Pros and Cons of Employment Contracts

May 10, 2016

Topics: Employment Agreements

As a general rule, employers and employees are not required to enter into employment contracts.  Employees in most states are considered “at will,” which means that they remain employed for as long as the employer is willing to employ them and the employees are willing to stay.  The employer may choose to terminate the employee for any reason – as long as it is not discriminatory or retaliatory – or for no reason at all, and is legally permitted to do so.  Employment “at will” is, by definition, employment for no specific term of years.

When an employer and employee enter into an employment contract, they might be doing so to establish a specific term of years during which the employment will continue.  Perhaps a medical practice wants to ensure a specialist is committed for three years, or a company wants to guarantee that its new CEO will be there for some foreseeable future.  Unless the contract specifies to the contrary, the employee’s employment is then no longer “at will.”  The contract has set out, among other things, the duration of the employment relationship.

For most employees, a formal employment contract is not necessary.  The employee’s compensation and specific benefits package would be set out in an offer letter.  The job responsibilities go in a job description and general employment policies and benefits are best communicated through an employee handbook.

That said, employment contracts can help retain key employees.   By setting out the duration of the employment relationship, the employer may encourage key employees to stay through the end of the term, or at least provide a contractually-mandated amount of advance notice before leaving the company.  This could be important when it costs significant time or money to find and train a new employee.  Such a contract can be used to lure a more senior employee with promises of a guaranteed compensation package and enhanced job security with a potential “golden parachute” (guaranteed severance package) if employment is terminated early.

To the contrary, employment contracts limit the employer’s right to terminate employees—and can require large-payouts of guaranteed severance for ending employment early.  Even if there is no guaranteed severance, if the employer decides to discharge the employee before the end of the contract term, the employer may be required to pay out the employee’s salary due through the end of the term.

Putting information regarding the terms and conditions of an employee’s employment in an employment agreement instead of, for example, in an employee handbook, can limit the employer’s right to change the terms of the employment relationship.   Instead of the employer having the ability to change policies as business dictates, the employer may be locked into providing specific benefits identified in an agreement with one or more employees.

Employment agreements can have advantages and disadvantages for employers.  Employers who decide to offer employment agreements to employees should review the terms of the proposed agreement with counsel, to ensure that the contract does not contradict the employee handbook or contain any provisions that will limit the company’s ability to act in its own interests.