THE BLOG

Compensation Plan or Employment Contract?

02/08/2014 01:21 pm ET | Updated Apr 09, 2014

U.S. employment-at-will law essentially allows an employer to fire at any time or an employee to quit at any time without legal consequences. Montana is the only state without employment-at-will after a probationary period. Most nations reject pure employment-at-will and require some combination of "good cause," advance notice or mandatory severance pay. U.S. companies employing workers within these nations may be surprised at the difficult procedures required to dismiss an employee. U.S. employees sometimes mistakenly believe that they have similar legal rights.

U.S. exceptions to employment-at-will include statutory restrictions (for example, anti-discrimination legislation), public policy considerations (for example, an employer cannot fire an employee who refuses to commit perjury), violations of an implied covenant of good faith and fair dealing (for example, firing a worker to avoid paying bonuses) and contracts. Not every exception may be recognized in a given state.

Courts may view an employee handbook as a contract. Consequently, many handbooks contain disclaimers asserting that they are not contracts and are subject to unilateral amendment by the employer at any time. Unions negotiate employment contracts and legislation may provide employment rights for public sector employees. Individual private sector employment agreements have their own set of legal issues. Typically a contract that cannot be completed with one year must be written and signed. A fundamental question is if the signed agreement is in fact an employment contract or something else.

The agreement must be very clearly written and internally defined as an employment contract for a specifically stated duration. The agreement must contain more than a statement of the compensation to be paid in various years. While one might suppose that references to multi-year salaries implies multi-year employment, courts do not agree. This comment provides two recent example of compensation plans that were not necessarily employment contracts.

The Connecticut Supreme Court in a recent opinion reviewed an ambiguous letter agreement to determine if it constituted an enforceable employment contract (Cruz v. Visual Perceptions, LLC). At the time of employment the employer and employee signed a document that stated the amount of compensation, benefits and work schedule. Two months later a second document amended these terms and was also signed. Ten months later the employee submitted to the employer a handwritten list of employment changes. This resulted in a third document being signed on March 1, 2007, that became the subject of litigation.

The document in question began: "Norma Cruz Employment Contract: This will cover the [thirty-six] month period starting April 1, 2007 and ending March 31, 2010." It contained a statement of the work schedule, how salary and bonuses were to be calculated, and the benefits provided. The employee was described as a "salaried employee." The document provided for the number of allowable personal days and that the employer would pay for the employee's health insurance "for the duration of the contract." The employer terminated the employee's employment on October 16, 2008.

The employee sued, asserting that she received a three-year employment contract that the employer breached. The employer replied that the document simply stated the terms and conditions of at-will employment. Both a trial court in a non-jury trial and an appellate court determined that the agreement was a three year employment contract. Considering the agreement to be unambiguous, these courts refused to consider extrinsic evidence beyond the words contained in the document. In contrast, the Connecticut Supreme Court decided that the document was ambiguous and might be interpreted either as a contract for a definite period of time or simply as a description of the conditions within an employment-at-will situation. Finding ambiguity, the Court remanded the case for a consideration of additional evidence outside the document to determine its meaning.

The Connecticut Supreme Court observed that the time period could mean that the stated conditions applied if the employee were employed within that period. The "duration of the contract" language did not precisely state what period that "duration" was. If the agreement continued to be ambiguous after considering the additional evidence, then the trial court could apply the rule that an agreement is interpreted against the party who wrote it (contra proferentem).

Another recent decision involved a prospective employee who stated that he would not go to work for the prospective employer with anything thing less than a three-year employment contract (Lamb v. Money Transfer Systems, Inc.). The New York employer and employee signed a document labeled "Jack Lamb Compensation Plan" that contained salaries for three distinct years but did not explicitly state an employment duration. When the employee was fired after six months, he sued alleging breach of contract. The federal District Court for the Western District of New York dismissed the lawsuit, finding that the agreement was unambiguous. Prior New York state court decisions held that a statement of compensation for a particular period of time does not require the employer to continue employment for any duration. Consequently, the statements made prior to signing the agreement would not be admissible in evidence.

Both decisions illustrate how difficult it is for employees to escape the limitations imposed by employment-at-will. In particular, stated multi-year salaries alone do not create an employment contract for multiple years. Realize that typically only the written words contained in the agreement are subject to judicial review. A prospective employee should not rely upon conversations concerning long-term employment or other employment conditions. Write any verbal understandings into the agreement. Write "employment contract" language and very carefully state a specific beginning date and a specific ending date.

Additional suggestions include the following few from among the many legal and practical concepts that should be understood. They are presented in no particular order. Assess your bargaining power based upon your unique skills, experience, knowledge, and industry connections. Be cautious when changing employers. Are you restricted by a current employment agreement? Does the individual that you are interacting with have the authority to make binding offers of employment and enter into binding employment contracts? What personal, legal, ethical, and financial environment will you be entering? Know precisely what person or entity will become your employer. Attempt to have multiple individuals and corporate entities bound by the agreement so that if one fails, others are still liable. Will you be furnished liability insurance (such as Directors and Officers) and indemnification by the employer? Carefully review your potential liabilities. What are the provisions, limitations, and exclusions contained in the insurance coverage, indemnification coverage, and the claims process? For example, have payments made to you immediately as you incur expenses and not at the conclusion of litigation.

An introductory "The Purpose of This Agreement" (or similar phrase) paragraph may provide courts a guide to interpretation if a dispute arises. Who will own the intellectual property that you may create? Specific language concerning the process of and the grounds for termination should be included. What types and duration of severance compensation will be provided? Realize, however, that some events such as the bankruptcy of your employer may modify or invalidate even a well written contract. Consider the basic assumptions that you have in light of the inherent uncertainty of the future. Attempt to include contingency language and plans in the contract.

Finally, to return to the topic at hand, is your agreement a compensation plan or an employment contract? Be very precise. Specific situations vary so both employers and employees should consult an employment law specialist.