Executive Contracts: Ties that Bind

Third Quarter 2012
Corporate Board Member
by Charles Keenan

Corporate Board Member recently interviewed Laura O’Donnell, partner, Haynes and Boone LLP, to talk about the current corporate landscape for executive retention and what boards should know when evaluating executive contracts.

Executive contracts have become the norm for just about all hires at the executive level. How does a company determine how far down the line to go with these agreements?
The general practice is to limit employment agreements to executives. Companies will, however, consider agreements for employees who are farther down the line when 1) offering a period of guaranteed employment is necessary to recruit a valuable nonexecutive employee or 2) when a business sale is conditioned on the buyer entering into the agreements. In addition, companies often require sales and management employees who have access to confidential information to sign noncompetition agreements, but these agreements are typically not tied to a guaranteed period of employment.

Is there such thing as a “typical” agreement? 
Every employment agreement is unique but in addition to compensation information, some of the “typical” clauses include severance provisions, reasons why a company would have “cause” to terminate the employee without paying severance, reasons why the employee would have “good reason” to resign and still receive severance, noncompetition covenants, and nonsolicitation covenants.

When is it important to include a noncompete clause?
If the employee has access to sensitive, confidential information or if the employee’s identity is connected with the business’s goodwill, which often happens in the context of a sale of the business, a noncompete is appropriate. Remember that noncompetes are only permissible if they are designed to protect a legitimate business interest, such as confidential information/trade secrets, business goodwill, or stock options.

As a good governance practice, what aspects of an executive contract should make it to the board level for review and approval? 
The board should be apprised of all of the key terms in any executive agreement and should have the opportunity to both review and approve these terms. The board should be specifically informed about the salary, bonuses, or other forms of potential income to the executive, the contract term, any renewal provisions and whether they are automatic or require some affirmative action, the amount of severance, any perquisites, the restrictive covenants, and anything unique to the particular executive agreement under review.

How can an outside adviser or the general counsel help guide the board to ensure such agreements are not opening the company up to potential risk?
The board should be advised of any substantive ways in which the agreement under consideration differs from other executive agreements. It is also essential that the board fully understand the potential income to the executive, including stock and stock options, and the potential severance that the company would owe if things don’t work out but there is no “cause” to terminate. Finally, the board needs to completely understand the restrictions on the executive in terms of noncompetition, nonsolicitation, and similar clauses (in other words, how the company is protected) in case he or she leaves the company.

Related articles:
Human Capital: Leveraging Your Company’s Greatest Asset
HR Analytics, In Search of a Standard

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