Employment Agreements

OVERVIEW: This section covers the following topics -

1. specifying whether your new hire will be full-time or part-time;
2. whether your new hire will be an independent contractor or an employee;
3. what kind of contract you should draft with a new hire;
4. agreements to arbitrate rather than sue;
5. agreements to protect trade secrets; and
6. agreements not to compete after termination.

• Full-time employees vs. independent contractors and part-time employees

A first issue in bringing on new workers is whether the new person will be an "independent contractor" or an "employee." This issue might seem to be of interest only to lawyers, yet it determines who pays the tax man: you or the new person.

However, you can't just call someone an "independent contractor" and avoid paying taxes on their wages. The legal test for whether someone is an independent contractor is fairly straightforward:

1. employees are those who follow employer instructions on the job; independent contractors are less closely supervised and exercise independent judgment.
2. If the employer trains the worker, the worker is likely to be an employee. Workers who get their training elsewhere are often independent contractors.
3. if the worker does the work himself, he is likely to be an employee. If the worker is allowed to subcontract the job out, he is likely to be an independent contractor.
4. if the worker's assistants and helpers are paid by the employer, the worker is likely to be an employee. If the worker pays his own assistants and helpers, he is likely to be an independent contractor.
5. if there is a long-term and continuing relationship, the worker is likely to be an employee.
6. If the worker is full-time, he is more likely to be an independent contractor.
7. If the work must be done at the employer's place of business, the worker is more likely to be an independent contractor.
8. If the worker has to submit regular reports on the work being done, he is more likely to be an employee than an independent contractor.
9. if the worker is paid by the hour, he is more likely to be an employee than an independent contractor.
10. If the worker is paid for traveling and business expenses, he is more likely to be an employee than an independent contractor.
11. If the employer furnishes most of the tools for the job, the worker is likely to be an independent contractor.
12. If the worker works for more than one firm at a time, the worker is likely to be an independent contractor.
13. if the worker makes his services available to the public rather than to one employer, he is likely to be an independent contractor.
14. If the worker can hire and fire his own assistants and helpers, he is more likely to be an independent contractor.

Even if someone meets the tests of "independent contractor" under this tax test, this still may not change whether the person is covered by your worker's compensation, by anti-discrimination laws, and by other employment-related laws.

If you hire a person who does not meet the independent contractor tests, but who works on a part-time basis, you have some freedom to treat them differently from your other employees. You can offer part-time employees fewer benefits (parking, medical, profit- sharing, etc) and lower wages than your full-time employees. However, in general you have to offer "similarly situated" workers the same opportunities for benefits and wages. This means workers who do similar work and who work similar hours should be offered similar benefits.

There are additional restrictions on what you can do with pensions and annuities. For many tax-deferred or tax-exempt pensions and annuities, you have to meet what are called "nondiscrimination" requirements. For example, pension plans must be offered to all employees on the same terms to be tax-deferred or tax-exempt. You can lose a pension plan's favored tax status by only giving it to highly compensated employees or executives.

• Contracts

When you hire someone, you create a contract - even if there is no piece of paper involved. A contract can be oral or it can even be implied from your behavior. Oral and implied contracts can be just as enforceable as written contracts.

In other words, you have to be careful of what you are agreeing to. A seemingly casual oral promise can come back to haunt you later. Years after hiring someone, you might find yourself in court, explaining your words. A first rule in dealing with employees, then, is to make sure all promises and agreements are in writing, and that no oral promises will be allowed to change the written promises.

You can do this by making sure the written contracts specifically state that no oral or implied promises can change the contents of the written contracts.

• At-will employment

Ordinarily, employment is "at will." This means that the employer or the employee can terminate the relationship "for any reason, for a bad reason, or for no reason." In other words, in most states, you can fire someone just because you are having a bad hair day.

This is an ancient rule of the common law. However, as with most sweeping rules, there are many, many, many exceptions! These exceptions fall into three classes:

1. You can't fire someone if you have a binding agreement not to do so. (This exception is accepted in every state, but different agreements not to fire can be considered "binding" in different states).
2. You can't fire someone for a reason prohibited by a specific law. (This exception is based on two kinds of law: (a) federal laws like those prohibiting race discrimination, and (b) laws in individual states like those on wrongful termination and whistleblower protection).
3. You can't fire someone for reasons prohibited by "public policy." (Not all states accept this exception).

In other words, the "at will" doctrine is loved by employers, hated by employees, and enforced rather selectively. Even if you live in a state with a strong "at will" doctrine, there are plenty of reasons for being careful.

Specifically, when you hire someone, you should be careful to make sure their employment remains "at will." You can do this by putting a disclaimer in all of your statements of workplace policy (employee manuals, benefits publications, etc). A disclaimer is a statement that the contents of the communication or publication are NOT to be construed as a contract or contractual offer. Put the disclaimer in large letters in a prominent part of the document.

• Employment for a definite time vs. contracts for lifetime employment.

One of the exceptions to the at-will doctrine mentioned above is where an employee and an employer agree to a specific period of employment, i.e., six months or a year. These agreements are enforceable! You don't get the benefit of the at-will doctrine if you have made an agreement to employ someone for a specific time.

On the other hand, if you agree to employ someone for the rest of their lives, based on some outstanding accomplishment (maybe the employee saved your life, or invented the "seronobator"), many states will not enforce such an agreement. These "contracts for lifetime employment" are frowned on by many courts, and some will try to interpret them out of existence rather than find them unenforceable.

• Implied contracts and employee handbooks

As noted above, one of the three major exceptions to the "at-will" employment doctrine exists where you agree not to fire someone for a specific reason, or where you agree not to fire someone for a specific time. This is a "contractual" agreement, meaning that it generally has to meet the requirements of a contract to be enforceable.

This is where a LOT of employment litigation arises. Often an employer will make what it considers a vague statement about the future, and the employee hears an ironclad promise. Suppose your employment manual says that no one in the company will be terminated without good cause. Is this an enforceable promise (a contract), or just a general statement of how you prefer to do things (a guideline)?

That depends on how specific the promise was, and on whether the employees gave up anything to get the promise. These two factors are called definiteness and consideration.

Consideration can be furnished by an employee's continuing to work at a job in reliance on the employer's promise. The employee is giving up the right to go to another job that might have better wages and more security, in exchange for the employer's promise of security.

Definiteness means that the language of the manual must contain a promise clear enough that an employee would reasonably believe that an offer had been made.

In most states, for an employee manual to be binding, it must be: (a) sufficiently definite to create an offer, (b) communicated to and accepted by the employee, and (c) supported by consideration -- the continued employment of the employee.

Not all states require that the manual be disseminated to the employee. You would think that to be a contract, the employee would have to be at least aware of its contents. However, a minority of states allow manuals to be contracts with employees who do not read them. The idea is that employees are entitled to rely on general policies they know to be in effect in the workplace, even if they don't know the specifics.

Again, this means that in any employment manual you issue, you should have disclaimers all over the place in BIG LETTERS. (The idea of a disclaimer is explained above).

• Non-competition agreements

Some employers with sensitive trade secrets or with particularly irreplaceable employees may want them to sign non-competition employees. Suppose your key salesperson wants to go over to the competition. He has all of your sales routes and customers sewn up; something like this could destroy the business.

Alternatively, if you have spent 10 years paying some technician's wages and they finally invent something useful, you don't want that person to go over and work for the competition right away! How can you prevent this?

In some states, you can make all new hires sign what are called non-competition agreements, or covenants not to compete. There are enormous differences in how individual states treat these agreements.

If your state allows non-competition agreements to be enforced, it is likely that they must meet a reasonableness test, i.e., the restrictions on competition must be reasonable. This is the case in Maryland, where the "reasonableness" test requires that:

1. The employee possess unique skills or perform unique services,
2. The employee has direct contact with customers or direct contact with trade secrets, and
3. The length of time and the geographic area covered by the agreement must be reasonable.

• Arbitration agreements

You may wish to ask prospective employees to sign an arbitration agreement. In an arbitration agreement, the employee agrees to bring any future employment disputes before a neutral third party, who is specified in the agreement.

Congress has specified in the Federal Arbitration Act that arbitration agreements are to be upheld by courts where possible. Courts have generally followed this requirement. The Supreme Court has recently held that an agreement to arbitrate is enforceable, though the agreement must be fair, allowing a free choice of arbitrators and an impartial arbitrator, among other things.

Copyright 1996 David Trieloff, Esq.

Mr. Trieloff passed away on April 16th, 1998 and is sadly missed by the staff of the Business Know-How where he was a member of the volunteer staff.