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Employment Agreements Help Prevent Misunderstandings

By Ted N. Kazaglis, Esq.

We have all heard or read about the situation where a company treats individuals as independent contractors, and ultimately the individuals are found to be employees. In the meantime, the company has not been paying taxes or providing benefits or workers’ compensation insurance to the individual. In most cases this is simply a misunderstanding of the differences between employees and independent contractors. There are other times where the distinction is a bit more subtle.

A Case in Point

The use of staffing agencies is one such example. In Vizcaino v. Microsoft Corp., 120 F.3rd 1006 (9th Cir. 1997), the court addressed whether individuals working as “freelancers” for Microsoft should be considered employees for purposes of employee benefit plans. During an employment audit, the IRS determined Microsoft’s “freelance” workers were actually its common law employees. Microsoft agreed to pay back employment taxes and issue retroactive W-2s to the affected individuals. Some of the workers were offered employment as W-2 employees and others were “leased back” to Microsoft as employees of a leasing company. The plaintiff sought back benefits under a broad range of employee benefit plans, including Microsoft’s 401(k) plan and employee stock purchase plan (“ESPP”) under Section 423 of the Internal Revenue Code.

The Ninth Circuit Court of Appeals held that Microsoft’s reasons for rejecting the workers’ participation in the disputed plans (the claim that they were not employees) were invalid. The case was remanded to the district court to determine the rights of the workers to participate in the ESPP and 401(k) plans. The district court restated the case as which of the two companies was the worker’s employer—the client or the staffing firm? The court applied the following five-prong test “in determining whether a temporary employee is a common law employee of the client”:

(1) Whether the client or the agency recruited the worker;

(2) The extent of the training the client provides to the worker;

(3) The duration of the worker’s relationship with the client company;

(4) The client company’s right to assign additional projects to the worker; and

(5) Whether the client company may influence the relationship between the worker and the agency.

Ultimately, some employees were found to be employees of Microsoft for purposes of benefit participation. Based upon the criteria listed by the court, the client’s ability to direct and control the employee is a critical factor in determining whether an employment relationship exists between the user of the temporary employees and the temporary employee. The moral of the story: Don’t assume you don’t have employer responsibilities in relation to temporary employees. If you direct and control their work, you are an employer, too.

The Need for an Employment Agreement

Once an employer defines whether an employment relationship exists, the use of employment agreements is useful in managing the employment relationship. Employment agreements are commonly used for executive employees, commissioned sales people, and employees who have access to proprietary and confidential information. By memorializing the employment relationship in writing, expectations with respect to issues such as compensation, termination of the relationship, and applicable benefits will be well established. Avoiding differing expectations is the key to avoiding litigation.

At-Will Versus Just-Cause Employment

“At-will” simply means that an employee is free to terminate employment at any time, for any reason, with or without cause, and the employer retains the same rights. There is no guarantee of employment for any specific period of time. The at-will disclaimer is the single most important statement that assists in preventing litigation. On the other hand, “just-cause” employment requires that an employer have a reason to terminate an employee that a judge or jury may need to agree is a justifiable reason.

At-will employment is not an e-ticket to firing employees. The termination must still be based on a legitimate, non-discriminatory reason. However, at-will employment avoids the claim by an employee of guaranteed employment, and the risk of having a judge or jury decide the legitimacy of the termination decision. Many times this decision is based upon the skill level and experience of the employee in question.

Simply because an employee has an employment agreement does not mean that the employment agreement cannot provide for at-will employment as a term of the agreement. A clear at-will disclaimer needs to be included in the employment agreement. Many times the inclusion of at-will employment is not acceptable for executive level employees. Therefore, reasons for terminating the employment relationship, such as commission of a crime, unauthorized use of proprietary information, intentional misconduct or gross negligence, and failure to perform duties, should be included in the agreement.

Compensation

With respect to compensation terms, the employee’s salary, bonuses, commissions, stock options, and any severance pay should all be addressed in the employment agreement. Criteria, benchmarks, and formulas related to compensation should be set forth in quantifiable terms. With respect to commissioned sales people, the agreement must be clear that termination of the employment relationship terminates any rights to commissions. Cases in many states have found that commissions in relation to a particular customer procured by that employee continue beyond the employee’s employment unless it is specifically addressed in the agreement.

Termination

Any severance benefits to be provided to the employee upon separation of employment should be specifically addressed in the agreement. A clear formula or explanation for determining severance benefits should be coupled with triggers for paying or not paying severance pay. For instance, if an employee violates his or her duty of loyalty to the company by exposing confidential proprietary information, such act would lead to termination of the employment agreement and denial of severance benefits. On the other hand, an employee who is terminated due to poor business conditions may be offered severance pay and outplacement services.

Resolution of Disagreements

Finally, the inclusion of an alternative dispute resolution (“ADR”) procedure for resolving disagreements in relation to an employee’s separation from employment is proving to be a cost-effective measure. Many employers have adopted ADR plans that require employees to resolve any employment dispute through mediation or binding arbitration. A well-crafted ADR program can be very effective.

The terms of the ADR program must reflect a sense of fairness to the employee. Courts around the country are split on many of the issues. While the nuances of an ADR program are beyond the scope of this article, it is safe to say that the inclusion of an ADR program in an employment agreement that has been reviewed by employment counsel will serve the parties well.

Summary

Employment agreements are perfect for defining the employment relationship and establishing the expectations of all parties. Indeed, employment agreements are becoming more and more common for all levels of employees. Instead of leaving the determination of whether an employment relationship exists and how that employment relationship will be defined to fate, the employment agreement provides a clear summary of the expectation of the parties. By applying the clear terms of an employment agreement, unnecessary litigation can be avoided.

ABOUT THE AUTHOR

Ted N. Kazaglis, Esq. is an attorney with Kastner Westman & Wilkins LLC in Akron, Ohio. He specializes in employment issues, particularly those involving professional employer organizations and temporary staffing companies. He can be reached at TKazaglis@kwwlaborlaw.com.

riskVue | The webzine for risk management professionals
December 2005