Legal Insight: The Employment Contract
The previous two columns focused on independent contractor agreements. This month, we focus on employment contracts. Usually, employment is “at will”-at any time, an employee can quit, or an employer can sever the employee. Most employees do not have written contracts for a guaranteed time period. While a good employee manual can provide many detailed policies, the manual should state that it is not a contract.
Usually, companies reserve written contracts for executives and key employees; they are personal service contracts for the employee’s labor. Sometimes, an executive will have special talent or connections that give them leverage when negotiating. Negotiation should occur before the relationship begins.
Contracts are a form of private law between parties. Durable contracts protect their parties’ interests. Parties should consider their own and one another’s interests. If a party does not perceive a benefit, there is an increased likelihood it will breach the contract. That can be a prelude to costly disputes.
Agreements should articulate the parties’ respective rights and responsibilities in as much detail as practical. Wherever possible, they should avoid ambiguity and vagueness. Clear communication of expectations must begin early. If a company tells an applicant something during an interview, but the employee later discovers that the job description, compensation or benefits are different, or promises will not be fulfilled, it will cause resentment. That will hurt morale and performance. As obvious as it sounds, this happens often.
Sometimes, the company will hire the employee only if certain conditions are satisfied. Conditions may include the company securing a large work order (such as a contract to manufacture a fleet of vehicles) or the employee obtaining a professional license (such as earning a black belt in Six Sigma).
A contract should include a detailed job description. This enables the company and employee to clarify the employee’s responsibilities and company’s objectives. Specifying the employee’s job title and identifying to whom or to what department the employee will report directly can avoid much confusion and frustration.
Employee compensation comes in many forms, including salary, incentives, bonuses, benefits (such as health and life insurance), paid time off, reimbursement of specified expenses, and perquisites (use of a company car or tuition for continuing education).
Companies hire employees to help earn or save money, either directly or indirectly. Well-crafted performance bonuses can reward an individual and help the company. Warren Buffett has long-favored bonuses over options, in part, because bonuses can be tailored to a worker’s specific performance rather than company-wide performance. This is not the whole story, though.
In “Out of the Crisis,” W.E. Deming noted that a worker’s performance is dependent upon a combination of forces-many of which are not within his control. In “Juran on Leadership for Quality,” Joseph M. Juran cautioned against suboptimization, the urge for departments (or individuals) to subordinate a company’s goals to their own. Companies and executives must think carefully about what to reward and how to measure it. They may decide to revisit or renegotiate this issue later if the job or business environment changes or when they better understand the job dynamics and develop new ideas to earn and save money.
Relationships end. Employees may resign, be fired, become disabled, or die. Contracts can define termination “for cause” and disability. They can protect employees from having their responsibilities changed too drastically or against relocation to a distant outpost where they never expected to go. They can address severance pay and compensation for accrued paid time off. They can create a mechanism to notify one another of immaterial breaches, giving the counterparty an opportunity to cure the breach through corrective action.
Disputes and grievances can be resolved cost-effectively and confidentially through the use of alternative dispute resolution (ADR) rather than litigation. Mediation gives the parties the best chance to preserve their working relationship. If that fails, an arbitration clause will enable the parties to resolve the dispute without it becoming a matter of public record parked in expensive, plodding, never-ending litigation.
Contracts vary depending on the parties’ needs, but a thoughtful negotiation process will try to anticipate problems and prevent them from occurring. Thus, parties should treat employment contracts as effective tools to clarify and incentivize performance and achieve mutual gain.
Editor’s note: This column does not constitute legal advice.