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An employment contract is a written, binding agreement between an employer and a prospective or current employee that, when properly drafted, can be a highly effective way of protecting a company's financial and intellectual resources.
Not every employment relationship will require a contract. Rather, employers most often require an employment contract as a condition of employment when the employee holds a position that is highly influential (e.g., chief executive officer), involves sensitive trade secrets or client information (e.g., sales positions, engineers, and computer programmers), or requires a significant amount of “front-end” cost (e.g., relocation packages, extensive or specialized training, sign-on bonus).
In addition, employers may use a separation or severance agreement at the end of the employment relationship or may enter into agreements that deal with a limited subject or scope, such as arbitration agreements or noncompete agreements.
All employment agreements are legally binding on the employer and, therefore, employers are best served by having them drafted and reviewed by an experienced employment law attorney.
Contract law is a particularly complex discipline that relies largely on common law, which is law as developed by judges and court cases. Contracts must generally be interpreted on a case-by-case basis that can change significantly depending on the facts of the particular agreement between parties.
Because of the variability and nuance involved, and the risk that comes with an improperly drafted contract of any type, it cannot be overemphasized how important it is for employers to seek the assistance of legal counsel when drafting and reviewing contracts of any type, including employment agreements.
This section will provide general guidance and information on the various elements and types of employment agreements and the provisions most commonly required by them, but any individual employment contract must be reviewed (if not completely drafted) by competent legal counsel in order to ensure its effectiveness.
In order for any contract to be enforceable in a court of law, certain basic requirements must be met. There must be an offer, acceptance of the offer, and adequate consideration (i.e., something of value) exchanged.
In employment contracts, the offer and acceptance are relatively straightforward. The employer offers the employee a job under certain terms and conditions, and the employee accepts the offer, perhaps after some negotiation.
Adequate consideration can be somewhat trickier. In initial employment contracts, the requirement for consideration is usually satisfied when the employee agrees to provide services to the employer and the employer agrees to pay the employee for the services. Thus, when an employment agreement is entered into at the commencement of employment as a condition of that employment, adequate consideration is generally not an issue.
However, in some states and contractual matters, additional consideration (beyond merely continuing employment) may be required when additional services or certain restrictions are requested of employees.
In particular, additional consideration may be required when employers seek to have employees enter into new or modified employment agreements during the course of employment.
Provisions that must be in every contract. To be enforceable, every contract must include the following:
• Identification of the parties to the contract;
• An offer and acceptance clause (e.g., the employer offers employment and the individual accepts the offer under the terms and conditions set forth in the agreement);
• A statement of consideration (e.g., the salary and/or benefits the employee will be granted);
• The duration of the agreement (when the contract starts and ends); and
• The signatures of all parties to the contract.
Provisions that should be in every contract.
• A final integration or “zipper” clause (a statement that the written document is the entire agreement between the parties on the subject matter therein and that the agreement supersedes any prior oral or written agreement);
• A statement providing that any amendments or modifications to the terms of the agreement will only be effective if agreed to in writing and signed by both parties;
• A “no conflicts” clause (a statement that the performance of the contract by the employee will not violate or conflict in any way with any other agreement to which the employee is bound);
• A statement setting forth the form of any notice that may be required under the agreement (e.g., a notice of termination must be sent via certified mail, return receipt requested);
• A statement providing that the agreement is not assignable by the employee but reserving the employer's right to assign the agreement in the event of a sale, merger, or other change;
• A choice of law provision setting forth the state law under which the agreement will be interpreted; and
• A severability clause providing that if any part of the agreement is held to be invalid, illegal, or unenforceable for any reason, the remaining provisions of the agreement will still be enforced.
Even if there is no written contract between an employer and employee, an oral agreement exists under which the employee agrees to provide services to the employer and the employer agrees to pay the employee for those services. This is known as at-will employment, which is the standard in a vast majority of the states.
Under the at-will doctrine, either the employer or employee may, subject to certain exceptions, terminate the employment relationship at any time, for any lawful reason (or for no reason).
Courts in many states, however, have found that, under certain circumstances, statements made in offer letters, employee handbooks or manuals, and other written statements made to employees can create an implied contract that alters this at-will relationship.
Avoiding implied employment contracts. The most important thing an employer can do to preserve the at-will employment relationship is include a disclaimer on its employment application, in every offer letter sent to prospective employees, and in its employee handbook.
The disclaimer should be placed prominently in the handbook, perhaps even on the first page, and should appear in large, bold type.
In addition, when a new employee receives a copy of the handbook, the employee should be asked to sign an acknowledgment stating that he or she understands and agrees that nothing in the handbook is intended to or does create a contract or alters the at-will employment relationship.
The signed acknowledgment should be kept in the employee's personnel file.
State courts have set different standards for how and when an implied contract may be created; therefore, employers must make sure that the disclaimer contains language that meets the minimum needs in their state(s) of operation.
Caution: The National Labor Relations Board (NLRB) has taken action against employers it deems to have included overly broad disclaimers in employee handbooks.
A disclaimer that may be reasonably construed by employees to restrict their right to act collectively will be in violation of the National Labor Relations Act (NLRA).
As noted above, employers should have legal counsel review handbook contract disclaimer language to ensure it complies with NLRB’s interpretation of the NLRA.
Please see the Employee Handbooks and NLRA topical analysis pages for additional discussion.
In addition to the at-will disclaimer, employers should:
• Train all employees involved in the hiring process or in management to avoid using language or making statements that may be construed as an offer or promise of permanent employment.
• Avoid using probationary periods. Instead, simply state that a new employee's performance will be evaluated after 90 days.
• Include, as part of any disciplinary policy, language reserving the employer's right to determine what type of discipline is appropriate in any given circumstance, including the immediate termination of employment. At the end of the disciplinary policy, include a statement that the employer may deviate from the policy at any time and without notice and that the policy in no way alters the at-will employment relationship.
• Include, before any list of prohibited conduct in an employee handbook, an additional statement noting that the list is not all-inclusive and that other conduct may result in discipline, up to and including the immediate termination of employment.
A collective bargaining agreement (CBA) is a contract between an employer and the labor union that represents its employees.
The federal NLRA provides for and protects the activities of organized labor in the workplace. Under the NLRA, when a union has been properly recognized as the bargaining unit for a group of employees, the employer must negotiate with the union over the terms and conditions of employment.
The result of these negotiations is a CBA that generally controls the major terms of employment, including wages; benefits; hours of work; working condition; job assignments; seniority provisions; employee discipline; vacation, holiday, and sick time; and grievance procedures for handling employee complaints.
Generally speaking, a CBA does not provide for at-will employment. The CBA is a complex document, and negotiations are usually long and sometimes contentious. Employers will want an experienced labor lawyer representing them in negotiating and drafting the CBA.
Please see the Unions and NLRA topical analysis pages for additional discussion.
One clause employers should include in a CBA is a carefully drafted management rights clause.
A strongly worded and comprehensive management rights provision preserves management's right to unilaterally make and effect core business decisions (e.g., the scheduling, transfer, or assignment of work) without the burden of consulting, advising, or obtaining approval from the union membership.
If a union employee believes that his or her employer has violated a particular term or provision of an existing CBA, the employee may file a grievance. A grievance is either an oral or written statement that outlines an alleged violation of the CBA and demands relief.
When an employer is presented with a grievance, it must hear and investigate the complaint and either remedy the violation to both parties' satisfaction or deny the grievance based on a finding of no violation. If the grievance is denied, the union may then appeal to the next designated stage of the process.
If the grievance ultimately moves through all of the CBA's defined stages without resolution, the union may then file a demand for final and binding arbitration.
Practice tip: Although most grievance and arbitration clauses seek to protect the contractual rights of organized employees, employers are advised to negotiate and secure a mirror CBA provision in order to preserve a similar right of recourse against the union.
High-level executives with complicated compensation arrangements generally have employment agreements that are more comprehensive than most standard employment contracts.
Because of their expertise and marketable skills, these employees often require additional contractual security to reduce opportunity cost—i.e., the loss experienced when one option is chosen instead of another, potentially more lucrative option.
For example, high-level executives may demand assurance that they will be protected if the company is sold or it decides to terminate the executive's employment.
Similarly, employers can protect their own interests through these comprehensive agreements and ensure that they “get what they’re paying for,” while reducing the disruption to business operations that occurs when executive team members leave an organization (perhaps for a competitor).
In most cases, both the employer and the employee are represented by legal counsel who draft and negotiate the language of the contract.
In addition to the language that should be included in all employment contracts, contracts for highly placed employees or executives usually include some or all of the following provisions:
• Job title, location, and description of the employee's duties and reporting relationship
• Date on which employment begins or ends if the contract is for a specific duration
• Base salary
• Reimbursement of relocation costs, if applicable
• Signing bonus, if applicable
• Other bonus payments or incentive plans
• Benefits (if the employee will be covered under the employer's group health plans in effect for other employees, this can simply be referenced)
• Stock options or other deferred compensation (stock option plans usually require separate stock option agreements as well)
• Change-in-control provisions
• Leave benefits (paid time off (PTO) and holidays, as well as any special leave incentives such as sabbatical options)
• Automobile and/or travel allowances
• Termination provisions, which may include severance payments if the employee is terminated without cause or resigns for good reason
• Restrictive covenants (e.g., noncompete, confidentiality, and nonsolicitation agreements)
A restrictive covenant is designed to protect an employer's interests by restricting the employee's conduct both during and after employment. The most common types of restrictive covenants are noncompete and confidentiality agreements. Employers also use nonsolicitation agreements to try to prevent former employees from soliciting their customers and other employees.
To improve the odds that a restrictive covenant will be enforced, employers should limit them to only those employees who are in a position to use confidential information or intellectual property. In addition, restrictive covenants must be consistently enforced.
Noncompete agreements. Noncompete agreements prohibit former employees from engaging in a certain type of work within a defined geographical area and period of time.
Noncompete agreements are regulated by state law, and their enforceability will vary depending on the state where the employee is located.
For instance, California law holds noncompete agreements per se unenforceable, as they are against public policy. Other states will enforce noncompete agreements if they serve an employer's legitimate interests and are not overly broad. Therefore, employers must review and comply with the specific requirements in their states.
As a general rule, noncompete agreements are not favored by the courts because they restrict an individual's ability to make a living. Therefore, employers must pay careful attention to the drafting of these agreements.
In order to be enforceable, noncompete agreements generally must be:
• Narrowly drafted so that they are limited to protecting the employer's legitimate business interests;
• Reasonable in geographic scope; and
• Reasonable in duration.
The following paragraphs are a more detailed discussion of these concepts.
Limited to the employer's legitimate business interests. The employer's legitimate business interests may include protecting client lists, trade secrets, and other confidential information. An employee who had access to this type of information and left the company to work for a direct competitor could use the information to the detriment of his or her former employer.
The definition of "competitor" used in a noncompete agreement should be narrowly tailored to protect only legitimate interests and not as a general prohibition against working for any competitor in any capacity.
Limited in geographic scope. This concept is best explained by example: If an employee was the sales manager for the Northeast and his or her customer contacts were limited to that geographic region, a noncompete agreement should not seek to prevent him or her from working for a competitor anywhere in the country. An attempt to prohibit the employee from working for a competitor on the West Coast, for example, would likely be viewed as unreasonable.
Reasonable in duration. A noncompete agreement that restricts an employee from working for a competitor for more than a year will generally receive close scrutiny from the courts. Courts vary, however, from state to state on what they consider reasonable and enforceable.
To prepare a valid and enforceable noncompete agreement, employers should consider the following factors:
• Individual state laws and changes in the law;
• The type of restriction necessary to protect what is most important to the employer, e.g., customer relationships or reputation;
• That the agreement should be written and signed;
• How aggressively the agreement can be drafted in light of individual state court approaches to modifying an otherwise unenforceable agreement to make it enforceable; and
• The enforceability and value of an assignment provision, which allows the noncompete to be transferred to a subsequent owner.
Consideration required for noncompete agreements. If employees are asked to sign a noncompete agreement once they have already begun working for the employer, the employer must ensure that there is adequate consideration for the agreement.
In some states, if an employee is at will, continued employment is sufficient consideration. In other states, the agreement will only be enforceable if the employee is given some consideration beyond continued employment, e.g., a bonus or pay increase, to which he or she would not otherwise be entitled.
Nonsolicitation agreements. Nonsolicitation agreements are usually included as part of a comprehensive employment agreement or noncompete agreement. This type of agreement prohibits the solicitation of employees and/or customers by a former employee.
As with noncompete agreements, nonsolicitation agreements must be reasonable and limited to protecting only the employer's legitimate business interests.
Confidentiality/nondisclosure agreements. These agreements are designed to protect the employer's proprietary information and intellectual property. Generally, such agreements identify the materials or types of information the employer considers to be confidential and state the employer's expectations for how such information will be used or disclosed.
These agreements also spell out the ownership rights to any inventions, technology, machines, developments, designs, processes, trade secrets, works of authorship, and related work product conceived, created, or first reduced to practice by the employee during the term of his or her employment with the employer. Employers may also require employees to agree to execute any documents necessary to protect the employer's ownership rights, such as a patent agreement or application for a patent.
A confidentiality agreement should be designed to meet an employer's specific needs. Since not all information or ideas require the same level of protection, employers should consider to what extent they need to protect certain intellectual property.
Specifically, the following categories of information should be considered:
• Patentable inventions
• Works subject to copyright
• Trade secrets
After determining which assets need to be protected, employers should consider the following steps when drafting and implementing the agreement:
• Training employees on the policy
• Determining whether a confidentiality policy alone is enough to protect the employer's interests under applicable state law or if additional measures are necessary
• Expressly claiming ownership of intellectual property and requiring that new hires disclose any prior patents or inventions
• Controlling outsider and visitor access to all facilities
• Limiting employee access to information and records on a "need to know" basis
• Monitoring and limiting access to electronic data
• Protecting both electronic and physical information
• Establishing procedures to detect and respond to breaches
• Considering the need for confidentiality agreements with third parties, such as vendors and independent contractors
Drafting an effective and enforceable confidentiality policy can be a complex undertaking. Individual state laws must be considered in creating such an agreement. Therefore, it is advisable to seek the assistance of an attorney.
Defend Trade Secrets Act (DTSA). Effective May 11, 2016, the federal DTSA is intended to provide some uniformity and predictability to businesses’ protection of their valuable trade secrets.
The DTSA created a federal claim for misappropriation of trade secrets. These claims have traditionally risen under the Uniform Trade Secrets Act (UTSA), which has been adopted by (and remains effective in) nearly all of the states. Yet, despite UTSA’s goal of providing a uniform system of trade secret protection, the interplay of state laws and judicial interpretation led to an inconsistent patchwork of trade secret protection.
Under the DTSA, businesses have an alternative, more consistent path to recover damages for trade secret violations. Meanwhile, note that the DTSA does not preempt or overturn existing state laws or the UTSA, so businesses also have access to those remedies in the event that they are more favorable.
Companies that wish to take full advantage of DTSA protections have some policy actions to take, first.
The DTSA provides immunity to employees and individual contractors who disclose trade secret information as part of whistleblowing activity. Specifically, the Act protects disclosures made “in confidence to a federal, state, or local government official or … attorney” when made “solely for the purpose of reporting or investigating a suspected violation of law.” The Act also protects sealed disclosures made in a complaint or other document filed in a lawsuit or other proceeding.
Employees and individual contractors must be given notice of this whistleblower protection in any contracts or policy documents related to trade secret protection that are entered into or updated after May 11, 2016.
Businesses that fail to provide this notice will not be actively penalized and will still be able to file claims under the DTSA; however, those businesses’ recovery under the Act will not include attorneys’ fees or punitive (up to double) damages from any employee or contractor to whom the notice was not provided.
For many businesses, it may be simpler to add the whistleblower notice to any newly drafted or revised employee agreements or policies related to trade secret protection, as this at least offers the chance for full recovery, including attorneys’ fees and punitive damages, under either the federal or state acts.
Computer Fraud and Abuse Act (CFAA). The federal CFAA is primarily a criminal statute that was originally enacted to prevent unauthorized access to government computers and to deter hackers (18 U.S.C. Sec. 1130).
In recent years, and with mixed success, employers have taken advantage of a provision in the CFAA that allows a private right of action when someone "knowingly and with the intent to defraud, accesses a protected computer without authorization or exceeds authorized access, and by means of such conduct furthers the intended fraud or obtains anything of value."
The CFAA has been used in suits against employees for, among other things, breach of noncompete agreements and misappropriation of trade secrets. However, courts are split on whether the CFAA applies under these circumstances. Their analyses have hinged on the meaning of the phrase "without authorization" as used in the statute.
Practice Tip: The CFAA can be a valuable tool for employers when employees misuse company-owned computers in violation of a noncompete or other employment agreement.
However, employers considering a CFAA claim should consult with local employment counsel to determine whether such a claim is viable in their jurisdiction.
Please see the Privacy topical analysis for additional discussion.
Potential employees and restrictive covenants. While hiring employees away from the competition may seem attractive, there are a number of risks employers take when recruiting and hiring such individuals. Before hiring, employers should determine whether the employee is bound by a restrictive covenant, the terms of the covenant, the likelihood of the covenant being enforced, and the costs and risks of hiring the employee.
If the decision is made to hire the employee, employers should confirm that the employee has terminated his or her employment with the former employer, obtain a copy of any applicable restrictive covenant to determine what the employee can and cannot do, prohibit the employee from using any confidential information obtained from his or her former employer, and refuse to accept any such information.
Employers may also want to consider including language in an offer letter stating that these steps have been taken.
Providing a separation or termination agreement can be an effective way to prevent litigation. The amount of compensation offered in a separation agreement is often significantly less than the employer would spend on legal fees alone to defend itself against a claim by a former employee.
Separation agreements are also useful in the context of layoffs or reductions in force, which can result in claims by multiple employees.
Whether an organization decides to offer an employee a separation agreement usually comes down to employer policy, practice, and philosophy. It is important, however, to draft an enforceable separation agreement in order to realize these benefits.
Provisions to include in a separation agreement. In addition to clearly laying out the elements of the separation package and what the employee will receive, employers also generally include the following standard provisions:
• Date of termination
• Nonadmission of liability clause
• Statement of noncoercion
• No-rehire clause, if applicable
• Confidentiality clause that covers both the terms of the agreement and proprietary information, such as trade secrets or client lists
• Noncompete agreement
• Nondisparagement agreement
• Nonsolicitation agreement
• Requirement that the employee return all company property
• A statement that the contract constitutes the entire agreement between the parties
State law requirements also must be taken into account; therefore, separation agreements should always be drafted by an attorney.
Releases/covenants not to sue. When an employer offers severance pay to a discharged employee, it should require the employee to sign a general release of claims.
Releases should detail the types of claims the employee is waiving to show that the employee understands that he or she has certain rights and is voluntarily waiving them. An employee cannot, however, waive prospective claims or ones that arise after the release is signed or effective.
In addition, the following legal issues must be considered when drafting a valid and enforceable release:
• Releases may not prohibit an employee from filing charges with administrative agencies such as the Equal Employment Opportunity Commission (EEOC). Releases also should not suggest or state that the employee cannot cooperate with a federal or state agency in connection with an investigation.
As such, releases should clearly provide that the employee is giving up the right to sue in court for monetary damages but not waiving his or her right to file an administrative charge or to participate in an agency investigation.
• Employees cannot waive minimum wage or overtime claims under the Fair Labor Standards Act (FLSA) unless the release is supervised by the U.S. Department of Labor.
• Employees cannot waive their prospective rights under the federal Family and Medical Leave Act (FMLA). The settlement or release of FMLA claims based on past employer conduct is permissible (29 CFR 825.220(d)).
• Releases may not limit employees’ exercise of rights under the NLRA. For example, a release may not require employees to promise not to engage in any union activity relating to the employer. As noted above, releases also may not interfere with a worker’s right to cooperate with NLRB proceedings.
• Specific requirements apply to releases of age claims under the Older Workers Benefit Protection Act (OWBPA). The release must specifically state that the employee is waiving his or her claims under the federal Age Discrimination in Employment Act (ADEA) and be written in plain language. In addition, the release must provide a 21-day consideration period, a 7-day revocation period, and advice to consult with an attorney before signing the agreement.
Additional requirements apply if the agreement covers multiple employees under a group layoff or exit incentive plan. More information is available on the Age Discrimination topical analysis page.
• In settlements related to sexual harassment, if payment of the settlement is made subject to a non-disclosure agreement, the payment will not be eligible for tax deduction as an ordinary and necessary trade or business expense. (Internal Revenue Code Section 162(q).
• State laws may also impose additional limitations on releases. For example, some states prohibit waivers of unpaid wage claims.
Consideration. As with any contract, for a separation agreement and release to be enforceable, there must be adequate consideration for the agreement.
This means that the employee must be provided with monetary compensation or something else of value to which the employee would not otherwise be entitled under the law or employer policy—for instance, accrued salary, commissions, or payments due under the employer's established severance plan would not be adequate consideration.
Examples of adequate consideration include continuation of health benefits or fringe benefits at the employer's expense, unearned vacation pay, outplacement services, continued use of a company car, vesting of unvested stock options, salary continuation, or a letter of reference.
The separation agreement should explicitly state that the receipt of any severance is conditioned on the employee signing the release.
Internal Revenue Code (IRC) Sec. 409A sets out rules for nonqualified deferred compensation (NQDC).
Under Sec. 409A, with few exceptions, a deferral of compensation exists if an employee obtains a legally binding right to compensation in one year that is paid in a later year. A legally binding right to such compensation is created even if the compensation is conditioned on the future performance of services or other conditions established by the employer and, therefore, may be paid in a later year.
There is no deferral, however, if an employer has unrestricted right to reduce or eliminate the compensation. Deferred compensation can be granted in a variety of ways, including by supplemental retirement plans, individual employment contracts, severance agreements, and settlement agreements.
Tax penalties. If deferred compensation covered by Sec. 409A meets the specified requirements, there is no effect on the employee’s taxes. The compensation is taxed in the same manner as it would be taxed if it were not covered by Sec. 409A. If the arrangement does not meet the requirements, the compensation is subject to certain additional taxes.
What does the law require? Sec. 409A imposes several requirements on nonqualified deferred compensation plans related to documentation, elections, funding, distributions, withholding, and reporting. Relevant to employment agreements, the law requires that such plans be in writing and specify the amount and timing of distributions.
Distributions are permitted only upon separation from employment, disability, death, at a specified time before the deferral period ends in the event of an unforeseen emergency, or upon a change in control.
Plans must also delay distributions for 6 months to key employees of publicly traded companies upon separation from employment. In addition, if the plan provides for elective deferrals, Sec. 409A specifies how and when those elections may be made.
Note: Section 409A is a complex law, so employers should consult with legal counsel when drafting employment agreements with deferred compensation provisions. More information is also available at http://www.irs.gov.
Employment litigation has exploded in recent years, and employers are continually faced with defending themselves against often frivolous claims in state and federal courts.
Arbitration has become increasingly attractive to employers because it is private, binding, and comparatively less expensive and time consuming than traditional litigation through the court system.
In enacting the Federal Arbitration Act (FAA), Congress recognized the benefits of arbitration as opposed to traditional litigation and codified a public policy favoring arbitration.
The U.S. Supreme Court has held that the FAA governs arbitration agreements in the employment setting (with the exception of transportation workers) (Circuit City Stores, Inc. v. Adams, 532 U.S. 105 (2001)).
The Supreme Court has also ruled that the FAA preempts state laws that would give jurisdiction to a court or administrative agency rather than the arbitrator (Preston v. Ferrer, 128 S.Ct. 978 (2008)). The Supreme Court has also upheld provisions in an arbitration agreement that granted the arbitrator, rather than a court, the authority to determine the enforceability of the arbitration agreement (Rent-A-Center v. Jackson, 130 S.Ct. 2772 (2010)).
These cases reflect the Supreme Court's favorable view of arbitration. For practical purposes, these rulings mean that well-drafted mandatory arbitration agreements between employers and employees will likely be enforced.
Also, employers may delegate extensive authority to arbitrators, including the authority to determine the validity of an arbitration agreement.
Discrimination charges. Despite its favorable view of arbitration, the Supreme Court has ruled that an agreement between a private employer and employee to arbitrate employment-related disputes does not bar the EEOC from pursuing a complaint against the employer for illegal discrimination (EEOC v. Waffle House, Inc., 534 U.S. 279 (2002)). Therefore, in order to be enforceable, a carefully drafted arbitration agreement should carve out an exception for the filing of a charge with the EEOC. In addition, such agreements must not limit an employee's legal rights and remedies, e.g., exclude the right to discovery or to recover certain types of damages that would be available to them in court.
The Supreme Court has also ruled that a provision in a CBA that clearly requires union members to arbitrate claims arising under the federal ADEA is enforceable (14 Penn Plaza, LLC v. Pyett, 129 S.Ct. 1456 (2009)).
In this case, three night lobby watchmen challenged their reassignments, claiming, among other things, violations of the ADEA. In compliance with their CBA, the workers' union requested arbitration of their claims but later removed the age discrimination claims from arbitration. The workers then filed an age discrimination suit in federal court.
Although the lower court denied a motion to compel arbitration, the Supreme Court found that neither the NLRA nor the ADEA precluded arbitration of age bias claims.
The Supreme Court rejected the argument that the arbitration clause was outside the permissible scope of the collective bargaining process because it affected the employees' individual, noneconomic statutory rights that can only be waived individually. The Court reasoned that the ability to take an age bias claim to court is not a substantive right guaranteed by the ADEA; the ADEA grants only the substantive right to be free from age discrimination. Therefore, a clear and freely negotiated age discrimination arbitration provision in a CBA is enforceable.
Class action arbitration. The U.S. Supreme Court has ruled that class arbitration is permitted only when the parties expressly agree to it (Stolt-Nielsen S.A. v. Animalfeeds International Corp., 559 U.S. ____, 130 S. Ct. 1758 (2010)).
The Court ruled that allowing class arbitration when the agreement is silent on the issue would violate the FAA. The Court reasoned that an arbitrator's role is to interpret and enforce the parties' contract, not to make public policy by inferring a class arbitration agreement. The Court noted there are significant differences between bilateral (two-party) and class arbitrations.
For example, unlike bilateral arbitration, in class arbitration, the arbitrator must resolve many disputes among hundreds, or even thousands, of individuals. Also, a class arbitration may involve enormous sums of money, but arbitration rulings are subject to only limited review in the courts.
On the other hand, the U.S. Supreme Court will not disturb an arbitrator’s decision finding that class action arbitration is permissible under the parties’ agreement when the parties agree that the arbitrator should decide whether their contract provides for class action (Oxford Health Plans, LLC v. Sutter, 569 U.S. ____, 133 S. Ct. 2064 (2013)).
In such cases, as long as the arbitrator makes a good-faith effort to interpret a contract, a court will not reverse the arbitrator's decision even if it is based on serious errors of law or fact.
Class action waivers. Arbitration agreements often contain class action waivers. Though such waivers had been expressly upheld as valid by the Supreme Court in consumer agreements (AT&T Mobility LLC v. Concepcion, 563 U.S. ____, 131 S. Ct. 1740 (2011)), there had been significant uncertainty and debate as to whether such waivers were permissible in employment agreements.
This matter was finally settled in a 2018 Supreme Court decision in which the court held that such waivers are permitted and enforceable under the FAA (Epic Systems Corp. v. Lewis, No. 16–285 (May 21, 2018)).
The Supreme Court’s decision in Epic resolved a years-long circuit split as to whether class action waivers in employment arbitration agreements violated the NLRA.
The divide arose in D.R. Horton, Inc. (357 NLRB No. 184 (2012)), in which the NLRB ruled that an arbitration agreement violated the NLRA when it required employees to waive their right to bring class or collective actions.
This decision was overturned by the U.S. Court of Appeals for the 5th Circuit, which disagreed with NLRB’s assertion that the agreement violated covered employees’ rights to protected, concerted activity. Citing the weight of the FAA, the 5th Circuit held that such arbitration agreements are valid and enforceable (D.R. Horton, Inc. v. NLRB, 737 F.3d 344 (5th Cir. 2013)).
In spite of this ruling, the NLRB continued to apply its restrictive reasoning in several later decisions that, when reviewed, created a significant divide among federal courts: the 5th, 2nd, and 8th Circuit Courts upheld class action waivers as valid and enforceable, while the Seventh and Ninth Circuits found them in violation of the NLRA.
The matter is now succinctly settled by the Supreme Court, and employers may be certain that class action waivers in arbitration agreements are not a violation of the NLRA.
However, whether such waivers make practical sense in the business context will be a matter for each employer to decide with its employment counsel.
Restriction on arbitration for defense contractors. The Department of Defense Appropriations Act 2010 (DDAA) bars federal contractors with defense contracts in excess of $1 million from requiring employees to arbitrate claims arising under Title VII of the Civil Rights Act of 1964 (Title VII) or any tort related to sexual assault or harassment, including assault and battery, intentional infliction of emotional distress, false imprisonment, or negligent hiring, supervision, or retention.
Federal contractors must certify that subcontractors with subcontracts over $1 million also comply with this law (DDAA 2010 Sec. 8116).
These restrictions on mandatory arbitration do not apply to agreements that are unenforceable in the United States. Additionally, the secretary of Defense may waive these restrictions if he or she determines that a waiver is necessary to avoid harm to national security interests.
Restriction on arbitration for federal contractors. The Fair Pay and Safe Workplaces Executive Order, signed into law and effective July 31, 2014, extends similar arbitration restrictions to all federal contractors.
The Executive Order bars federal contractors with contracts in excess of $1 million from requiring employees to arbitrate claims arising under Title VII or any tort related to sexual assault or harassment, including assault and battery, intentional infliction of emotional distress, false imprisonment, or negligent hiring, supervision, or retention.
Federal contractors must certify that subcontractors with subcontracts over $1 million also comply with this law.
Contracts and subcontracts for the acquisition of commercial items or commercially available off-the-shelf items are exempt from this restriction. Valid agreements to arbitrate that were entered into before the effective date of the Executive Order will not be affected unless the contractor or subcontractor is permitted to change the terms of the contract or the contract is replaced or renegotiated.
Finally, the arbitration restrictions do not apply to employees who are covered by a CBA negotiated between the contractor and a representative labor organization.
State laws. Employers interested in adopting a mandatory arbitration agreement must also pay careful attention to applicable state laws.
Because arbitration is a dynamic area of the law, employers should seek the assistance of an attorney in drafting arbitration agreements and in implementing an arbitration policy for all employees.
If either party violates the terms of an employment agreement, the other party may sue for breach of contract.
If, for instance, an employee breaches a noncompete agreement, the employer may seek a court order to stop the employee from working for the competitor and damages.
On the other hand, if an employee was promised a bonus that was set out in an employment agreement or, in some instances, in an oral agreement or promise, and the employer refuses to pay, the employee will have a claim for breach of contract against the employer.
Last reviewed on August 26, 2018..
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An employment contract is a written, binding agreement between an employer and a prospective or current employee that, when properly drafted, can be a highly effective way of protecting a company's financial and intellectual resources.
Not every employment relationship will require a contract. Rather, employers most often require an employment contract as a condition of employment when the employee holds a position that is highly influential (e.g., chief executive officer), involves sensitive trade secrets or client information (e.g., sales positions, engineers, and computer programmers), or requires a significant amount of “front-end” cost (e.g., relocation packages, extensive or specialized training, sign-on bonus).
In addition, employers may use a separation or severance agreement at the end of the employment relationship or may enter into agreements that deal with a limited subject or scope, such as arbitration agreements or noncompete agreements.
All employment agreements are legally binding on the employer and, therefore, employers are best served by having them drafted and reviewed by an experienced employment law attorney.
Contract law is a particularly complex discipline that relies largely on common law, which is law as developed by judges and court cases. Contracts must generally be interpreted on a case-by-case basis that can change significantly depending on the facts of the particular agreement between parties.
Because of the variability and nuance involved, and the risk that comes with an improperly drafted contract of any type, it cannot be overemphasized how important it is for employers to seek the assistance of legal counsel when drafting and reviewing contracts of any type, including employment agreements.
This section will provide general guidance and information on the various elements and types of employment agreements and the provisions most commonly required by them, but any individual employment contract must be reviewed (if not completely drafted) by competent legal counsel in order to ensure its effectiveness.
In order for any contract to be enforceable in a court of law, certain basic requirements must be met. There must be an offer, acceptance of the offer, and adequate consideration (i.e., something of value) exchanged.
In employment contracts, the offer and acceptance are relatively straightforward. The employer offers the employee a job under certain terms and conditions, and the employee accepts the offer, perhaps after some negotiation.
Adequate consideration can be somewhat trickier. In initial employment contracts, the requirement for consideration is usually satisfied when the employee agrees to provide services to the employer and the employer agrees to pay the employee for the services. Thus, when an employment agreement is entered into at the commencement of employment as a condition of that employment, adequate consideration is generally not an issue.
However, in some states and contractual matters, additional consideration (beyond merely continuing employment) may be required when additional services or certain restrictions are requested of employees.
In particular, additional consideration may be required when employers seek to have employees enter into new or modified employment agreements during the course of employment.
Provisions that must be in every contract. To be enforceable, every contract must include the following:
• Identification of the parties to the contract;
• An offer and acceptance clause (e.g., the employer offers employment and the individual accepts the offer under the terms and conditions set forth in the agreement);
• A statement of consideration (e.g., the salary and/or benefits the employee will be granted);
• The duration of the agreement (when the contract starts and ends); and
• The signatures of all parties to the contract.
Provisions that should be in every contract.
• A final integration or “zipper” clause (a statement that the written document is the entire agreement between the parties on the subject matter therein and that the agreement supersedes any prior oral or written agreement);
• A statement providing that any amendments or modifications to the terms of the agreement will only be effective if agreed to in writing and signed by both parties;
• A “no conflicts” clause (a statement that the performance of the contract by the employee will not violate or conflict in any way with any other agreement to which the employee is bound);
• A statement setting forth the form of any notice that may be required under the agreement (e.g., a notice of termination must be sent via certified mail, return receipt requested);
• A statement providing that the agreement is not assignable by the employee but reserving the employer's right to assign the agreement in the event of a sale, merger, or other change;
• A choice of law provision setting forth the state law under which the agreement will be interpreted; and
• A severability clause providing that if any part of the agreement is held to be invalid, illegal, or unenforceable for any reason, the remaining provisions of the agreement will still be enforced.
Even if there is no written contract between an employer and employee, an oral agreement exists under which the employee agrees to provide services to the employer and the employer agrees to pay the employee for those services. This is known as at-will employment, which is the standard in a vast majority of the states.
Under the at-will doctrine, either the employer or employee may, subject to certain exceptions, terminate the employment relationship at any time, for any lawful reason (or for no reason).
Courts in many states, however, have found that, under certain circumstances, statements made in offer letters, employee handbooks or manuals, and other written statements made to employees can create an implied contract that alters this at-will relationship.
Avoiding implied employment contracts. The most important thing an employer can do to preserve the at-will employment relationship is include a disclaimer on its employment application, in every offer letter sent to prospective employees, and in its employee handbook.
The disclaimer should be placed prominently in the handbook, perhaps even on the first page, and should appear in large, bold type.
In addition, when a new employee receives a copy of the handbook, the employee should be asked to sign an acknowledgment stating that he or she understands and agrees that nothing in the handbook is intended to or does create a contract or alters the at-will employment relationship.
The signed acknowledgment should be kept in the employee's personnel file.
State courts have set different standards for how and when an implied contract may be created; therefore, employers must make sure that the disclaimer contains language that meets the minimum needs in their state(s) of operation.
Caution: The National Labor Relations Board (NLRB) has taken action against employers it deems to have included overly broad disclaimers in employee handbooks.
A disclaimer that may be reasonably construed by employees to restrict their right to act collectively will be in violation of the National Labor Relations Act (NLRA).
As noted above, employers should have legal counsel review handbook contract disclaimer language to ensure it complies with NLRB’s interpretation of the NLRA.
Please see the Employee Handbooks and NLRA topical analysis pages for additional discussion.
In addition to the at-will disclaimer, employers should:
• Train all employees involved in the hiring process or in management to avoid using language or making statements that may be construed as an offer or promise of permanent employment.
• Avoid using probationary periods. Instead, simply state that a new employee's performance will be evaluated after 90 days.
• Include, as part of any disciplinary policy, language reserving the employer's right to determine what type of discipline is appropriate in any given circumstance, including the immediate termination of employment. At the end of the disciplinary policy, include a statement that the employer may deviate from the policy at any time and without notice and that the policy in no way alters the at-will employment relationship.
• Include, before any list of prohibited conduct in an employee handbook, an additional statement noting that the list is not all-inclusive and that other conduct may result in discipline, up to and including the immediate termination of employment.
A collective bargaining agreement (CBA) is a contract between an employer and the labor union that represents its employees.
The federal NLRA provides for and protects the activities of organized labor in the workplace. Under the NLRA, when a union has been properly recognized as the bargaining unit for a group of employees, the employer must negotiate with the union over the terms and conditions of employment.
The result of these negotiations is a CBA that generally controls the major terms of employment, including wages; benefits; hours of work; working condition; job assignments; seniority provisions; employee discipline; vacation, holiday, and sick time; and grievance procedures for handling employee complaints.
Generally speaking, a CBA does not provide for at-will employment. The CBA is a complex document, and negotiations are usually long and sometimes contentious. Employers will want an experienced labor lawyer representing them in negotiating and drafting the CBA.
Please see the Unions and NLRA topical analysis pages for additional discussion.
One clause employers should include in a CBA is a carefully drafted management rights clause.
A strongly worded and comprehensive management rights provision preserves management's right to unilaterally make and effect core business decisions (e.g., the scheduling, transfer, or assignment of work) without the burden of consulting, advising, or obtaining approval from the union membership.
If a union employee believes that his or her employer has violated a particular term or provision of an existing CBA, the employee may file a grievance. A grievance is either an oral or written statement that outlines an alleged violation of the CBA and demands relief.
When an employer is presented with a grievance, it must hear and investigate the complaint and either remedy the violation to both parties' satisfaction or deny the grievance based on a finding of no violation. If the grievance is denied, the union may then appeal to the next designated stage of the process.
If the grievance ultimately moves through all of the CBA's defined stages without resolution, the union may then file a demand for final and binding arbitration.
Practice tip: Although most grievance and arbitration clauses seek to protect the contractual rights of organized employees, employers are advised to negotiate and secure a mirror CBA provision in order to preserve a similar right of recourse against the union.
High-level executives with complicated compensation arrangements generally have employment agreements that are more comprehensive than most standard employment contracts.
Because of their expertise and marketable skills, these employees often require additional contractual security to reduce opportunity cost—i.e., the loss experienced when one option is chosen instead of another, potentially more lucrative option.
For example, high-level executives may demand assurance that they will be protected if the company is sold or it decides to terminate the executive's employment.
Similarly, employers can protect their own interests through these comprehensive agreements and ensure that they “get what they’re paying for,” while reducing the disruption to business operations that occurs when executive team members leave an organization (perhaps for a competitor).
In most cases, both the employer and the employee are represented by legal counsel who draft and negotiate the language of the contract.
In addition to the language that should be included in all employment contracts, contracts for highly placed employees or executives usually include some or all of the following provisions:
• Job title, location, and description of the employee's duties and reporting relationship
• Date on which employment begins or ends if the contract is for a specific duration
• Base salary
• Reimbursement of relocation costs, if applicable
• Signing bonus, if applicable
• Other bonus payments or incentive plans
• Benefits (if the employee will be covered under the employer's group health plans in effect for other employees, this can simply be referenced)
• Stock options or other deferred compensation (stock option plans usually require separate stock option agreements as well)
• Change-in-control provisions
• Leave benefits (paid time off (PTO) and holidays, as well as any special leave incentives such as sabbatical options)
• Automobile and/or travel allowances
• Termination provisions, which may include severance payments if the employee is terminated without cause or resigns for good reason
• Restrictive covenants (e.g., noncompete, confidentiality, and nonsolicitation agreements)
A restrictive covenant is designed to protect an employer's interests by restricting the employee's conduct both during and after employment. The most common types of restrictive covenants are noncompete and confidentiality agreements. Employers also use nonsolicitation agreements to try to prevent former employees from soliciting their customers and other employees.
To improve the odds that a restrictive covenant will be enforced, employers should limit them to only those employees who are in a position to use confidential information or intellectual property. In addition, restrictive covenants must be consistently enforced.
Noncompete agreements. Noncompete agreements prohibit former employees from engaging in a certain type of work within a defined geographical area and period of time.
Noncompete agreements are regulated by state law, and their enforceability will vary depending on the state where the employee is located.
For instance, California law holds noncompete agreements per se unenforceable, as they are against public policy. Other states will enforce noncompete agreements if they serve an employer's legitimate interests and are not overly broad. Therefore, employers must review and comply with the specific requirements in their states.
As a general rule, noncompete agreements are not favored by the courts because they restrict an individual's ability to make a living. Therefore, employers must pay careful attention to the drafting of these agreements.
In order to be enforceable, noncompete agreements generally must be:
• Narrowly drafted so that they are limited to protecting the employer's legitimate business interests;
• Reasonable in geographic scope; and
• Reasonable in duration.
The following paragraphs are a more detailed discussion of these concepts.
Limited to the employer's legitimate business interests. The employer's legitimate business interests may include protecting client lists, trade secrets, and other confidential information. An employee who had access to this type of information and left the company to work for a direct competitor could use the information to the detriment of his or her former employer.
The definition of "competitor" used in a noncompete agreement should be narrowly tailored to protect only legitimate interests and not as a general prohibition against working for any competitor in any capacity.
Limited in geographic scope. This concept is best explained by example: If an employee was the sales manager for the Northeast and his or her customer contacts were limited to that geographic region, a noncompete agreement should not seek to prevent him or her from working for a competitor anywhere in the country. An attempt to prohibit the employee from working for a competitor on the West Coast, for example, would likely be viewed as unreasonable.
Reasonable in duration. A noncompete agreement that restricts an employee from working for a competitor for more than a year will generally receive close scrutiny from the courts. Courts vary, however, from state to state on what they consider reasonable and enforceable.
To prepare a valid and enforceable noncompete agreement, employers should consider the following factors:
• Individual state laws and changes in the law;
• The type of restriction necessary to protect what is most important to the employer, e.g., customer relationships or reputation;
• That the agreement should be written and signed;
• How aggressively the agreement can be drafted in light of individual state court approaches to modifying an otherwise unenforceable agreement to make it enforceable; and
• The enforceability and value of an assignment provision, which allows the noncompete to be transferred to a subsequent owner.
Consideration required for noncompete agreements. If employees are asked to sign a noncompete agreement once they have already begun working for the employer, the employer must ensure that there is adequate consideration for the agreement.
In some states, if an employee is at will, continued employment is sufficient consideration. In other states, the agreement will only be enforceable if the employee is given some consideration beyond continued employment, e.g., a bonus or pay increase, to which he or she would not otherwise be entitled.
Nonsolicitation agreements. Nonsolicitation agreements are usually included as part of a comprehensive employment agreement or noncompete agreement. This type of agreement prohibits the solicitation of employees and/or customers by a former employee.
As with noncompete agreements, nonsolicitation agreements must be reasonable and limited to protecting only the employer's legitimate business interests.
Confidentiality/nondisclosure agreements. These agreements are designed to protect the employer's proprietary information and intellectual property. Generally, such agreements identify the materials or types of information the employer considers to be confidential and state the employer's expectations for how such information will be used or disclosed.
These agreements also spell out the ownership rights to any inventions, technology, machines, developments, designs, processes, trade secrets, works of authorship, and related work product conceived, created, or first reduced to practice by the employee during the term of his or her employment with the employer. Employers may also require employees to agree to execute any documents necessary to protect the employer's ownership rights, such as a patent agreement or application for a patent.
A confidentiality agreement should be designed to meet an employer's specific needs. Since not all information or ideas require the same level of protection, employers should consider to what extent they need to protect certain intellectual property.
Specifically, the following categories of information should be considered:
• Patentable inventions
• Works subject to copyright
• Trade secrets
After determining which assets need to be protected, employers should consider the following steps when drafting and implementing the agreement:
• Training employees on the policy
• Determining whether a confidentiality policy alone is enough to protect the employer's interests under applicable state law or if additional measures are necessary
• Expressly claiming ownership of intellectual property and requiring that new hires disclose any prior patents or inventions
• Controlling outsider and visitor access to all facilities
• Limiting employee access to information and records on a "need to know" basis
• Monitoring and limiting access to electronic data
• Protecting both electronic and physical information
• Establishing procedures to detect and respond to breaches
• Considering the need for confidentiality agreements with third parties, such as vendors and independent contractors
Drafting an effective and enforceable confidentiality policy can be a complex undertaking. Individual state laws must be considered in creating such an agreement. Therefore, it is advisable to seek the assistance of an attorney.
Defend Trade Secrets Act (DTSA). Effective May 11, 2016, the federal DTSA is intended to provide some uniformity and predictability to businesses’ protection of their valuable trade secrets.
The DTSA created a federal claim for misappropriation of trade secrets. These claims have traditionally risen under the Uniform Trade Secrets Act (UTSA), which has been adopted by (and remains effective in) nearly all of the states. Yet, despite UTSA’s goal of providing a uniform system of trade secret protection, the interplay of state laws and judicial interpretation led to an inconsistent patchwork of trade secret protection.
Under the DTSA, businesses have an alternative, more consistent path to recover damages for trade secret violations. Meanwhile, note that the DTSA does not preempt or overturn existing state laws or the UTSA, so businesses also have access to those remedies in the event that they are more favorable.
Companies that wish to take full advantage of DTSA protections have some policy actions to take, first.
The DTSA provides immunity to employees and individual contractors who disclose trade secret information as part of whistleblowing activity. Specifically, the Act protects disclosures made “in confidence to a federal, state, or local government official or … attorney” when made “solely for the purpose of reporting or investigating a suspected violation of law.” The Act also protects sealed disclosures made in a complaint or other document filed in a lawsuit or other proceeding.
Employees and individual contractors must be given notice of this whistleblower protection in any contracts or policy documents related to trade secret protection that are entered into or updated after May 11, 2016.
Businesses that fail to provide this notice will not be actively penalized and will still be able to file claims under the DTSA; however, those businesses’ recovery under the Act will not include attorneys’ fees or punitive (up to double) damages from any employee or contractor to whom the notice was not provided.
For many businesses, it may be simpler to add the whistleblower notice to any newly drafted or revised employee agreements or policies related to trade secret protection, as this at least offers the chance for full recovery, including attorneys’ fees and punitive damages, under either the federal or state acts.
Computer Fraud and Abuse Act (CFAA). The federal CFAA is primarily a criminal statute that was originally enacted to prevent unauthorized access to government computers and to deter hackers (18 U.S.C. Sec. 1130).
In recent years, and with mixed success, employers have taken advantage of a provision in the CFAA that allows a private right of action when someone "knowingly and with the intent to defraud, accesses a protected computer without authorization or exceeds authorized access, and by means of such conduct furthers the intended fraud or obtains anything of value."
The CFAA has been used in suits against employees for, among other things, breach of noncompete agreements and misappropriation of trade secrets. However, courts are split on whether the CFAA applies under these circumstances. Their analyses have hinged on the meaning of the phrase "without authorization" as used in the statute.
Practice Tip: The CFAA can be a valuable tool for employers when employees misuse company-owned computers in violation of a noncompete or other employment agreement.
However, employers considering a CFAA claim should consult with local employment counsel to determine whether such a claim is viable in their jurisdiction.
Please see the Privacy topical analysis for additional discussion.
Potential employees and restrictive covenants. While hiring employees away from the competition may seem attractive, there are a number of risks employers take when recruiting and hiring such individuals. Before hiring, employers should determine whether the employee is bound by a restrictive covenant, the terms of the covenant, the likelihood of the covenant being enforced, and the costs and risks of hiring the employee.
If the decision is made to hire the employee, employers should confirm that the employee has terminated his or her employment with the former employer, obtain a copy of any applicable restrictive covenant to determine what the employee can and cannot do, prohibit the employee from using any confidential information obtained from his or her former employer, and refuse to accept any such information.
Employers may also want to consider including language in an offer letter stating that these steps have been taken.
Providing a separation or termination agreement can be an effective way to prevent litigation. The amount of compensation offered in a separation agreement is often significantly less than the employer would spend on legal fees alone to defend itself against a claim by a former employee.
Separation agreements are also useful in the context of layoffs or reductions in force, which can result in claims by multiple employees.
Whether an organization decides to offer an employee a separation agreement usually comes down to employer policy, practice, and philosophy. It is important, however, to draft an enforceable separation agreement in order to realize these benefits.
Provisions to include in a separation agreement. In addition to clearly laying out the elements of the separation package and what the employee will receive, employers also generally include the following standard provisions:
• Date of termination
• Nonadmission of liability clause
• Statement of noncoercion
• No-rehire clause, if applicable
• Confidentiality clause that covers both the terms of the agreement and proprietary information, such as trade secrets or client lists
• Noncompete agreement
• Nondisparagement agreement
• Nonsolicitation agreement
• Requirement that the employee return all company property
• A statement that the contract constitutes the entire agreement between the parties
State law requirements also must be taken into account; therefore, separation agreements should always be drafted by an attorney.
Releases/covenants not to sue. When an employer offers severance pay to a discharged employee, it should require the employee to sign a general release of claims.
Releases should detail the types of claims the employee is waiving to show that the employee understands that he or she has certain rights and is voluntarily waiving them. An employee cannot, however, waive prospective claims or ones that arise after the release is signed or effective.
In addition, the following legal issues must be considered when drafting a valid and enforceable release:
• Releases may not prohibit an employee from filing charges with administrative agencies such as the Equal Employment Opportunity Commission (EEOC). Releases also should not suggest or state that the employee cannot cooperate with a federal or state agency in connection with an investigation.
As such, releases should clearly provide that the employee is giving up the right to sue in court for monetary damages but not waiving his or her right to file an administrative charge or to participate in an agency investigation.
• Employees cannot waive minimum wage or overtime claims under the Fair Labor Standards Act (FLSA) unless the release is supervised by the U.S. Department of Labor.
• Employees cannot waive their prospective rights under the federal Family and Medical Leave Act (FMLA). The settlement or release of FMLA claims based on past employer conduct is permissible (29 CFR 825.220(d)).
• Releases may not limit employees’ exercise of rights under the NLRA. For example, a release may not require employees to promise not to engage in any union activity relating to the employer. As noted above, releases also may not interfere with a worker’s right to cooperate with NLRB proceedings.
• Specific requirements apply to releases of age claims under the Older Workers Benefit Protection Act (OWBPA). The release must specifically state that the employee is waiving his or her claims under the federal Age Discrimination in Employment Act (ADEA) and be written in plain language. In addition, the release must provide a 21-day consideration period, a 7-day revocation period, and advice to consult with an attorney before signing the agreement.
Additional requirements apply if the agreement covers multiple employees under a group layoff or exit incentive plan. More information is available on the Age Discrimination topical analysis page.
• In settlements related to sexual harassment, if payment of the settlement is made subject to a non-disclosure agreement, the payment will not be eligible for tax deduction as an ordinary and necessary trade or business expense. (Internal Revenue Code Section 162(q).
• State laws may also impose additional limitations on releases. For example, some states prohibit waivers of unpaid wage claims.
Consideration. As with any contract, for a separation agreement and release to be enforceable, there must be adequate consideration for the agreement.
This means that the employee must be provided with monetary compensation or something else of value to which the employee would not otherwise be entitled under the law or employer policy—for instance, accrued salary, commissions, or payments due under the employer's established severance plan would not be adequate consideration.
Examples of adequate consideration include continuation of health benefits or fringe benefits at the employer's expense, unearned vacation pay, outplacement services, continued use of a company car, vesting of unvested stock options, salary continuation, or a letter of reference.
The separation agreement should explicitly state that the receipt of any severance is conditioned on the employee signing the release.
Internal Revenue Code (IRC) Sec. 409A sets out rules for nonqualified deferred compensation (NQDC).
Under Sec. 409A, with few exceptions, a deferral of compensation exists if an employee obtains a legally binding right to compensation in one year that is paid in a later year. A legally binding right to such compensation is created even if the compensation is conditioned on the future performance of services or other conditions established by the employer and, therefore, may be paid in a later year.
There is no deferral, however, if an employer has unrestricted right to reduce or eliminate the compensation. Deferred compensation can be granted in a variety of ways, including by supplemental retirement plans, individual employment contracts, severance agreements, and settlement agreements.
Tax penalties. If deferred compensation covered by Sec. 409A meets the specified requirements, there is no effect on the employee’s taxes. The compensation is taxed in the same manner as it would be taxed if it were not covered by Sec. 409A. If the arrangement does not meet the requirements, the compensation is subject to certain additional taxes.
What does the law require? Sec. 409A imposes several requirements on nonqualified deferred compensation plans related to documentation, elections, funding, distributions, withholding, and reporting. Relevant to employment agreements, the law requires that such plans be in writing and specify the amount and timing of distributions.
Distributions are permitted only upon separation from employment, disability, death, at a specified time before the deferral period ends in the event of an unforeseen emergency, or upon a change in control.
Plans must also delay distributions for 6 months to key employees of publicly traded companies upon separation from employment. In addition, if the plan provides for elective deferrals, Sec. 409A specifies how and when those elections may be made.
Note: Section 409A is a complex law, so employers should consult with legal counsel when drafting employment agreements with deferred compensation provisions. More information is also available at http://www.irs.gov.
Employment litigation has exploded in recent years, and employers are continually faced with defending themselves against often frivolous claims in state and federal courts.
Arbitration has become increasingly attractive to employers because it is private, binding, and comparatively less expensive and time consuming than traditional litigation through the court system.
In enacting the Federal Arbitration Act (FAA), Congress recognized the benefits of arbitration as opposed to traditional litigation and codified a public policy favoring arbitration.
The U.S. Supreme Court has held that the FAA governs arbitration agreements in the employment setting (with the exception of transportation workers) (Circuit City Stores, Inc. v. Adams, 532 U.S. 105 (2001)).
The Supreme Court has also ruled that the FAA preempts state laws that would give jurisdiction to a court or administrative agency rather than the arbitrator (Preston v. Ferrer, 128 S.Ct. 978 (2008)). The Supreme Court has also upheld provisions in an arbitration agreement that granted the arbitrator, rather than a court, the authority to determine the enforceability of the arbitration agreement (Rent-A-Center v. Jackson, 130 S.Ct. 2772 (2010)).
These cases reflect the Supreme Court's favorable view of arbitration. For practical purposes, these rulings mean that well-drafted mandatory arbitration agreements between employers and employees will likely be enforced.
Also, employers may delegate extensive authority to arbitrators, including the authority to determine the validity of an arbitration agreement.
Discrimination charges. Despite its favorable view of arbitration, the Supreme Court has ruled that an agreement between a private employer and employee to arbitrate employment-related disputes does not bar the EEOC from pursuing a complaint against the employer for illegal discrimination (EEOC v. Waffle House, Inc., 534 U.S. 279 (2002)). Therefore, in order to be enforceable, a carefully drafted arbitration agreement should carve out an exception for the filing of a charge with the EEOC. In addition, such agreements must not limit an employee's legal rights and remedies, e.g., exclude the right to discovery or to recover certain types of damages that would be available to them in court.
The Supreme Court has also ruled that a provision in a CBA that clearly requires union members to arbitrate claims arising under the federal ADEA is enforceable (14 Penn Plaza, LLC v. Pyett, 129 S.Ct. 1456 (2009)).
In this case, three night lobby watchmen challenged their reassignments, claiming, among other things, violations of the ADEA. In compliance with their CBA, the workers' union requested arbitration of their claims but later removed the age discrimination claims from arbitration. The workers then filed an age discrimination suit in federal court.
Although the lower court denied a motion to compel arbitration, the Supreme Court found that neither the NLRA nor the ADEA precluded arbitration of age bias claims.
The Supreme Court rejected the argument that the arbitration clause was outside the permissible scope of the collective bargaining process because it affected the employees' individual, noneconomic statutory rights that can only be waived individually. The Court reasoned that the ability to take an age bias claim to court is not a substantive right guaranteed by the ADEA; the ADEA grants only the substantive right to be free from age discrimination. Therefore, a clear and freely negotiated age discrimination arbitration provision in a CBA is enforceable.
Class action arbitration. The U.S. Supreme Court has ruled that class arbitration is permitted only when the parties expressly agree to it (Stolt-Nielsen S.A. v. Animalfeeds International Corp., 559 U.S. ____, 130 S. Ct. 1758 (2010)).
The Court ruled that allowing class arbitration when the agreement is silent on the issue would violate the FAA. The Court reasoned that an arbitrator's role is to interpret and enforce the parties' contract, not to make public policy by inferring a class arbitration agreement. The Court noted there are significant differences between bilateral (two-party) and class arbitrations.
For example, unlike bilateral arbitration, in class arbitration, the arbitrator must resolve many disputes among hundreds, or even thousands, of individuals. Also, a class arbitration may involve enormous sums of money, but arbitration rulings are subject to only limited review in the courts.
On the other hand, the U.S. Supreme Court will not disturb an arbitrator’s decision finding that class action arbitration is permissible under the parties’ agreement when the parties agree that the arbitrator should decide whether their contract provides for class action (Oxford Health Plans, LLC v. Sutter, 569 U.S. ____, 133 S. Ct. 2064 (2013)).
In such cases, as long as the arbitrator makes a good-faith effort to interpret a contract, a court will not reverse the arbitrator's decision even if it is based on serious errors of law or fact.
Class action waivers. Arbitration agreements often contain class action waivers. Though such waivers had been expressly upheld as valid by the Supreme Court in consumer agreements (AT&T Mobility LLC v. Concepcion, 563 U.S. ____, 131 S. Ct. 1740 (2011)), there had been significant uncertainty and debate as to whether such waivers were permissible in employment agreements.
This matter was finally settled in a 2018 Supreme Court decision in which the court held that such waivers are permitted and enforceable under the FAA (Epic Systems Corp. v. Lewis, No. 16–285 (May 21, 2018)).
The Supreme Court’s decision in Epic resolved a years-long circuit split as to whether class action waivers in employment arbitration agreements violated the NLRA.
The divide arose in D.R. Horton, Inc. (357 NLRB No. 184 (2012)), in which the NLRB ruled that an arbitration agreement violated the NLRA when it required employees to waive their right to bring class or collective actions.
This decision was overturned by the U.S. Court of Appeals for the 5th Circuit, which disagreed with NLRB’s assertion that the agreement violated covered employees’ rights to protected, concerted activity. Citing the weight of the FAA, the 5th Circuit held that such arbitration agreements are valid and enforceable (D.R. Horton, Inc. v. NLRB, 737 F.3d 344 (5th Cir. 2013)).
In spite of this ruling, the NLRB continued to apply its restrictive reasoning in several later decisions that, when reviewed, created a significant divide among federal courts: the 5th, 2nd, and 8th Circuit Courts upheld class action waivers as valid and enforceable, while the Seventh and Ninth Circuits found them in violation of the NLRA.
The matter is now succinctly settled by the Supreme Court, and employers may be certain that class action waivers in arbitration agreements are not a violation of the NLRA.
However, whether such waivers make practical sense in the business context will be a matter for each employer to decide with its employment counsel.
Restriction on arbitration for defense contractors. The Department of Defense Appropriations Act 2010 (DDAA) bars federal contractors with defense contracts in excess of $1 million from requiring employees to arbitrate claims arising under Title VII of the Civil Rights Act of 1964 (Title VII) or any tort related to sexual assault or harassment, including assault and battery, intentional infliction of emotional distress, false imprisonment, or negligent hiring, supervision, or retention.
Federal contractors must certify that subcontractors with subcontracts over $1 million also comply with this law (DDAA 2010 Sec. 8116).
These restrictions on mandatory arbitration do not apply to agreements that are unenforceable in the United States. Additionally, the secretary of Defense may waive these restrictions if he or she determines that a waiver is necessary to avoid harm to national security interests.
Restriction on arbitration for federal contractors. The Fair Pay and Safe Workplaces Executive Order, signed into law and effective July 31, 2014, extends similar arbitration restrictions to all federal contractors.
The Executive Order bars federal contractors with contracts in excess of $1 million from requiring employees to arbitrate claims arising under Title VII or any tort related to sexual assault or harassment, including assault and battery, intentional infliction of emotional distress, false imprisonment, or negligent hiring, supervision, or retention.
Federal contractors must certify that subcontractors with subcontracts over $1 million also comply with this law.
Contracts and subcontracts for the acquisition of commercial items or commercially available off-the-shelf items are exempt from this restriction. Valid agreements to arbitrate that were entered into before the effective date of the Executive Order will not be affected unless the contractor or subcontractor is permitted to change the terms of the contract or the contract is replaced or renegotiated.
Finally, the arbitration restrictions do not apply to employees who are covered by a CBA negotiated between the contractor and a representative labor organization.
State laws. Employers interested in adopting a mandatory arbitration agreement must also pay careful attention to applicable state laws.
Because arbitration is a dynamic area of the law, employers should seek the assistance of an attorney in drafting arbitration agreements and in implementing an arbitration policy for all employees.
If either party violates the terms of an employment agreement, the other party may sue for breach of contract.
If, for instance, an employee breaches a noncompete agreement, the employer may seek a court order to stop the employee from working for the competitor and damages.
On the other hand, if an employee was promised a bonus that was set out in an employment agreement or, in some instances, in an oral agreement or promise, and the employer refuses to pay, the employee will have a claim for breach of contract against the employer.
Last reviewed on August 26, 2018..
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