When No Longer in the Driver’s Seat – How To Craft or Revise Enforceable Employment Contracts
One of the best principles of leadership I have heard is: "Treat every employee like a volunteer."
In a hot economy, combined with a mobile workforce and Gen X and Gen Y attitudes, this is especially wise counsel.
At the same time, the importance of developing and keeping an effective workforce and the fragility of intellectual capital makes it all the more crucial to ensure that the employer’s interests are protected.
The task addressed by this presentation is to get the protections you need without creating unnecessary barriers to recruiting and keeping the talent that will drive your company’s future.
Controlling the Offer
Every employee has an employment contract. It is typically a mixture of written, oral and implied terms. The employer’s goal should be to have as much of the contract in clear, written form as possible. To do that requires some discipline and systems at the point of hiring.
Every contract is made up of an offer, acceptance and consideration. In an employment situation, this can be as simple as the employer verbally offering a particular job for which it will pay a certain salary, and the employee accepting that offer. The contract is then formed and it will be very difficult to rely on any terms or conditions that were not explicitly made part of the offer.
No offer of employment should be made until all important terms of the offer are made in writing. And the employee should be required to sign the offer to show acceptance prior to starting work.
Completing the Contract
Whatever conditions or promises the employer wants to be able to rely on must be part of the employment offer when it is first made.
To properly complete the contract, there should be an approval process to ensure both senior management and administrative staff have completed all they need to do to make and carry out a decision to hire. For example:
Instead of concluding an interview by saying: "We’d like you to join us and you can start on Monday",
the message should be:
"We are going to make you an offer of employment. We will send a package of material to you for your review. We look forward to the possibility of working with you."
All the important terms of the offer, and the places where they are found (such as in separate agreements or employment manuals), must be identified. Create a checklist of the required elements and documents that comprise a proper employment offer.
This need not be burdensome or time consuming and the candidate will be much more impressed with a well-presented and comprehensive offer of employment.
The Employment Terms
There is no single form of written employment agreement that will cover all situations – written employment agreements must be drafted to cover the specific concerns of the parties involved. It is not necessary to have a comprehensive employment agreement – many situations are adequately covered by a one or two page summary of the key terms. What is essential is that the terms that are key to the needs and operations of the employer be explicitly stated and agreed to.
This is not an exhaustive list of the provisions that might be in an employment agreement, but these are the major points that should be considered:
Identify the parties using the correct legal name of the employer.
Nothing should be said, done or written to suggest that any officer or director of the employer is assuming a personal obligation to the employee.
For what period is the agreement?
Is there a probation period and, if so, what are the rights and obligations of the parties if probation is not successfully completed?
Is the agreement for a definite or indefinite term?
Can the agreement be renewed and, if so, how and on what terms?
If for a definite term, is there automatic renewal or termination in absence of notice?
State explicitly any conditions that must be met before employment begins, such as:
a satisfactory criminal records check;
a certificate of fitness for the duties of the position;
completion of a course of study; or
board of directors approval.
Set out at least a general statement of duties. For example:
The Executive agrees to carry out the duties of Chief Financial Officer of the Company under the direction of the Chief Executive Officer, and such other duties as may reasonably be assigned from time to time by the Chief Executive Officer.
This statement can be as general or specific as the parties feel is necessary.
It is always wise to state who will provide directions to the employee.
Sometimes the parties will prefer a more specific statement. The employer may want to make sure that express lines of authority are established. On the other hand, the employee may want to ensure that the employee will not be subject to carrying out tasks considered to be beneath the employee’s dignity or qualifications.
There is a risk with being too specific. The employer needs flexibility so that it can adapt its operations to meet changing conditions. If the duties are too specifically described, and the employer makes a unilateral change to these duties, the employee may be able to claim constructive dismissal.
As with many of the terms of the contract, you must find a proper balance between certainty and flexibility.
Again, the provisions on compensation can be general or specific:
What are the forms of compensation?
Amount of salary?
Frequency of payments?
Is there a procedure/formula for increases?
Are hours of work defined? Will the employee receive overtime?
Are there funding requirements which will affect compensation?
Given the complexity of most group benefit plans, it is usually sufficient to set out in the contract:
the employee’s entitlement to participate in the group benefit plan;
the waiting period, if any;
the amount of any employee contribution to premiums; and
the entitlement of the employer to amend the plans with respect to eligibility criteria, coverage, coverage maximums, deductibles and employee premium contributions;
and include a copy of the benefit booklet with the offer letter.
It is not recommended that the employer attempt to paraphrase the terms of the group benefit plan in the offer letter, as it is possible that if the terms are not correctly represented, the employee will be entitled to the greater benefit outlined in the offer letter.
Consider whether a provision needs to be inserted to provide for amendments to benefits from time to time (particularly where specific benefits are negotiated for senior employees).
What is the vacation entitlement?
Can an employee carry over unused vacation into future years (subject to Employment Standards legislation)?
Are there restrictions on when the vacation can be taken?
If the employer has policies or rules which will apply to the employment relationship, they should be referred to in the contract, a copy provided to the employee, and a provision included by which the employer is entitled to amend them.
Resolution of Disputes
Employers may wish to stipulate the manner in which disputes will be resolved during or after employment. These provisions include granting exclusive jurisdiction to the courts of a particular jurisdiction, stipulating the law which applies, requiring arbitration and stipulating the terms under which it will occur, or requiring mediation.
Consider the possible advantages of arbitration or mediation. Alternatives to litigation can lead to effective and private dispute resolution by a person chosen by the parties, and it may be faster and less costly than going to court.
Restricting Activity During Employment
Having settled the terms of compensation and put some of the "boilerplate" in place, you now move on to the challenge of telling today’s mobile employees what they cannot do, and that what comes from their brains and efforts may belong to someone else.
One possible approach is to rely on the common law, but your intellectual capital and competition concerns are probably too important to not at least tell the employee what those obligations are. And if you are going to do that, you should probably take the opportunity to specifically deal with the particular needs of your business.
Every employee, regardless of position or seniority with the firm, owes a general duty of loyalty and good faith to the employer. An important aspect of that duty is confidentiality.
An employee must keep confidential whatever confidential information the employee acquires (no matter how, and regardless of the form or medium) in the course of employment. The confidential information may be a sophisticated trade secret, such as a unique formula for a product, or the name of a customer (if it is truly confidential). The duty of confidentiality lasts as long as the information remains confidential but can last no longer.
Many confidentiality covenants are little more than a statement of the common law obligation that employees already have. Nevertheless, it can be a useful covenant to have as a reminder of the duty both during employment and at the time of termination.
Most confidentiality covenants will go beyond the common law obligation and require confidentiality for information that has competitive significance. It is common to cover items such as customer lists and pricing even if many of the details are already known outside the employer. Note however that it will be difficult to enforce confidentiality clauses after termination to the extent they cover more than truly confidential information.
Ownership of Inventions
Another important principle of the employment relationship is that the employer is the owner of inventions, improvements and ideas developed by an employee in the course of employment. While that is the general principle, there are various provisions in copyright, trade mark and patent law that recognize certain rights of the employee. Therefore, it is common for any employer engaged in product development or which otherwise relies on inventions and unique innovations in its business to have agreements with their employees to clarify the employer’s rights and the employee’s obligations in this regard.
Ownership of inventions clauses should not be overbroad but should clearly:
- state the employer’s rights in the employee’s efforts;
- require the employee to report all ideas and inventions in the course of employment;
- require the employee to cooperate in assigning ownership to the employer and in applying for protection such as patents, trade marks and copyright.
Conflict of Interest
A third general obligation of employees is not to be involved in any activity in which their personal interests could directly or indirectly conflict with the interests of their employer. That is a breach of the duty of loyalty and good faith and the avoidance of such conflicts of interest is a duty of all employees. However, the possibility of such conflicts generally increases with the level of authority of the employee and it is common to have management employees disclose their outside interests on a regular basis to help avoid such conflicts arising or being perceived to have arisen.
The simplest conflict of interest is working for a competitor while working for the employer and that can always be prohibited whether or not the employer allows "moonlighting", but any attempt to restrict competitive activity after the termination of the employment relationship requires a specific agreement as discussed below.
Many employees will resist a blanket policy that seeks to restrict all activity outside of work. Such a policy is not consistent with the typical employee’s wish to pursue different interests and to achieve a balance between work and other activities. Any provision that restricts an employee’s outside activities or that requires disclosure of other interests should be drafted so as to only touch on things that are of legitimate concern to the employer.
Once the scope of the obligation and restriction has been properly set, make sure to allow for other interests (such as ownership of up to 5% of the stock of a publicly traded company) and for consent to be sought and reasonably given for other outside interests. Be practical and consistent in administering the policy – again focusing on the real, legitimate interests of the employer.
Controlling the Termination
Thinking Ahead: Knowing the Cost of Termination
When the employment of an employee is terminated without cause and without notice, it triggers statutory and common law obligations of the employer. The statutory requirement is found in employment standards legislation which establishes minimum amounts of notice or compensation that must be given. These are relatively modest, topping out around eight weeks.
It is the common law requirement for reasonable notice that can create much greater obligations. Based on the employee’s length of service, age, type and character of position and the availability of suitable alternative employment, the notice requirement can be 24 months and higher. For any executive position, you can expect common law notice will be at least six months for even young and short service employees.
The statutory requirement can be satisfied, and the common law obligation can be supplanted, by an enforceable written agreement about termination that is clearly drafted and at least meets the employment standards minimum.
For such an agreement to be valid and enforced by the courts, it must have been part of the offer of employment as discussed above, and there must be no evidence that the employee did not fully understand the effect of the term, or that the employee was pressured, however subtly, to agree to such a term.
In negotiating a termination without cause provision with a prospective employee, it is important to understand the common law alternative.
First, the common law obligation is to give notice. In most cases, actual notice is not given and compensation in lieu of notice is provided. That means:
- the compensation must account for all salary and other wages that the employee would have earned during the notice period;
- the employee can claim for the cost of benefits or the loss incurred because the benefits are no longer available during the notice period; and
- the employee may have a claim with respect to bonuses, stock options, etc. that would have been paid or matured during the notice period.
Second, when actual notice is not given, the employer has technically breached the employment contract and is liable for the resulting damages. But the employee has a duty to mitigate – to make every reasonable effort to find suitable alternative employment – and any money the employee earns from other employment during the notice period will reduce the employer’s liability.
Your termination provision should be drafted with those principles in mind, and you will need to consider and draft clear language on the following points:
- how much notice or compensation is to be provided for termination without cause? – give yourself flexibility and allow for notice, or compensation or any combination of notice and compensation;
- will compensation be provided in a lump sum or by salary continuance? – be precise: "compensation" is too vague and it is better to use a defined term like "base salary";
- with salary continuance, will there be a requirement to mitigate? – if so, state how that requirement is to be monitored and how actual mitigation earnings are to be accounted for;
- if the employee typically earns commissions, bonuses, or overtime, what compensation for those items will be provided for the notice period? – be precise about if and when the commissions and bonuses are considered to be earned and payable;
- when will benefits end and what compensation if any will be provided in lieu of benefits? – use flexible language to allow for changes to existing benefits and if compensation in lieu of benefits is being offered be precise by saying something like "the current premium cost paid by the employer"; see the more detailed discussion below;
- will outplacement counselling be provided? – by whom, on what terms, and how much; and
- how will various monetary benefits be treated, such as car allowance, stock options, employee purchase plan, or pension? – see the more detailed discussion below.
The loss of benefits which would have been provided during a common law reasonable notice period can create large liabilities for the employer if handled incorrectly. If the employee is not able to or does not replace some of these benefits, the employer may be liable not just for the cost of purchasing the benefit but for the loss of the benefit itself. This is potentially the most costly area to be considered.
Benefits such as long-term disability or life insurance can lead to great exposure. In some cases, benefits can be replaced but are either too expensive or an employee is unwilling to do so. In some cases, the employee may not be able to replace the benefit due to poor health or because the benefit is not available outside a group plan.
One objective of the employment agreement is to have a clear statement about what will happen to benefits upon termination of employment so that any risk is transferred to the employee in exchange for some kind of payment from the employer. Again, because of the potentially catastrophic consequences for an employee who is without benefits, the language will have to be clear and unambiguous.
Bonuses and Stock Options
An employee is entitled to all remuneration he or she would have received under the employment contract if he or she had worked during the notice period. Bonuses and stock options must be paid to the departing employee if they vest under the employment contract or the bonus or stock option plan during the notice period.
A purely discretionary bonus that is not an integral part of the remuneration package of the employee does not have to be paid during the notice period. However, even where an employment contract provides that a bonus is discretionary, it may nonetheless be considered part of the employee’s remuneration package if it is a regular and significant part of the employee’s compensation.
To preclude an employee who is dismissed without cause from receiving a bonus or exercising stock options during the notice period, very clear language expressly excluding the notice period is required. For example, the following wording has been found to effectively exclude employees who are terminated without cause from claiming entitlement to a bonus during the notice period:
If the employee’s employment with the Employer is terminated for any reason other than death, disability or retirement prior to the bonus being vested, the bonus will not be paid to the employee. Any termination of the employee’s employment for any reason shall occur on the date the employee ceases to perform services for the Employer without regard to whether the employee continues thereafter to receive any compensatory payments from the Employer or is paid salary by the Employer in lieu of notice of termination."
A similar clause would also effectively exclude employees terminated without cause from exercising stock options during the notice period, with wording amended to reflect the employee’s stock option rights.
In both cases, the employer should ensure the language of the bonus and stock option plans is consistent with this treatment of the employee’s rights upon termination.
Thinking Ahead: Restricting Activity After Employment
Employers need to understand and regularly review where they are vulnerable to the activities of a former employee and take appropriate, protective measures, preferably in enforceable employment agreements entered into at the time of hire.
Typical areas of vulnerability are confidentiality of information, ownership of employee inventions, and competition. These concerns can be addressed in an employment agreement and certain conditions and restrictions can be imposed which will survive the termination of employment.
Confidentiality and Ownership of Inventions
We have discussed above confidentiality and ownership of inventions clauses for restricting the activity of a current employee. These clauses remain important after termination:
The confidentiality clause can, and should, be stated to apply beyond termination and will be enforceable with respect to all information the former employee learned during the course of employment that continues to be confidential.
The ownership of inventions clause cannot cover the ideas and inventions that come after the term of the employee’s employment, but it can, and should, create a continuing obligation to cooperate in the registration and protection of ideas and inventions generated during employment.
Restrictions on Competition
It is very common for employers engaged in highly competitive businesses, or who are very vulnerable to the competitive activities of former employees, to have agreements restricting competitive activity after the end of the employment relationship.
As a general principle, such agreements are not enforceable unless the former employer can show that the restriction is reasonable in all the circumstances.
If an employer wishes to have an enforceable covenant that restricts a former employee’s ability to engage in competitive activity, it will have to show that no aspect of the restriction — length, geographic scope, or breadth of application — is more than is reasonably necessary to protect the employer’s legitimate business interests.
Because of this requirement, such restrictions are more commonly sought from senior management or from employees with special customer or other business relationships, than from other employees.
The broadest of these types of agreements is a non-competition covenant that prohibits work or assistance of any kind to a competitor in a certain area and for a certain time. To be enforceable, the restriction must be reasonable in duration, scope of prohibited activity and geographic area. Whether the restriction is reasonable involves a detailed analysis of the business and its vulnerability to competition by former employees.
Another form of restriction is commonly called a non-solicitation covenant. Such a covenant typically will prevent a former employee from taking the initiative to do competitive business with a customer or supplier with whom the former employee dealt in the last year or so of their employment. Such a covenant may have a geographic scope but it is not necessary since it is specific to customers and suppliers and would leave the former employee free to compete with respect to any other potential customers and suppliers.
It is also possible to restrict a former employee’s ability to recruit other employees to work for their new employer or enterprise. Again, such a restriction must be reasonable in all the circumstances and is more commonly sought from supervisors and managers than from other employees.
An employer should not seek to impose post-employment restrictions unless it intends to enforce them. That means there must be a will to take action to protect the business interests at risk and a restriction that is not too long or broad to be enforceable.
As noted above, the length, breadth and scope of a restriction must be carefully considered in all the circumstances of the business being protected and the role of the employee. Any restriction that goes beyond the geographic area or the scope of activity that the former employee can be expected to affect will likely be unenforceable. Similarly, the length of the restriction is of crucial importance. It is hard to state any general rule for length except to say that anything longer than six months will have to be supported by solid evidence that the nature of the business, or the sales cycle, or the product development process, is such that a longer restriction is necessary.
The general rule has been that if a restriction is unreasonable, it will be unenforceable. And even if the contract invites a court to enforce the broadest form of restriction that would not be unreasonable, courts have generally refused to do so.
Recent cases have suggested some relaxation of this approach if the clause is drafted such that the court need only delete certain parts of the clause – not add or re-write anything – to make it enforceable. For example, listing the individual provinces in which activity is sought to be restricted instead of simply having the restriction apply in "Canada", combined with a clear direction that any unenforceable part can be severed without affecting the balance of the clause, may be upheld. In that case, if all of Canada is too broad, the employer may still be able to enforce the restriction in the provinces where it can establish a legitimate business interest that requires protection.
However, a court will only go so far in making contractual terms enforceable for the parties. Employers should strive to draft restrictive covenants which are reasonable and therefore should be enforceable, rather than trying to get broader protection based on the hope that a court will sever as requested and give them broader protection than might otherwise have been negotiated with the employee.
Certain employees, such as directors, officers and a limited class of senior management employees, owe a fiduciary duty to their former employer. The hallmarks of fiduciary duty are loyalty, good faith and avoidance of a conflict of interest. Where it is arguable that such a duty exists, it may be used to restrict or prevent the solicitation of customers or the pursuit of maturing business opportunities by these employees.
An argument that a former employer was employed in a fiduciary capacity can help to enforce other obligations contained in the employment agreement. The ability to argue fiduciary duty will be enhanced if the employment agreement contains an acknowledgement by the employee that he or she is employed in a fiduciary capacity.
Revising the Employment Contract Midstream
Employment contracts drafted in the past may not accurately reflect the current needs or risks of an organization. For example, many employers wish to introduce non-competition or non-solicitation covenants into the contracts of existing employees. If an employer seeks to introduce new or revised terms in the employment contract, there are several issues that must be considered and addressed.
An employer seeking to make changes during the employment relationship must consider the risk of an employee claiming constructive dismissal. Constructive dismissal occurs when an employer, without reasonable notice, makes a change which is fundamental to the employment relationship. The change has to be such that it is as if the employer is ignoring the terms of the employment contract. In that case, the employee is allowed to consider the employment contract to have been terminated and may sue the employer for damages.
It may be difficult to avoid claims of constructive dismissal for fundamental "midstream" changes to the employment relationship other than by providing employees with reasonable notice of the intended change. What constitutes "reasonable notice" is unique to each employee, depending on their age, length of service and position.
It may not always be practical to provide reasonable notice, but in all cases, the employer should endeavour to provide as much notice as possible. When providing notice of the change, affected employees should be clearly informed about the significance of the change and that it is a final decision to be implemented by the employer.
The employment contract may itself provide that changes to certain terms may be made at any time without notice. If such a term is included in the employment contract, less significant changes to employment, such as a shift in duties, are less likely to constitute constructive dismissal. However, such a term may not preclude a claim for constructive dismissal if compensation is also changed, the term is fundamental to the position or the change causes the employee embarrassment or loss of prestige.
Additional Consideration is Required
If reasonable notice is not provided, new or additional consideration is required to ensure that a variation to an existing agreement which disadvantages the employee is enforceable. Typically, additional consideration for the new term will be a small payment, bonus, increased pay or benefits, or a promotion.
Continued employment, without some tangible incentive or benefit to the employee, is insufficient consideration for a new term. Continued employment may be adequate consideration for a new term if it is more than a promise by the employer not to terminate employment for an unknown period of time. The new or altered term must provide, expressly or implicitly, greater job security in exchange for the employee agreeing to the new or altered term.
Employees should also be given an opportunity to obtain legal advice regarding the altered contract.
There will be times when the employer wants to make changes to the advantage of an employee, by providing a promotion and increase in pay for example.
Any time such a change is to be made, the employer should consider three things:
- are there terms in the existing contract that need to be preserved?;
- are there terms in the existing contract that need to be changed?; and
- are there new terms that should be introduced?
For example, you may already have a termination provision that limits the cost of a without cause termination. If such a clause was agreed to when the employee was hired as Plant Manager, it may not be considered to apply some years later when terminated from his subsequent position of Vice President Manufacturing. When giving the promotion, the employer should explicitly state in writing, and the employee should agree, that all terms of the employment contract not explicitly changed by the promotion continue in full force and effect.
At the same time, there may be terms you want to change. For example, a promotion to a management position may allow you to avoid the overtime obligations of the Employment Standards Act. Such a change needs to be explicitly agreed to and the promotion and increased compensation or status can be the consideration necessary to support the employee’s agreement.
Introducing New Terms
A promotion or other change to the advantage of the employee represents a golden opportunity to introduce other significant changes such as a non-competition or non-solicitation covenant. As noted above, such positive changes offered by the employer can be the consideration necessary to support the new obligations or restrictions agreed to by the employee.
The employees of the 21st century have more rights and a greater appreciation of those rights than previous generations. The employees of the 21st century are also much more likely to have many different jobs and possibly several different types of careers in their working lives.
Employers are now buyers of employee service in a volatile and tight market where employees have significant bargaining power. Nevertheless, employers can look after their legitimate interests, advance their businesses, and allow employees to advance their careers. It just takes some planning, work, imagination and energy, not to mention carefully drafted employment agreements.
Note: This article was originally presented at an Insight Conference in Vancouver on November 27 and 28.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.