How to Protect Your Career Earnings with an Employment Contract

I’ve talked several times about how your career is your most important financial asset. 

Given this, you want to treat your career like other major assets. You want to grow it, of course. But just as important is protecting it. That’s why I wrote Career Insurance: Protecting Your Most Valuable Asset.

One of the best ways to protect your career, but also one of the hardest and least known, was covered in a post I first wrote for Financial Samurai several years ago. It focused on employment contracts.

Most people are familiar with contracts for professional athletes — where the athletes agree to play for a given team for a given time at a given wage. Few people realize that there are similar contracts for top business executives. There are a few differences as I’ll detail below, but essentially do the same thing — they lock in a key employee in exchange for a guaranteed payday.

Now let’s get to the post I wrote, which I have updated a bit for the ESI Money audience…

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As most Financial Samurai readers know, Sam is the expert on engineering your layoff.

His methods have helped hundreds negotiate great packages as they leave their employers. Obviously this is a tried and true method for maximizing your exit from a company.

But it’s not the only way. Today I’ll be telling you how you can negotiate your severance before you even take a job.

Overview

This post will detail the ins and outs of employment contracts (sometimes referred to as employee agreements). I prefer the former since that’s what every executive I’ve ever worked with called them.

Employment contracts are negotiated between an employer and employee prior to the employee joining the company. The contracts grant rights and privileges to each party as well as imposes requirements on both.

I am not a lawyer but I play one on the internet. Seriously, this is not meant as legal advice but rather a guideline to help you learn about employment contracts and potentially make use of them. I’m hoping some lawyers with personnel contract experience join us in the comments to fill in any blanks I miss.

That said, I was a business executive who dealt with employment contracts for two decades, had employment contracts with four separate companies over almost 20 years, and had payouts on two of those agreements.

Key Parts of an Employment Contract

As with any legal document, employment contracts can take many forms. But here are some of the most common requirements an employee may agree to in an employment contract:

• Keep company trade secrets confidential while employed by the company and within some period after leaving.
• Not solicit fellow employees or former clients from the company for a given period of time after leaving the company.
• Act in the best interest of the company and not make business agreements that could cause harm.
• Not use company contacts, resources, and relationships for personal gain outside of work (such as divert work from the company to a personally owned business).
• That any work done on company time and with company resources belongs to the employer. There may even be a clause stating that whatever ideas you have while employed with the company belong to the company if the ideas are within their line of business.
• Shall devote full business energies, interest, abilities and productive time to the company (will not accept other employment, consulting work or render other services to any person, business or organization).
• Agree not to acquire, assume or participate in, directly or indirectly, any position, investment or interest that employee knows is adverse or antagonistic to the company, its business, clients, strategic partners, investors or prospects.
• Agree to termination for cause (if employee materially breaches this contract, disobeys a reasonable directive of the company, or violates any written company policy that is determined to be materially contrary to the best interests of the company; engages in any knowing or intentional act or omission that is materially contrary to the best interests of the company; fails to restrict use of, or abuses, drugs or alcohol, including impairment of ability to function at work; commits any fraud, embezzlement or other act of dishonesty against the company; commits a criminal act, or is convicted of, or pleads no contest to, a felony.)

Here are some common provisions an employer may agree to:

• Amount of compensation the employee gets if terminated.
• Detail the employee’s annual salary, bonus criteria, and annual raises.
• Explain employee benefits and vacation.
• List employee title and reporting structure (especially title of person employee will report to).
• Specifics of employee relocation package.
• Allow the employee to purchase stocks or securities in given amounts at given rates.
• List what happens if employee dies, is disabled, or voluntarily resigns.

In addition to the above, there are often sections pertaining to the overall agreement such as:

• Provisions regarding how disputes should be legally resolved (i.e., arbitration).
• Lists what state laws will be used to decide differences.
• Catch-all legal mumbo-jumbo that covers other (usually minor) parts of the contract.

Can I Have that in English?

The previous section may read to you like a foreign language. Believe me, the bullet points are actually pretty readable when compared to reviewing the actual contract.

To boil things down to the vital elements, here’s the essence of an employment contract:

• The employer agrees to hire the employee and spells out his/her compensation.
• The employee agrees to work for employer and work in its best interests.
• If the employee is terminated for cause (doing something illegal, immoral, or hurting the company), then he can be released without any additional compensation.
• If the employee is terminated for any other reason, there’s an agreed upon payout and method of payout.
• If the employee leaves of his own free will, he gets nothing extra.

If it’s not obvious, the pros and cons for the employee boil down to these:

• Pros — Knows that he has a certain amount of income guaranteed even if he’s fired.
• Cons — Employee has to agree to some conditions, though these are ones most would likely fulfill anyway.

In other words, it’s a pretty sweet deal for the employee. You can see why most executives want an employment contract.

How It Works in Practicality

Generally at some time in the recruiting process, the subject of an employment contract is brought up, usually by the employee. Employers are loathe to sign such an agreement as it requires them to pay an employee if there’s a falling out.

Employees want a contract, of course, because it guarantees them a payout if the relationship goes south.

So the topic is brought up and the negotiation is started. Is there an agreement? What are the key provisions? Who does what? And so forth. Until there’s some sort of resolution.

How to Get an Employment Contract

Here’s the bad news: employment contracts are difficult to get, especially in a slack labor market.

As I noted above, employers don’t like to give them because they basically take on financial liabilities (which no company likes to do) without a lot of compensation in return.

So why do employers give them and who gets them?

Employers give contracts to key employees in order for them to 1) accept a job initially and 2) remain in a job (with a sense of security) as long as useful.

In short, the employee has to be valuable enough that the benefit of having the employee is greater than the liability of the agreement.

As such, they are generally given at the executive level to managers who have the ability to deliver substantial business results. That said, any level of employee, as long as they are important to the company, can get one. The key is: you have some skill or ability that brings great value to the company.

My Story

Many of these principles can be illustrated through my personal experience.

In 1999 I joined a new company as a vice president.

It was standard for them to have employment contracts with all executives.

The standard agreement at the company basically entitled me to one year’s salary if I was let go for almost any reason. The exceptions were so unlikely to happen (get convicted of a felony, act immorally in a way that hurt the company, etc.) that there was virtually zero chance of me not getting a payout if fired. I was thrilled.

Five years down the road I was ready for a change and preparing to be hired by a new company as an executive vice president. This organization was much smaller, but about as profitable as my current company. The new, small company had no one with an employment contract — they didn’t even know what one was (or said they didn’t).

I provided them with a copy of my current agreement and told them I needed one before I would come aboard. They consulted their lawyer and basically copied the one I had at the old firm. The only change was they reduced the one year payout to six months. This was agreeable to me given my new compensation was much better and I joined the firm.

I worked for that company for nine years when another company wanted to hire me as their president, a significant move for me. Again when I brought up the subject of the employment contract the Owner/CEO claimed he’d never heard of one. I provided my copy and they eventually copied it. I joined the firm.

The first full year I was with them, we had a record sales year. The fourth month into year two the CEO left to run another business, they brought in a new CEO who didn’t want a president, and they fired me. Or in kinder terms they “exercised my contract”. I was paid to go away. You can read all the sordid details in The Day My Most Valuable Asset Took a Hit. 

At that point I contemplated early retirement, but Sam had not yet convinced me of its benefits. I interviewed with a new firm and was hired within three months of being fired. They too claimed they had never heard of an employment contract. I gave them a copy of my most recent one and we began to negotiate back and forth. Two significant provisions changed:

1. There was a sliding scale based on when I was let go of what I would receive (if fired within the first year I got one year’s salary, if fired within years 2-5 I got six month’s salary, and so forth)
2. There was a provision added that detailed how the employer could get rid of me if I didn’t perform the way they wanted.

I was fine with option #1 but pushed back on #2. The purpose of an employment contract is to pay the employee a set amount if he is let go for ANY reason other than criminal activity or significantly hurting the company. They wanted to add a performance element, something that is usually not in an employment contract because it is highly subjective and can be manipulated by the employer. I had been around the block a few times and knew that employers can trump up almost anything to be a performance issue if they want, so I didn’t want the provision.

But they held fast and gave me a take-it-or-leave-it ultimatum. In the end I took it since even if they enacted the performance clause I would still received five months’ worth of guaranteed salary which wasn’t that different than the six months I had.

Plus, by this time, I was financially independent and the move got me to Colorado, so I felt I was adequately prepared and compensated.

Well, as you might know, things did not go well. They created nonsensical issues and gave me unattainable objectives to hit within a 40-day grace period (the first part of my severance time). I knew I wouldn’t hit them, didn’t even try since they were unachievable, and 40 days later they exercised part two of my contract and paid me to get lost. This is when I decided it was time to retire and that’s what I did.

My only regret — that I didn’t retire much, much sooner (which I could have done since I had been FI for a decade).

Tips for Making the Most of an Employment Contract

Now that we all have a common understanding of how employment contracts work, here are a few tips for you to consider as you work to negotiate your severance before you’re hired:

• As you grow in skill and experience, try to get a contract (it’s generally easier when you switch companies). If your work/skill is valuable enough you can do it. Even if it’s basic and doesn’t guarantee much, get one as it can be used as a foundation to build upon at your next move.
• Make the amount/length of time which the employer has to pay you if terminated as high/long as possible. As a general guideline, six months is great and a year is phenomenal. Three months is probably more likely and more acceptable to most employers.
• Try to avoid a declining scale that ends at zero. If the scale starts at a year’s salary and ends at six months, that’s fine, but don’t accept something that works down to a minimal amount, especially if it’s zero. The only way I’d do that would be if it was my first agreement. At that point it’s better to have something than nothing if that’s all the employer will agree to.
• Ensure the amount renews daily and not be for a fixed period. This is similar to the previous comment. You want your six-month (or whatever) agreement to pay for six months, so it will renew daily. You don’t want an agreement that starts with six months when you begin the job, then counts down day by day until it hits zero six months later.
• Once you have an agreement, take it to the next employer. Try to get terms at least as good as you had but improve if you can. I wasn’t successful at this as I started so high that the only way was down, but most will begin lower and work their way up. You may go down but perhaps you can leverage a lower contract for something you prefer like higher compensation.
• Use a lawyer if you’re not versed in dealing with contracts. I handled my own agreements as I have business contract experience, but most people need advice. If there’s any question, at least have a lawyer give it a once-over. You do not want to end up with a contract you think covers you and does not. And believe me, they can be difficult to read for someone not used to them.
• Reduce your job-related emergency fund. If you want six months’ salary in your “get fired” emergency fund, a six-month contract covers it. This allows you to take money that could be in savings and invest it. You’ll still need some emergency cash to cover other unexpected expenses.
• Don’t quit because you hate the job/company/people. Even if it gets bad, try to stick it out. You can always ask them to “exercise your contract” or even reach a compromise if you really dislike your situation (for instance, you may have a six-month guarantee but would be willing to leave if they paid you for three months). In the end you get nothing if you leave voluntarily so don’t do it unless you have a great opportunity you’re moving on to.
• Try to eliminate performance-based clauses. These tend to favor the employer and give them plenty of latitude to let you go and pay less (or nothing!) than they might otherwise be required to.
• You can ask for more than money. Everything’s negotiable, so if it’s in the contract (or you want it in), be sure it’s included. Perhaps you want more vacation, a car allowance, or added benefits only for a select few. Get these in the agreement to ensure they are given (I had one friend who was promised stock options verbally and then didn’t get them. If they had been in his contract, the company would have been required to pay them).
• Don’t agree to any extra commitments if they fire you. One employer tried to get me to agree to a whole host of extra provisions in order to get my severance check. I told them they had two choices: 1) pay me with no extra commitments on my part or 2) offer me extra compensation to consider the extra provisions. They paid me. My contract did not stipulate that I needed to agree to anything extra to get a payout so I wasn’t going to do so.

In closing let me encourage you that the time to think about getting an employment contract is the same time you’re considering taking a new position. Take the steps upfront to ensure your severance is set before you even set foot at the company.