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The Pros and Cons of Employment Contracts

Thursday, May 4 2017 1:18 PM

An employment contract is a document, signed by both employer and employee, that lays out the terms of the employment relationship. It makes clear what you expect from the employee in terms of job duties and responsibilities, and what he or she can expect from you (salary and benefits).employment contract

This article covers employment contracts that limit the right to terminate employment “at will,” usually by dictating the term/duration of employment, notice requirements and conditions or limitations for early termination, and/or grounds for termination.

An employment contract may also include:

  • PTO/vacation policies
  • Non-disclosure and non-compete agreements
  • Ownership agreements and assignment clauses
  • Grievance procedures
  • Dispute resolution methods (such as mediation or arbitration)
  • Provisions for breach of contract

Most employment relationships in the United States are “at will” rather than under contract. Written employment contracts are generally used for specific key or high-level employees. They offer several benefits and protections, but drawbacks as well. Let’s take a look at the pros and cons of employment contracts.

Advantages of Employment Contracts

Retain Valuable Employees

One of the biggest advantages of employment contracts is the ability to retain top performers and reduce costly, disruptive turnover. A contract can specify the term of employment and limit the reasons the employee may resign early.

While you can’t stop an employee from leaving your company, he or she may be less likely to do so if there are penalties involved.

Stand Out to Attract Top Talent

Competition can be fierce when it comes to attracting top candidates to your organization. A highly sought-after candidate will likely have more than one offer of employment. Offering job security and beneficial terms through an employment contract may help tip the scales in your favor.

Reduce the Risk of Up-Front Investment

If you invest considerable time and money training a new employee, the last thing you want is all that investment walking out the door six months later if the employee resigns. You may also incur other up-front expenses, such as recruiting costs, relocation costs, and sign-on bonuses.

An employment contract can help mitigate the risk by locking in an employee for a specified time period. He or she may be less likely to quit too soon if doing so will have specified consequences.

Protect Business Interests

If you have employees who work with sensitive company information (such as trade secrets or client lists), you can include a confidentiality clause in your contracts that prevents employees from disclosing this information or using it for personal gain. A properly written non-compete agreement can prevent former employees from working for your competitors or clients for a specified amount of time after leaving your company. A non-solicitation clause can keep one employee from taking others with them when they leave.

Ease Employment Transitions & Limit Disruption

You may stipulate in your contract that an employee provide a certain amount of notice when resigning, so you have adequate time to find and train a replacement. You may require that the departing employee train his or her replacement, helping smooth the transition.

Disadvantages of Employment Contracts

Less Flexibility in Adapting to Changing Conditions

A contract limits your ability to terminate employment early should your business needs change. For example, if you hire an employee under a year-long contract, but a month later there’s an unexpected downturn, you can’t simply let him go unless that has been stipulated in the contract as acceptable grounds. You will have to renegotiate the contract, settle with the employee, or face financial penalties for breach of contract.

Employment contracts may limit your flexibility in other ways. For example, if you need to reduce costs in benefit spending but you’ve promised a certain level of health benefits in a contract, you won’t be able to do so without renegotiating.

Limits Your Ability to Fire an Employee

There may be cases where a contracted employee isn’t performing as you’d hoped, or simply isn’t a good fit, but hasn’t met the grounds for termination specified in the contract. Unlike “at will” employment, you won’t be able to fire him or her without breaking the contract.

Administrative Burden and Costs

Each customized employment contract must be tracked by your HR or legal department to ensure that it is up-to-date, and that actions you take as an organization—for example, changing your benefits package or PTO policy—don’t breach the terms of your agreements.

This may not be burdensome if you use contracts only for certain key employees. However, if you use employment contracts across the board as a matter of course, the time and expense can quickly add up.

Legal Ramifications of a “Bad Faith” Breach

Once under contract, you and your employee are also legally obligated to act according to the “covenant of good faith and fair dealing.” If you breach the contract in a way that a judge or jury finds unfair (in “bad faith”), you may be held responsible not only for violating the contract, but for breaching your duty to act in good faith. This can have further legal ramifications.

In Conclusion

Employment contracts offer many protections and benefits, but they can have drawbacks that should be considered. They are legally binding and should always be reviewed by legal counsel. An employment law attorney can review your employment contracts to determine their validity, and if the provisions are enforceable for both sides.  At Fleeson Gooing, Bill Tretbar, David Seely, Brooks Severson and Ryan Meyer are knowledgeable in this area of the law and available to provide assistance.

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