate a provision that allows him to terminate his employment for “Good Reason” and still receive certain compensation and benefits from his employer. The provisions for termination for good reason by the executive can range from a few sentences to several paragraphs.
Categories of Good Reason
The employment agreement should define “Good Reason.” Such definition may include an event where the assignment to the executive of any duties inconsistent in any material respect with the executive’s position, duties, responsibilities or status with the company as of the date of his employment agreement, or if a change in control has occurred, immediately prior to such change in control. It may include a change in the executive’s reporting responsibilities, titles or offices with the company. It may include any failure to re-elect the executive to any position with the company held by the executive. It may include a reduction of the executive’s rate of annual base salary. It may include any demand that the executive be based anywhere other than at the facility where the executive is currently located. It may include travel on company business to an extent substantially more burdensome than the ordinary travel requirements of the executive. It may include the failure of the company to continue in effect any employee benefit plan or compensation plan in which the executive is enrolled. It may include the failure of the company to continue to provide executive and executive’s dependents medical, dental, disability, and life insurance benefits. It may include failure of the company to provide the executive with paid vacation. It could include failure to reimburse promptly the executive for any reasonable employment expenses.
Negotiating Termination Clause
The list could go on and on about the various events that could be deemed a Good Reason for an executive to terminate the employment agreement. Like anything else, it is a matter for negotiations.
The more star power an executive has, coupled with his lack of need to take the position will increase his leverage to negotiate his right to terminate with resulting substantial compensation and benefits.
It is a wise executive who controls the circumstances of his employment. An executive employee’s right to fire his employer is a huge step in that direction.
Because this is a blog that discusses both employment agreements and severance/separation agreements, which are contracts by another name, an executive can benefit from understanding some basic contract concepts.
One of these concepts is “consideration.” A valid employment contract must comprise the elements of offer, acceptance, and consideration.
Consideration is a legal concept and is the bargained for exchange of promises or performances. “The test of a sufficient consideration is whether the act, forbearance or return promise results in a benefit to the promisor or a detriment to the promisee.” (Laurence P. Simpson, Contracts 2nd Edition, p. 80).
In an employment context, sufficient consideration to support an offer of employment would be the obligation to perform services by the employee and the obligation to perform wages/benefits/ and other compensation by the employer.
In a severance agreement, you may see a clause that reads something like this: “In consideration for signing this Agreement and complying with its terms, Employer agrees to pay Employee a total sum of $xxxx.”
The Severance Agreement might state further that the parties agree that the contract clauses pertaining to severance payment and other compensation/benefits constitute sufficient consideration for this Agreement
Like all contracts, the terms of an employment agreement must also be clear and definite. Of course, we are not trying to turn our readers into lawyers as we have too many as it is. Now when you hear a lawyer discussing contract issues and she says “there is a lack of consideration,” you will now know she is not complaining about some rude person.
Sometimes it is necessary to state the obvious: An employment agreement is a contract that is subject to basic contract principles, interpretation and construction.
Good Faith and Fair Dealing Required
We will often see in employment agreement express covenants not to compete and not to solicit. What is not express in contracts, but implied in the law in many states, is the Covenant of Good Faith and Fair Dealing. For example, Illinois law reads a duty of good faith and fair dealing into all contracts. The duty is implied in every contract. Employment agreements are no exception.
What does “good faith” and “fair dealing mean?” The idea is that whatever contractual discretion a party has, the party must exercise such discretion reasonably and not capriciously or arbitrarily. Good faith is not taking an opportunistic advantage that was not contemplated by the parties when they entered into their agreement.
Not Playing Nicely
An act of bad faith could be where an employer with some discretion under a for-cause termination provision terminates an employee arbitrarily or capriciously for allegedly disreputable behavior. Or it could be where an employer terminates an employee to avoid a payment deadline for stock vesting or bonus payment. An employee example could be where an employee makes his employment contingent on his spouse finding a similar job in the new locale as the employee but the employee and his spouse purposely fail to obtain a new job because the employee has a change of heart and does not want to move.
In short, it is a matter of fair, honest and sincere course of dealing where the parties have some discretion.
Bullet Proof Your Agreement by Expressing Yourself
Courts cannot use this implied covenant to override an express term of an agreement. Nor does this implied covenant ordinarily create a separate cause of action. The courts use the covenant as an aid to interpretation and construction. A well drafted, comprehensive agreement should not fall victim to this covenant.
Without express disavowal in the employment agreement, the implied covenant exists. Accordingly, one party, who believes the other party is engaging in sharp practices by exploiting gaps in their employment agreement, may try to invoke the covenant.
Most employment contracts will have provisions that dictate that A) the contract will be governed by the laws of a particular state (“choice of law”) and B) the litigation, if any, must take place in a certain state, e.g., California (“forum selection”). These provisions are often overlooked entirely or given short shrift in the employment contract review process. That is a big mistake.
Choice of Law (Governing Law)
Generally, the basic limitations on enforcing a choice of law provision are that there be some relationship between the transaction that is the subject of the agreement and the selected jurisdiction or that there is some other reasonable basis for the choice of law of the selected jurisdiction.
Forum selection dictates the location of the court that shall adjudicate the parties’ disputes arising from a contract. Forum selection provisions are prima facie valid. As parties are free to contract, again, generally, the enforceability of a forum selection provision becomes a matter of its reasonableness and it not being against public policy.
Employer Drives Choice of Law and Forum Selection
An employer will usually designate the state in which it is headquartered for both choice of law and the location where a lawsuit concerning the contract may be physically brought. For many employers these are reflexive choices because they believe the forum for litigation in their headquartered state is more convenient for the employer.
The lawyer for the employer is usually admitted in the state in which the employer is headquartered and, therefore, the lawyer is more familiar and comfortable with contract, labor and other laws of that state. However, an examination of the “home state” laws may reveal that some or all of these laws may actually be more favorable to the employee. For example, if we look at non-compete provisions that are found in many employment contracts, some states’ courts are more liberal in enforcing them. Some other state courts have a stricter standard in upholding the enforceability of non-competes because these courts frown on restraints preventing an individual from being able to earn a livelihood.
Some states are friendlier for individual plaintiffs and less friendly toward large corporations involved in litigation against individuals. Even certain counties within a particular state may be more or less friendly toward individual plaintiffs or defendants; therefore, a corporate party may even seek to designate a specific county. Employees are more likely to negotiate for a selection of forum closest to where they live as litigating a lawsuit 1,000 miles away may be cost prohibitive.
So the selection of forum can be a very important decision for either the employer or the employee.
I published a 17 May 2010 post on the concept of the “claw back” in executive employment contracts and compensation. POWER WORD PLAY (A Word, Term or Concept an Executive Ought to Know): CLAW BACK. For those readers who have not yet read this earlier post, a claw-back provision allows a company, or sometimes a government, to take back compensation previously given an executive because of some misinformation or wrongful conduct that would have precluded the compensation if the company or government, as the case may be, had known about the misinformation or wrongful conduct. We discussed the extraordinary $468 million dollar claw back that the U.S. Security and Exchange Commission invoked in 2007 against the CEO of United Health Group Inc.
Recently I was reading my friend Darryl DePriest’s fascinating multi-part series on the public relations management of one the biggest attempted claw backs of executive compensation. In his blog piece, Litigation Communication in Spitzer v. Grasso, DePriest does a case study on the controversy surrounding the former head of the New York Stock Exchange.
In August of 2003, the NYSE board approved a total of $187.5 million in compensation to Chairman and CEO Richard A. Grasso. As bits and pieces of the compensation became public, Grasso and the NYSE became embroiled in a firestorm eventually leading to Grasso’s forced resignation. The New York Attorney General at the time, the ever enterprising Eliot Spitzer, filed a law suit seeking the return of payment of $100 million out of $139 million in compensation paid by the NYSE. Grasso fought back both in the court and in the media. He prevailed! He was saving both his money and his reputation at the same time. Both are important. At different points in a person’s life, money may be more important to the person than reputation, and vice versa.
It goes to show you that each case must be evaluated on its own merits. Rolling over and being passive in a claw-back scenario may not be justified. For other executives, when you do wrong, the honorable thing to do is to take your lumps and show remorse. In any event, the take-home point that we all have is that an executive should consider at the outset 1) whether he deserved to be clawed back, and, if not, 2) whether he should hire public relations counsel to complement his retention of legal counsel. As Grasso proved, the retention of vigorous public relations and legal counsel is money well spent.
Also, the idea that a contract should be honored and upheld no matter how excessive the compensation may appear to third parties is fundamental to the rule of law and the protection of property – without which we cannot have an effectively functioning market economy or democracy. If third parties find fault with a compensation package, they need look no further than the compensation committee of the board of directors. Now whether a board’s compensation committee has properly vindicated its duties, responsibilities and obligations is a different matter to consider.
In employment contract negotiations, employers and employees often will focus on different points and will have different priorities. One typical provision where the parties may diverge in their hierarchy of important negotiating points is the mandatory arbitration clause, which is an alternative way to resolve disputes other than litigation.
Arbitration clauses are not necessarily standard in every employment agreement, but their significance should not discounted. Parties need to pay attention to them. Employers generally favor them because of the time, expense and unpredictability of litigation. Courts are increasingly willing to enforce mandatory arbitration clauses involving employment disputes, including discrimination rights claims. Although an arbitration process ordinarily will not have the expensive, expanded discovery process and extensive motions phase that occur in civil litigation, the arbitration hearing itself can be as expensive as a trial.
Under mandatory arbitration, the arbitrator’s decision is final and binding and enforceable in any court of competent jurisdiction. The arbitrator is obviously supposed to be neutral and may or may not have familiarity or expertise in the subject matter. Arbitration proceedings are much less formal than the legal rules and procedures of a court and the arbitrator may receive and consider evidence that may not pass muster in a court of law. Because arbitration is a cousin of mediation, the arbitrator may be more inclined to split the baby, so to speak, rather than to make a draconian up or down, win-lose decision. By arbitration, an employer usually does not run the risk of a runaway jury or a plaintiff-employee-prone judge.
An important consideration for the employee is that in the arbitration clause, the employer will designate the location of the arbitration hearing, which may not be in a locale that is near the employee. If the hearing is required to be in Chicago, but the employee lives in Los Angeles, then that will be inconvenient and expensive for the employee.
If done fairly, arbitration could be helpful to both employer and employee. As far as alternative dispute resolution forums go, mediation, I believe, is a more cost-effective, less onerous way to go for both employer and employee, but that is another blog post for another day.