Articles
Originally Presented at:
Lee, Hecht, Harrison, on July 31, 2002
Executive and Professional Employment and Severance Contracts
Seymour J. Mansfield
(email)
and
V. John Ella
(jella@mansfieldtanick.com)
Mansfield, Tanick & Cohen, P.A.
1700 U. S. Bank Plaza South
Minneapolis, MN 55402
Tel: 612.339.4295
FAX: 612.339.3161
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INTRODUCTION
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Presentation Focus: This presentation will explore typical contract forms used in employment and severance situations, the basics of negotiating and drafting such contracts, and the special nuances of negotiating and drafting contracts regarding executive and professional level employees. Such contracts are the most powerful means of altering the employment-at-will status, which is the baseline norm for all employees in Minnesota and throughout the United States.
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At-Will EmpIoyment vs. Employment Contracts: An at-will employee may be terminated, or may quit, at any time for any reason. This is the starting point, or baseline norm, for analyzing employment rights and obligations. The at-will rule, however, is subject to many statutory and common law exceptions, including alteration by contract. Employment contracts have routinely been used to eliminate the at-will relationship, but may also be used to preserve and clarify an at-will relationship or impose special obligations on the employee, such as noncompete, and confidentiality obligations or other restrictive covenants.
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TRENDS AND RECOGNIZING CONTRACTUAL OPPORTUNITIES
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The Times They Are Changing: Employment and severance contracts have become more common and accepted for various reasons, including:
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The greater mobility of employees and lack of long term security offered by companies.
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The waves of merger and acquisition, which have led to change in control ("CIC") or "Parachute" contracts protecting top executives. These have also spilled over somewhat into non CIC situations, proliferating high level employee contracts.
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More prevalent use by employer of restrictive covenant agreements, which has led to employees seeking some mutual protections as consideration for noncompete, confidentiality and assignment of invention covenants.
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With the dying ethos of employee loyalty in return for the company's promise of long term security, the values of "trust and a handshake" and corresponding stigma against written contracts have largely disappeared.
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Employers now frequently seek severance and release agreements from departing employees, especially high level employees. Some employers and employees now attempt to define these obligations "up front" at the inception of the relationship through employment contracts.
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Counter-Trends in a Post-Enron Environment: For publicly-held companies (and to some degree, any company with numerous outside investors), these trends have been dampened by the emerging, stricter regulatory environment and self regulation in the wake of the scandals and corruption involving Enron, Worldcom, Tyco, Global Crossings and other public companies. New restrictions and public disclosures established by Congress, the SEC, NYSE or NASDAQ, and sensitivity to shareholders' reactions may cause public companies and their boards to take a restrictive view of long term employment contracts for their top management, particularly terms relating to substantial stock options and equity compensation.
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Recognizing the Opportunities; Spotting the Dynamics for a Contract. In addition to these trends, the executive or professional employee should look and test for the signs that the situation may be conducive for an employment agreement, including:
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Do top executives already have employment and/or CIC agreements?
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Is the employer asking for the employee's consent to restrictive covenants, stock options, or incentive plan agreements? Can these be expanded to provide other substantive employment protections? A full scale employment agreement?
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Is the employer making many, broad promises regarding long term tenure, increasing compensation and advancement, ownership and equity compensation, etc.?
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Do you have a preexisting relationship and/or a strong reputation with top management, HR insiders, the owners, or board members?
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Were you specifically targeted and recruited away from a high level secure job at another company with direct or implied inducement that your new terms would meet or exceed those of your former employment? Do you currently have an employment contract?
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Do you present some unique added value to the prospective company (e.g., special skill set, needed management talents, scientific or technical know how marketing or key customer relationships, etc.)?
Even in the absence of these obvious signs, testing the situation, can and should be done.
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Severance Situations: Any time a severance and release agreement is proposed, it is probably, to some degree, more or less negotiable. If none is offered to you as a terminated high level employee, it is worth seeking outside counsel to evaluate your situation and determine whether the circumstances are conducive to negotiating a severance package.
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BROAD RANGE OF EMPLOYMENT CONTRACTS
Every employment relationship forms a contract, even if there is no written agreement. Specific, firm promises made to an employee during the application or employment phase can give rise to a contract. For instance, a firm promise, even if oral, that an employee will not be terminated for at least one year may be enforceable. However, vague statements typically will not give rise to a contract. For instance, merely stating that "good employees are taken care of" will not usually alter the at-will relationship. Most oral agreements, however, are difficult, if not impossible to enforce, and generally result in factual disputes or are superseded by the "at will" doctrine. However, there are many forms of partial or complete written contracts.
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Types of Employment Contracts:
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Offer Letters: An offer letter containing specific, firm promises, once accepted, may give rise to an enforceable contract. For instance, an offer letter firmly promising specific wages and benefits might be enforceable as a contract. Sometimes, a series of written exchanges, although informal, such as proposals, counterproposals, acceptance, with other specifications, written samples of terms (e.g., sample bonus calculations) taken together, will be construed to be a binding contract. If the employer refuses to provide a contract, the employee may want to send a letter or series of letters to the company "confirming" or fleshing out the parties' arrangement, with the objective of creating contractual obligations.
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Implied Handbook Claims: Under Pine River State Bank v. Metille, 333 N.W.2d 622 (Minn. 1983), and its progeny, an employee handbook containing firm, specific promises may give rise to a contract. Today, most employers avoid contract claims arising out of such handbooks by including appropriate disclaimers and discretionary language in its handbooks and personnel policies.
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Employee Benefit Plans / Group Insurance Policies: An employer will typically be required to follow the terms of its employee benefit plans or group insurance policies. These employee benefit plans will almost always be governed by the federal Employment Retirement Income Security Act, 29 U.S.C. ' 1001, et. seq. ("ERISA"), which provides minimum protections, but can be altered and strengthened by individual contracts.
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Collective Bargaining Agreements: Employers are bound by the terms of collective bargaining agreements with union employees.
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Individual Employment Contracts: An employer and employee might negotiate and enter into formal, individualized employment agreements governing the terms of an employment relationship or any particular aspect thereof.
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Stock Option / Equity Compensation Agreements: Generally, any such agreement will be in writing and involve both a generalized "plan" for all employee participants and an individual "grant" agreement.
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Confidentiality / Non-Compete Agreements: Employees may be asked to enter into restrictive covenants, providing that the employee assigns rights to inventions and copyrights; will not engage in conduct detrimental to the employer; will not disclose confidential information acquired in the course of employment; and/or will not compete with the employer, solicit customers or recruit away employees during his/her employment and for a designated time period thereafter and in a defined geographic location or industry sector. Such covenants, if supported by adequate consideration and reasonable in scope, are generally recognized as valid by Minnesota courts.
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Closely Held Companies: In closely held, private companies, other agreements, such as stock redemption or shareholder control agreements, may also impact a shareholder's employment related rights.
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Separation / Severance Agreements: Employers and employees may negotiate written agreements to govern the termination of employment and to avoid future litigation concerning employment related issues. These are frequently initiated by the employer and required as a condition of receiving some or all of the severance package.
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EMPLOYMENT CONTRACTS
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Negotiating the Employment Agreement
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Term of the Contract: Consider and decide whether the employment contract is designed to preserve or alter the at-will relationship. Typically, executive contracts will be designed to provide a guaranteed duration, rather than at-will employment.
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At-Will Contracts: Where the contract is meant to preserve the at-will relationship, the agreement should clearly state that the employee remains at-will and can be terminated, or can quit, for any reason at any time. This is sometimes added to restrictive covenant agreement.
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Term and "For Cause" Contracts: A contract altering the at-will relationship can be structured in many ways. The most common are:
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Indefinite Term / For Cause: The contract may provide that the employee will be employed for an indefinite term, and may only be terminated for cause, as defined by the contract. "For cause" provisions may be defined very narrowly; for example, only for commission of a crime, dishonesty, de-licensing, etc., or more broadly. Where performance-related cause is included, the employee frequently seeks a notice and cure provision.
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Set Term / For Cause: The contract may also provide for employment for a defined term, such as one year. The set term contract commonly provides that the employee may be terminated before the end of the term "for cause," as defined by the contract.
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Term / For Cause / Buy Out: This common variation on the above types of contracts allows the employer to terminate "for cause" or without cause for a "buy out" or liquidated compensation and benefits.
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Common Provisions: A typical employment agreement covers the following items:
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Introduction:
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Parties
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Date of Agreement
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Reasons for Forming the Agreement
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Term of Employment:
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Effective Date of Agreement
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Termination Date: As stated, this will vary depending on whether the relationship is at-will, indefinite / for cause, or set term / for cause.
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Renewing Contract: If a set term contract, identify whether the contract will automatically renew at the end of the term and the manner in which notice can be provided to prevent renewal of the contract.
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Employee's Duties and Responsibilities:
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Title / Position
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Basic Duties
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Supervisor Relationships
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Time and Effort Expected of Employee: The time and effort required of an employee, i.e., is the position full time or part-time and can the employee hold other employment.
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Facilities and Support (Staffing and Capital): This provision is more common for CEOs or COOs in a management change over or turn-around situation.
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Compensation / Benefits:
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Base Salary: Identify the exact amount of salary in annual or monthly terms, and note that applicable deductions and withholdings will be made from salary. Identify the method of payment of salary, i.e., bi-weekly or monthly, and state the basis for potential salary increases.
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Incentive Pay: Identify the method for determining and providing bonuses and incentive pay.
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Other Employee Benefits and Perquisites: Identify relevant and applicable benefits and perks, including, but not limited to: signing bonus; training and educational stipends; holidays, vacation, and personal time off; cars; mobile phones; parking; medical and dental benefits; short and long term disability benefits; life insurance; retirement, pension, or related plans; excess or nonqualified benefit plans; reimbursement for professional or club memberships; reimbursement for business related expenses, and the like.
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Termination:
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By Terms of Contract or By Employer:
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At-Will: At-will employees can be terminated at any time for any reason.
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Indefinite Term / For Cause: Employee can be terminated only for "cause," as "cause" is defined in contract.
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Set Term / For Cause: Employee can be terminated at end of term. If term contract provides that notice must be given, or contract automatically renews, employer must give proper and timely notice.
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Buy Out: Typically, whether an indefinite term or set term, employee may be terminated for "cause," as "cause" is defined in the contract, or without cause only in exchange for a "buy out" in the form of liquidated compensation and benefits.
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CIC: Change in control ("CIC") agreements often do not provide any protections until there is a CIC (usually defined as majority change in equity ownership, purchase of substantially all the assets, or change in majority of the board), and thereafter, these agreements accord substantial protections for a set term.
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By Employee:
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Resignation: Employment contracts typically provide that an employee may resign upon giving a specified number of weeks, or months, of notice to an employer, but in that event, receives no severance compensation.
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Death: An employment contract terminates upon an employee's death. Although less common, an employer may seek a payout to his/her estate, either an amount based on former compensation or funded with life insurance death benefit, such as split-dollar, key man insurance.
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Total Disability: Employment contracts terminate if an employee becomes totally disabled from performing job. Most companies provide only insurance disability benefits in these circumstances, although some employees seek to augment this with severance payments
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For "Good Reason:" These clauses offer powerful protection to the employee, allowing him/her to declare a breach or claim liquidated compensation and benefits, where the executives title, salary, benefits, authority, or other material conditions are materially diminished. This is a very important, but sometimes overlooked, feature of a high level employee's complete protection, which should be triggered by:
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diminution in status, authority or responsibility;
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reduction in cash compensation, equity compensation or benefits;
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change in control;
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failure of acquirer to assume obligation of employment contract, or
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distant relocation of executive's working place; and
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perhaps other customized grounds, such as curtailment of staffing support, facilities or working capital; onerous travel requirements, etc.
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By Change in Control: If there is a change in control of the company, an employment contract may terminate providing for a severance package, or a whole new array of protections binding on the acquirer may spring into effect for several years, depending on the terms of the CIC agreement. These are typically inserted for the protection of executive employees. In the late 1990's, these "golden parachutes," at two-to-three times annual compensation, acceleration of stock options, lock-in of long term benefits, and enhanced retirement benefits, were also used in part, as anti-hostile takeover devices.
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Post-Termination Rights and Obligations:
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Wrongful Termination of the Contract / Severance Pay: The contract may provide for the employer to pay an employee a liquidated sum if the employer terminates the contract in violation of its terms, e.g., without good cause, or the employee terminates with good reason, or the acquirer does not assume the contract. For certain highly compensated employees or top officers, where this package is triggered by a CIC and the "parachute payments" amount to three times total compensation, excess parachutes may not be deductible to the company and may subject the employee to a 20% excise tax pursuant to ' 280G and ' 4999 of the Internal Revenue Code. To avoid this tax impact employees sometimes seek a gross up or their "parachute payments."
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Fees and Expenses: Attorney's fees and legal expenses incurred in enforcing the contract may be provided to a prevailing parry.
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Reimbursements: A contract may provide for reimbursement of any reasonable, business-related expenses.
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Return of Property: A contract typically requires that, upon termination, an employee return an employer's property or business records.
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Arbitration. The parties may be required to resolve disputes by arbitration in lieu of the court system.
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Restrictive Covenants. Such noncompete and confidentiality obligations and the like survive and bind the employee after the termination.
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Merger Clause: A merger clause provides for the integration of prior negotiations, documents, or agreements into final contract.
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Modification: Typically, an employment contract provides it may only be modified by a writing, signed by all parties.
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Nonwaiver: Employment contracts often provide that the employer's occasional waiver of certain employee conduct will not constitute a waiver of the employer's right to challenge that conduct at a later time.
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Successors and Assigns: Employment contracts typically provide that an employee's contractual rights are not assignable. An employment contract may also specify the obligations of any successor employer with regard to the contract. Specifically, it is important that any successor or acquirer of the company be required to assume the obligations to the employee under his/her employment agreement.
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State Law: The contract should specify what state law governs the contract.
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Severability: The contract should provide that contract provisions are severable.
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Signatures: Authorized parties must sign the contract.
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Special Provisions: The following provisions may be present in any employment contract, but more frequently appear in executive and professionals' employment contracts.
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Restrictive Covenants: As stated, employers may wish to enter into agreements with employees to limit conduct that could be potentially damaging to the employer. For instance, an employee might be asked to sign agreements governing employee inventions, confidentiality, trade secrets, noncompetition, nonsolicitation, or nonrecruitment. In such cases, the employer and employee may enter into either a separate agreement, or may incorporate restrictive covenants into an individualized employment agreement. Post termination violation of restrictive covenants may result in the loss of, or obligation to pay back, severance payments or so-called "claw back" clauses resulting in the loss of stock options.
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Executive Compensation and Benefits: Executive employees often have special, enhanced compensation and benefits. For instance, an executive employee, in addition to base salary, may have signing bonuses, incentive compensation (bonuses or commissions), stock options and grants; deferred compensation plans; special retirement plans; excess nonqualified benefit supplements; more generous life and health insurance, etc. Again, these issues can be addressed in a standard employment agreement, although stock options and grants are typically governed by separate contractual agreements.
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Stock Options may be qualified/incentive or unqualified/nonstatutory, with differing tax treatment and statutory requirements.
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Accelerated Vesting: By statute, incentive stock options, unlike nonstatutory options, must terminate upon the employee's separation. Most nonstatutory stock options provide the same limitation by grant agreement. Thus, without contractual protections, unvested options will be forfeited and vested option must be exercised immediately. To avoid this loss of value, the employee should seek acceleration of vested and extended exercise either in their forward-looking employment agreements or, upon separation, in their severance agreements.
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Post-Enron Trends: Again, for a public company, accelerated vesting and extended exercise has come under increasing scrutiny in a post-Enron environment. This is accentuated by variable accounting rules which may result in such accelerated vesting negatively impacting the company's balance sheet. If the various pending Congressional legislation or agency regulation are adopted or your company (like Boeing Co., Winn-Dixie Stores, Coca-Cola, Inc.) voluntarily expenses outstanding options on their income statements, this impact is already accounted for. However, the option "overhang" for companies with a large volume of issued options may result in more conservative use of such equity compensation.
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Equity and Control: In addition to the more common stock option grants, particularly in private, closely held companies, an executive contract may provide for a phase-in of equity position or ownership, in return for services or at a heavily discounted price, as well as control positions as an officer or director of the business. Such equity positions, particularly in a closely-held business, create shareholder rights and special fiduciary duties to the shareholders/employees, and thus, should be carefully considered and drafted.
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Indemnification; Insurance: The executive employee may seek indemnification by the employer beyond that provided by Minnesota statute, or the maintaining of D&O insurance coverage.
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Guaranty: Where the employer is thinly capitalized, a start-up, or a subsidiary, or in similar circumstances, the executive employee may want a guaranty of the performance of the contract by the individual owners or the parent corporation.
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Continued Cooperation: A contract may provide that the employee/executive continue to cooperate with the employer for purposes of ongoing projects, litigation, audits and/or investigations.
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Nondisparagement: An employer may require that an employee/executive agree that he/she will not, during the term of employment or thereafter, make disparaging comments regarding the employer. The employee may seek reciprocal protection against employer disparagement.
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Dispute Resolution: An employment agreement may provide a mechanism for resolving employment related disputes out of court. For instance, as part of an employee handbook, or an individualized employment contract, employers and employees may contract to arbitrate all employment related disputes. Minnesota courts are increasingly upholding agreements to arbitrate employment disputes.
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SEVERANCE AND RELEASE AGREEMENTS.
Increasingly, employers and employees, particularly executive and professional employees, are engaging in negotiations regarding the termination of employment. Separation agreements, containing general releases of employment claims to avoid future litigation, are a way of replacing the uncertainty for employers and employees of employment disputes with certainty of defined rights, compensation, benefits, and the settlement of all disputes. Typical terms contained in a separation agreement are as follows:
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Resignation / Termination: Identify whether separation is a resignation or termination. This may include recharacterizing a termination as a resignation, to improve the employee job searching opportunities.
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Transition / Timing: A phased final employment stage, together with outplacement and executive offices, may be very helpful in enhancing the executive's or professional's hiring opportunities.
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Unemployment Insurance: If the separation is structured as a resignation, an employer may agree not to contest an employee/executive's claim for reemployment insurance benefits, since an employee who quits is not entitled to unemployment (reemployment) insurance. However, even without a contest by the employer, the Minnesota Department of Economic Security can challenge the employee's eligibility on its own initiative.
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Severance / Settlement Payment: Identify the payment to be made to the employee for releasing his/her potential claims against the employer. Common Severance / Settlement Payment issues include:
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ump sum payment vs. monthly
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Payment in succeeding calendar year may reduce tax liability.
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Even if characterized as settlement payments, the payments remain subject to state and federal and state income tax (through quarterly estimated tax and annual tax returns, rather than payroll deduction), and may be reported as 1009 Misc. income, which is not subject to FICA and FUTA.
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Automatic forfeiture clause favors the employer, providing for automatic loss of future payments upon an alleged breach by the employee.
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Bonus Eligibility: Eligibility for yearly bonus at/before the end of the year may be negotiated for the employee, either in full or on a prorated basis.
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Employee Benefits / COBRA Reimbursement: Employees may request that employers continue to provide various employee benefits, including, but not limited to, medical and dental benefits. While under the federal COBRA law 18 months of continued health care coverage is required, the full cost of coverage is at employee expense. Thus, the employee may negotiate for shifting this cost to the employer.
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Pension Plans: In certain circumstances, employees can obtain a "bridge" to full vesting for retirement. Regardless, special attention should be given to the effective date of employment termination or continuing service credit during the severance period where this results in a bump up in the benefits provided in the employee's defined benefits retirement plan (e.g., reaching "Rule of 80's or 90's," reaching early retirement date).
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Equity Compensation: Stock options, phantom stock, stock grants, stock appreciate rights, stock funded deferred compensation plans and ESOPs are all various forms of equity compensation. Qualified (incentive) or unqualified (nonstatutory) stock options, which are unvested may be vested, in whole or in part, by agreement, and exercise dates, which otherwise expire at termination or shortly thereafter, may be extended for years. Note that where there are incentive stock options, such changes may require a "swap out" and replacement with unqualified options. Generally stock option plans will give the company discretion to accelerate vesting, extend the exercise period or even re-price or have new stock grants as part of a settlement with the employee. From the employer's perspective, so-called "clawback" provisions, taking back stock options upon alleged violation of noncompete or other employee restrictions, may be demanded. Regardless, here too, special attention should be given to the effective date of employment termination or extending that date to vest a near term installment of stock options or other equity compensation.
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401(K) or 403(B) Plans: These accounts belong to and are controlled by the employee, but should be transferred to a qualified IRA rollover account or new employer qualified plan to avoid excise tax.
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Letter of Reference; Press Release: Employees often request positive letters of reference and that, if the employer receives a request for a verbal reference, the employer provide information consistent with the reference letter. For a CEO, COO, CFO or other senior executive of a public company, an agreed upon press release and internal announcement within the company can be important.
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Outplacement Assistance: Many companies will cover the cost of outplacement assistance or temporary executive offices at firms such as LEE HECHT HARRISON.
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Nondisparagement: Employers and employees often mutually agree not to disparage each other after the termination of the employment relationship.
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Confidentiality: Employers and employees often mutually agree not to disclose their separation disputes or the terms of any separation/settlement agreement.
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Release of Claims: Employers and employees often mutually agree to exchange releases of claims, agreeing not to pursue any employment-related claims arising up to the date of the separation/settlement agreement.
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Statutory Requirements: To insure the validity of the release, mandatory state and federal law provisions must be included, such as the 21-to-45-day consideration period; advice to seek legal counsel; the 7-day rescission period under federal Older Worker's Benefits Protection Act ("OWBPA"), 29 U.S.C. ' 621 et. seq., and the 15-day rescission period under the Minnesota Human Rights Act, Minn. Stat. ' 363.031, subd. 2.
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Boilerplate Clauses: Separation Agreements also will include boilerplate clauses, such as those mentioned above in connection with Employment Agreements.
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ADDITIONAL NUANCES OF NEGOTIATING EXECUTIVE CONTRACTS
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Do homework on corporate history and culture as related to employment agreements.
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Assess your value and leverage as discussed in Part II.C. above.
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Get your offer and oral assurances first; avoid hitting the employer with a long, detailed contract prematurely.
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Early is always better. Your leverage is usually greatest when the company is recruiting you (before you start your employment). There are circumstances after employment (e.g., promotion, recruitment by another employer), which may reestablish leverage to negotiate an employment contract.
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Coaching "on the side" can help you with negotiations.
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The written employment contract can be used as a "value clarification tool." What the parties each think is their understanding can be dramatically different. A written contract will require the parties to clarify their respective "values" and terms of understanding.
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Should the lawyer be in the foreground or background, and when should he/she become visible?
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Alternatives to the formal, integrated contract.
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Bells and whistles for executives and professionals.
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Severance: Importance in structuring the departure and timing thereof and characterization of reason for leaving to protect the executive's future career track.
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