Effect of An Employment Contract with a Term of Years

October 6, 2017

Topics: Employment Agreements

Companies often hire senior executives on employment contracts for a certain number of years.  These executives get the benefit of potential job security for a period of time, and the company also knows that it likely has the services of the executive for a period of time.  However, unless these contracts are carefully drafted, they can have unexpected pitfalls for companies.

First, employees in most states are generally hired “at-will” which means that either the employer or the employee can terminate the relationship at any time, without cause or notice.  The “term” of an at-will employment situation is “indefinite.”  There is no set length to the employment relationship.

Employers can therefore terminate at-will employees when the company wishes without necessarily having a specific cause to do so or providing notice to the employee.  (Please note that there are other reasons to have a business reason for the termination, see Why Can’t I Just Fire Them? However, conversely, an at-will employee can also leave without providing notice.  When the employee is a senior executive, this can cause problems for the company in terms of continuity and transition.

That is where a contract for a term of years comes in.  Companies need to be mindful, however, that once an employee has a term of years put on the employment relationship, the relationship is no longer “at-will.”  That means that the company now must have cause for the termination and must provide the employee with notice.  Executive employment agreements for terms of years must be sure set out how “cause” is defined and what notice is needed so there is no question as to how to proceed should the company need to do so.

“Cause” in such agreements is usually defined as something pretty serious -- fraud, embezzlement, violation of law; intentional damage to company’s assets or disclosure of confidential information; violation of a non-compete agreement; violation of harassment or discrimination policies etc.  However, there may be situations where a company wants to terminate an employee in situations that do not rise to the level of “cause.”  The executive is not delivering as promised and is not just working out, for example.  To prepare for that possibility, such employment agreements should include provisions that cover what occurs when an employee is terminated “without cause.”  These are usually structured to provide the executive with some type of severance package because the employee is no longer at will and, technically, cause would be needed.

It is also important to be mindful of the fact that executive salaries are usually specified in terms of how much the executive will receive annually.  Should an executive’s employment agreement be silent as to how the executive is paid following termination of employment, it may be possible to read the agreement as requiring that he or she receive the entire annual salary for the balance of the contract term.  For that reason, such contracts should specify any amounts the executive is due on termination and clarify that nothing further will be paid.

Executive employment agreements for terms of years can be complicated legal documents.  Sometimes companies want to forego them to start an amicable relationship with a new executive—only to have it be to their chagrin when the relationship does not work out.  Consulting with employment counsel to be sure your company is best protected with appropriate agreements can avoid such potentialities.