Provisions Employers Should Consider Including in Employment Contracts and Severance Agreements

Posted on by David F. Dabbs in Employment Law

Businesses of all types regularly have the need to document arrangements for the employment of important personnel and for the discharge of any employee. If daily contracts in an employer’s line of business are created from forms, employment contracts and severance agreements may be the most common types of custom-negotiated and custom-written contracts entered into by many businesses. Awareness and understanding of the potential terms of such contracts will be helpful in making satisfactory arrangements for employees and, where necessary, their termination.

Some of the key types of provisions in employment and severance agreements may appear in both types of contracts, but others only appear in one or the other. The following is intended to offer suggestions about the most important provisions that a business will normally want to consider including in such contracts.

Provisions in Employment Contracts

Compensation. Most fundamentally, employment contracts need to address compensation and the intended term of employment. Absent formal agreement, a unilateral contract is typically offered by the employer and accepted by the employee’s performance of the work, which creates a contract liability for the promised compensation. Overlapping obligations to pay may also arise under state wage payment laws like Va. Code § 40.1-29 or the federal Fair Labor Standards Act, which often require the payment of attorneys’ fees if pay is wrongfully withheld, but a contract claim remains available. A written contract is therefore usually not essential to an employee’s right to compensation. Formal employment contracts, whether for a term or not, typically specify a minimum rate of wages or salary, subject to later increase at the employer’s discretion. (Such increases may create an exception to a merger clause, discussed below.) For salaried employees, the contract will often specify that the employee will spend substantially all working time in the service of the Company, and/or give the company a right of approval over any other employment.

Term. As to the term of employment, by contrast, Virginia’s interpretation of its statute of frauds prevents the formation of oral employment contracts for a term of more than a year. Therefore a written contract is essential to create a binding contract for such a term. However, a written contract may still specify that employment is “at will” for either or both parties, with the result that compensation normally accrues only while the employment continues. Where employment is for a term, the employer typically retains the ability to terminate for “cause,” like misconduct or conviction of a felony, and the employee may retain the right to resign for “good reason,” such as relocation or a material reduction in the employee’s authority or position. The contract may also require either party to give advance notice of termination, and some causes for termination may give rise to opportunities to cure. However, an employee’s promise to work or remain employed is never absolute – it is merely a promise to either perform or pay damages, and the employee cannot be enjoined or otherwise compelled to perform.

Benefits on termination. Employment litigation very commonly arises from parties’ failure to specify carefully in their contract what compensation will or will not be due when the employment ends. Salary is simple to handle, and may be continued for some period as severance pay in the event of termination by the employer. Other types of pay will require more thought. For example, if an employee will earn an annual bonus for each calendar year, what is paid or not paid for a partial year? Or, if an employee is paid on commissions, will trailing commissions be paid for any period after employment ends, and if so, for how long, and how computed? The best contracts will answer all such questions unambiguously.

Compliance with laws. Employees who will act independently can be asked to promise that they will comply with applicable laws in the performance of their duties – for example, that salespeople will not violate applicable laws regarding unsolicited fax or telephone communications.

Intellectual property. Employees who will create or work with legally-protected intellectual property can usually be required to convey to the employer such intellectual property as they create in the course of their employment. Such employees should often also be required to warrant and represent that they will not improperly use any intellectual property of others in their work for the employer.

Restrictive covenants

Restrictive covenants, intended to limit the employee’s competitive behavior after the end of employment, must generally be included in employment contracts entered into before the performance of at least some work. In most states, courts permit restrictive covenants, in essence, because they make employment possible, or better paid, in some cases. It is therefore too late, as a rule, for an employer to think of a desired restrictive covenant and attempt to include it in a severance agreement when employment ends. Virginia deems continued employment to be sufficient consideration for restrictive covenants, so it is not too late while an employee remains employed – but bear in mind that an existing employee may choose to resign rather than sign an onerous agreement. Restrictive covenants may also provide that they can be enforced by injunction, and despite any counterclaims an employee might have (for example, for underpayment of compensation). Restrictive covenants that employers should consider including in employment agreements include non-competition, non-solicitation of customers, non-solicitation of employees, and restrictions on the future use of company confidential information.

In Virginia, non-competition restrictions generally must include three limitations to be deemed reasonable and thus enforceable: time, geography, and function. These limits may be created by defining a “Restricted Period” (usually two years or less), a “Restricted Area” in which the employee has sold or worked, and “Restricted Activities” based on the employee’s work, and then providing that “During the Restricted Period, Employee agrees that he/she will not engage in Restricted Activities within the Restricted Area,” or similar. Business people sometimes expect that they can gain leverage by including broad restrictions in employee contracts, but the requirement that restrictions be reasonable, in order to be enforceable, means that the opposite is true. Broad restrictions will often be less enforceable, and thus less valuable; in this context, less is more.

Specific common issues should inform the drafting of other types of restrictive covenants. Provisions prohibiting the solicitation of customers for competitive products or services should often include referral sources, and should consider the question of how the former employee will know who it is that they are prohibited from soliciting. Provisions prohibiting the solicitation of employees should usually also prohibit the diversion of vendors who may be independent contractors, and will usually be limited to persons who were employed or engaged during the employee’s employment and remain so at the time of the solicitation. Provisions restricting the use of confidential business information may expressly include internal information about company employees and their performance, which could otherwise allow a competitor to “cherry-pick” the employer’s best remaining employees. Certain restrictions on the use of “Trade Secrets” are defined by statute, but the employer may enhance their potential remedies by advising employees in their contracts of certain provisions of the Defend Trade Secrets Act of 2016.

Provisions that May Be Included in Either Employment Contracts or Severance Agreements

Unlike the other types of restrictive covenants discussed above, restrictions on the use of confidential company information can be included in severance agreements as well as employment agreements.

Both employment and severance agreements can and often should provide for the return, at the end of employment, of the employer’s property, of all types. Obviously, the employer will want to recover valuable physical objects like vehicles, computer equipment, cell phones, digital storage media, and keys and card keys. However, such clauses should not neglect to recite an employee’s obligations also to return intangible property or information such as contact information for sales prospects, control of cell phone numbers, usable copies of company computer files that may exist only on the employee’s personal devices, and passwords for devices and accounts of the employer (including social media accounts!) that the employee has accessed or controlled during their employment.

Another broad category of clauses that can and often should be included in both employment and severance agreements are general terms for interpretation and enforcement. These include:

  • Merger clause. A merger clause provides that the written agreement reflects the entire bargain between the parties, and/or that no other representations or agreements are being relied upon. Such clauses usually also provide that the agreement may be amended only in a writing signed by both parties. Care must be taken with these if a non-compete or other restrictive covenants are being imposed in a separate agreement.
  • Multiple counterparts. These provisions make clear that all parties do not have to sign the same original to make a contract.
  • Assignability. Usually the employer wants the ability to assign the contract, but the employee will not have such a right.
  • Choice of law & venue. Under what state’s law will the contract’s validity, interpretation, and effect be determined, and what locale should be the venue for any disputes? Note that some states (notably California) may not enforce choice of law provisions against their citizens.
  • Severability. Because there are so many particular legal restrictions on contract terms, we are routinely surprised to see otherwise sophisticated contracts that contain no clause to preserve the remainder of the agreement in case one provision or a few provisions are found invalid or unenforceable. Some provisions may be severable anyway, but why take a chance of the entire agreement being thrown out if that is not what would be desired?
  • Waiver of breach. Out of the sight of their lawyers, parties will often neglect details of their agreements, like notice procedures or exact dates of payment. A provision that a party’s waiver of a breach on one occasion will not excuse different, future, or continuing breaches will often yield results closer to the parties’ mutual intention at the time of contracting.
  • Jury waiver. Jury trials are expensive. Generally, parties can waive their right to have disputes tried to a jury.
  • Liquidated damages. For defined breaches of the agreement, if damages will be hard to determine, can a specific dollar amount be awarded instead of requiring evidence of damages? The amount must be a reasonable estimate or it could be void as a penalty.
  • Attorneys’ fees. In the event of a dispute, will one or either party be entitled to their attorneys’ fees, expert witness fees, and other costs, if they prevail?

Provisions in Severance Agreements

The central provision of most severance agreements is a general release by which the employee gives up any legal claims they have against the employer or its affiliates or agents. However, there are multiple – and perhaps innumerable – categories of claims and rights that cannot be effectively released, as a matter of law, including:

  • claims for retirement benefits,
  • claims for unemployment insurance benefits,
  • claims for workers’ compensation benefits without the approval of the state workers’ compensation authority,
  • claims for minimum wage or overtime required under the Fair Labor Standards Act (FLSA) without the approval of a court or the federal Department of Labor,
  • claims under the federal Age Discrimination in Employment Act (ADEA) absent compliance with the Older Workers’ Benefit Protection Act (OWBPA), and
  • rights to file complaints against the employer with various state and federal agencies (such as the Equal Employment Opportunity Commission), even if the employee validly waives rights to receive any damages or other personal relief arising from the subject of the complaint.

Rather than attempting to enumerate all such types of claims, a typical approach is to provide or explain that the release applies to all claims “to the maximum extent permitted by law,” or words to that effect.

OWBPA compliance is especially onerous, as EEOC regulations provide that an age discrimination release (generally required only of employees age 40 or older) may be invalid if it violates a list of requirements, including that the release may not recite as consideration anything to which the employee is already entitled. This inverts the common law rule (which would generally require only that the consideration given include something to which the employee was not already entitled). OWBPA thus requires a clear explanation breaking out what the employee will receive if the agreement is not signed – typically just pay for time worked, and perhaps unused leave time. Other OWBPA provisions requiring certain periods for consideration, various specific recitations, and the provision of census information are complex enough to fill another article. Amateurs should not attempt OWBPA compliance.

Other types of provisions that may be usefully included or requested in severance agreements include:

  • A “pseudo release” of certain unreleasable claims. Even where a claim cannot be validly released, an employee can be asked to represent that they do not know of such claims – for example, that so far as they know, they have been paid for all time worked and have not suffered any unreported workplace injuries. Difficult retaliation issues can arise if the employee reports that the representation is not true, but the inclusion of such clauses can force the disclosure of information about such matters, and complicate the later assertion of such claims by employees who make the representation requested.
  • A cross-release by the employer. Sometimes employees are concerned about their former employer asserting claims against them, for example, for contribution where work for a customer has gone wrong. Employers are typically concerned that they might be waiving claims of which they are unaware, for example, if the employee were later discovered to have been embezzling from the employer. Often a viable compromise is to exclude claims arising from any criminal acts by the employee.
  • Stipulations re unemployment claims. Where an employee is being terminated for any type of misconduct, it may be a matter of great concern (especially to lower-paid employees) whether the employer will oppose the employee’s application for unemployment benefits. Employers who do not plan to contest such benefits can provide in a severance agreement that they will not do so, which may encourage acceptance of the agreement by the terminating employee.
  • Confidentiality of agreement, confidential advisors, and consequences of breach. A terminating employee’s promise to keep an agreement confidential may need to encompass the terms, existence, and negotiation of the agreement. Bear in mind also that the terminating employee is relatively likely to discuss the settlement with their spouse, an attorney, or possibly even a therapist. The employer can seek to control and regulate such disclosures by providing that if the employee tells any such confidential advisors about the agreement, he or she must instruct them to keep the information confidential, and that such persons will be treated as the employee’s agents if they make further disclosure.
  • Neutral reference / non-disparagement.
    • Employees being terminated are frequently worried – with good reason – about how they will need to represent the circumstances of their termination as they apply for future jobs. Most employers of any size maintain a policy of providing only neutral references for former employees, to minimize potential claims for defamation or other torts. A contractual commitment to give a terminating employee a neutral reference under specified circumstances (e.g., requests directed to human resources) will often give valuable reassurance to the terminating employee at minimal cost to the employer.
  • Employers often want non-disparagement commitments from their terminating employees, but justifiably hesitate to reciprocate, because so many employees’ statements could be within their scope of employment and thus create liability to the former employee. If all such employees were notified to watch what they say, the confidentiality of the agreement would be effectively destroyed. Often a viable compromise is to provide that a few, specifically-named officers or managers of the employer will be instructed not to defame or disparage the employee – often, those who already know about the severance agreement.

About the Author

David F. Dabbs advises and represents employers on all aspects of employment law, including applications, contracts, deferred compensation plans, handbooks, policies, terminations, releases, and restrictive covenants.

Spotts Fain publications are provided as an educational service and are not meant to be and should not be construed as legal advice. Readers with particular needs on specific issues should retain the services of competent counsel.