Executive Termination – Planning for the End

There are some phrases that show up in contracts and simultaneously amuse me and remind me of the importance of careful legal drafting. One such phrase refers to the right of a company to “terminate the Executive” on certain grounds. After conjuring up images of Arnold Schwarzenegger in one of his most famous roles, I correct the language to say “terminate the employment of the Executive” or something like that.

But that’s not what this post is about. This post is about the need to differentiate between types of terminations and, indeed, types of resignations. Whether I am representing the company or the executive, I believe it is important to think in a disciplined manner about each such type and the consequences that should follow a termination or resignation of that type.

There are seven major ways in which an executive’s employment can end:

1. Expiration of the agreement;
2. Termination by the company “without Cause”;
3. Termination by the company “with Cause”;
4. Resignation by the executive “without Good Reason”;
5. Resignation by the executive “with Good Reason”;
6. Death of the executive; or
7. Disability of the executive.

Many readers may be familiar with the concept of “Cause” as a trigger for termination of employment. The key to drafting the ”Cause” definition is to determine the right language along three continua:

• how narrow (e.g., commit a crime) or broad (e.g., perform inadequately) the definition will be;
• how easy (e.g., Board decision) or difficult (e.g., court order) the trigger will be; and
• how soft (e.g., material breach) or hard (e.g., fail to achieve 25% growth in 2 years) the trigger will be.

To paraphrase a congressional aphorism, on these questions “where you stand depends on where you sit”.

The concept of “Good Reason” in termination provisions may be less familiar to some readers. Essentially, it is the flip side of “Cause” and forms the grounds on which an executive can terminate her employment with more favorable consequences than if she just quit for no reason. Common examples of “Good Reason” include salary reduction, demotion of position or diminution of responsibility, relocation, and the like.

In some cases, it is appropriate to hire an employee on an “at will” basis. An employment agreement can specify that the employment is at will, or it might be deemed to be the case (depending on state law) in the absence of an employment agreement. Either way, at-will employment effectively allows the company to fire the employee, or the employee to quit his employment, at any time with little or no notice and without any adverse consequences. In cases of at-will employment, the seven termination types above are not relevant.

For most executive employment relationships, however, things are not that simple. Rather, the company wants to know that it will have the long-term services of the executive, and the executive wants to know that she will have long-term job security. If either party’s long-term expectations are not met, certain meaningful consequences will follow.

Well, what can those consequences be? There are six major ones to consider:

1. Severance – payment of additional salary and/or anticipated bonuses for a period of time (perhaps in a lump sum) following the termination;
2. Bonuses – payment of past bonuses that have accrued but not yet been paid, and payment of current bonuses that have not yet formally accrued (fully at least);
3. Benefits - continuation of fringe benefits (at the company’s expense) such as insurance, automobile allowance, housing expenses, memberships in health clubs or country clubs, etc.;
4. Treatment of equity ownership or options – forfeiture of shares or options, accelerated vesting, buyback of shares (either at FMV or, in some cases, a discount or premium);
5. Treatment of restrictive covenants – especially any non-compete or non-raid/non-solicitation covenants; and
6. Other valuable matters in the specific employment agreement.

Without wanting to over-complicate matters, I believe it is useful to think about the seven types of terminations and the six types of consequences as a matrix, where you contemplate the reasonable answer for each box in the matrix one at a time. In a few agreements, I’ve included an actual matrix to set forth the rights, since that made them much easier to understand than the dense prose that normally appears in these sections.

One other feature that I’ve used effectively in some employment agreements, in appropriate cases, is to delineate two types of “Cause” (such as “Cause” and “Severe Cause”) and two types of “Good Reason” (such as “Good Reason” and “Severe Good Reason”). This feature should only be used when the substantial economics at issue warrant the extra complexity, but it can help to address the situation, for example, when a company would like to terminate an executive and stop paying his salary, and the executive is prepared to live with that but would not accept that such a termination would result in the forfeiture of the executive’s vested options.

While an elaboration of the arguments and counter-arguments with respect to each box in the matrix is beyond the scope of this post, they may be covered in a future post. In the meantime, readers are invited to make comments and ask questions about these topics on this page.

The Often-Signed, Rarely Read 'Confidentiality Agreement'

A confidentiality agreement is seldom a strategically important agreement. But you can make a strategically important mistake in signing one. The risk of this is exacerbated if you are among the droves of managers who sign confidentiality agreements (sometimes called non-disclosure agreements, or NDAs) without really reading them.

Here’s the key risk:  some confidentiality agreements, especially those offered up by potential business partners, will contain restrictions on your engaging in a competitive business (a ‘non-compete’) or on your soliciting or hiring employees, customers, suppliers, etc. (a ‘non-raid’). If you do nothing else before signing a confidentiality agreement, check to see if it contains one of these extraordinary restrictions.

Such restrictions are rarely appropriate at the early stage of discussions when the confidentiality agreement is signed. One exception may be where a seller is nervous about introducing a potential buyer to the seller’s key employees unless a non-raid is put in place. In that case or other unusual cases, it is important to carefully tailor the language to the specific circumstances so as not to be overly broad and restrictive. And, the document should be renamed — in my opinion, it is never appropriate to include a ‘non-compete’ or ‘non-raid’ in a document that only has ‘confidentiality’ in the title.

What else should you look for in a confidentiality agreement? While I’ll answer that question, first let me say that these agreements are both (1) usually impractical to enforce and (2) often used for information that isn’t truly confidential. The net result is that, in most cases, I think of these documents as good faith expressions of intent rather than legally enforceable agreements. (If you’re holding the Coca-Cola formula or some other highly valuable trade secret, this doesn’t apply to you.) Nevertheless, as a lawyer I have to focus on the details too (the devil often being in them):

• Check the survival period. Many confidentiality agreements say they expire after some number of years (e.g., 1, 2 or 3 years). Frankly, if you’re the recipient of information, that works to your advantage. However, I believe that most confidentiality agreements should not have an express time limit, because there is already the natural time limit of ‘as long as the information is confidential’. If you believe your business plan is confidential, I’m sure you wouldn’t be happy to see it published in the Wall Street Journal a year or even two years later. But that is exactly what an expiration date would permit. Note that there should never be an expiration date if you are disclosing true trade secrets.
• Consider whether you have to explicitly mark information as confidential (and explicitly summarize in writing any confidential information disclosed orally) in order for it to be treated as confidential. I usually try to avoid that requirement (especially when representing the discloser of information), instead relying on the broader, though admittedly tautological and vague, designation of all confidential information as confidential. Legally, information that is explicitly marked will be more protectable, but I am more concerned about (1) the practical reality that people will forget to mark all relevant information as confidential and (2) the implication that unmarked information is somehow ‘fair game’.
• Make sure the usual carve-outs to the definition of confidential information appear. Essentially, these say that information in the public domain, information you already possessed, information you receive later from someone else, and information you create on your own, are not considered confidential information under the agreement.
• Make sure you are expressly permitted to disclose information if required by law (e.g., government or court order). While many agreements contain this exception, they often add that you first have to notify the other party. Try to modify that language by adding ‘if permitted by law’, since you may be prohibited from telling the other party they are under investigation.
• Consider your future obligation to give back the confidential information. I try to avoid an automatic obligation to return the information at some later date (e.g., if a deal doesn’t take place), and instead give the other party the right to request it back. The main reason is that, in practice, information is rarely actually returned, and I prefer that my agreements not say things that I know will not occur. Also, you should ask for the right to destroy the information rather than give it back, particularly with respect to your own work product (e.g., notes, memos, etc.) that contain confidential information (as opposed to the original information that the other party delivered to you). Furthermore, you may want to carve out exceptions for archival copies (e.g., electronic backups that are difficult to purge) or copies held in your lawyer’s or accountant’s office.

One final, practical suggestion:  if you are going to sign the other party’s form of confidentiality agreement, it is better to sign their ‘mutual’ form rather than their ‘one-directional’ form — even if you will not be disclosing any significant confidential information to them. Besides the fact that you may end up disclosing some confidential information to them, it is also likely that their mutual form will be more balanced and reasonable in its specifics.

The ‘Non-Competition’ Covenant

Non-competition provisions appear in several different types of agreements, including employment agreements, consulting agreements and acquisition agreements, among others. Most attorneys and clients recognize that the basic issues to negotiate are the scope, territory and duration of the non-compete.

What I think is often overlooked is the practical reality that the very existence of the non-compete can greatly harm a client’s interests. There are at least two reasons for this.

• First, in case of any question about whether a particular activity would violate the non-compete, the client may need to steer clear of the activity because he or she cannot accept the risk of undertaking the activity. Note that the issue may not be tested until the allegedly competitive activity has proven successful, and both the recipient and the maker of the non-compete have a lot to win or lose (respectively).
• Second, the existence of a non-compete must be disclosed to any subsequent contracting party. That new party may hesitate to enter into a contract with someone who is subject to a non-compete that might apply, for fear of being charged with ‘tortious interference with contract’ or some such claim. In that way, even if the client would prevail in a court case interpreting the non-compete, he or she has suffered in practice because of the chilling effect of the threat.

Obviously, non-competes are required by contracting parties in many circumstances, so avoiding one altogether typically is not realistic (though that doesn’t mean I wouldn’t try). At a minimum, however, clients giving a non-compete should insist on defining the scope as narrowly and clearly as possible. The proper mindset is to assume that only things clearly outside the non-compete are okay, as opposed to thinking that only things clearly inside the non-compete will be prohibited (in court the reverse may be true, but in practice the fear is as big a problem as the ultimate conclusion). It is generally not advisable to rely on the fact that ‘both parties really know what it means’ or that an overly broad non-compete will not be enforceable. By the time it comes to that, the damage will already have been done.

The ‘Notices’ Provision

This section is often given short shrift by lawyers and clients alike. However, it can be quite meaningful. Three key issues to consider are (1) the method or methods by which notices must be sent, (2) the time at which notices are deemed to be effectively given, and (3) who should be copied on the notices besides the primary contact (e.g., legal counsel).

Many Notices provisions will permit notices by first class mail, fax and sometimes email. That’s okay for unimportant notices. But, in circumstances where a notice can have dramatic importance (for example, a money release demand under an escrow agreement), I wouldn’t want my client’s money hinging on whether they saw and acted on a regular letter, fax or email. Rather, I prefer to require that important notices be sent by overnight courier or perhaps registered or certified mail. My sense is that FedEx packages or certified letters are treated with more urgency than more ordinary forms of communication. The key is to ensure that the client doesn’t inadvertently lose a right.

Regarding the time at which notices are deemed to be effectively given, there are two main considerations:  (a) should notices be deemed to be given only if actually received, or upon some stated number of days after sending? (note that the ‘right’ answer depends on the client and the context); and (b) is the number of days provided for realistic? (e.g., one business day for courier packages sent overseas is typically insufficient).

In addition, the manner by which notices are given must dovetail properly with the nature and timing of the provisions requiring notice. For example, if a party has “5 days after notice” to take action, and the Notices provision says that notices are deemed to be given upon deposit in the U.S. mail, it is quite possible that 2 or 3 days of the 5-day period will elapse before the party actually receives the notice (thereby reducing the actual response period to only 2 or 3 days).

One other consideration, usually addressed in the applicable contract sections, is the required content of notices. For example, it is worthwhile to indicate that ‘breach of contract’ notices specify in detail the nature of the breach and the remedy requested by the party giving notice. Similarly, it may be desirable to provide that ‘right of first refusal’ notices must disclose the proposed buyer’s identity as well as just the proposed price. In both cases, the extra information may be quite relevant and valuable, yet would not clearly be required in the absence of a specific clause.