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10 Mistakes Employers Make When Dealing With Executives and Other Key Employees

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10 Mistakes Employers Make When Dealing With Executives and Other Key Employees

 

 

 

Jeffrey B. Oberman
Oberman Thompson, LLC
Canadian Pacific Plaza
120 South Sixth Street, Suite 1700
Minneapolis, MN 55402
Telephone: 612-217-6441
joberman@obermanthompson.com

BUSINESS LAW INSTITUTE

Minnesota State Bar Association
Continuing Legal Education

May 7-8, 2013

THESE MATERIALS ARE PROVIDED FOR EDUCATIONAL AND INFORMATIONAL PURPOSES ONLY. THEY ARE NOT INTENDED TO CONSTITUTE LEGAL ADVICE IN ANY PARTICULAR SITUATION.

© 2013 by Jeffrey B. Oberman

TABLE OF CONTENTS
        Page

INTRODUCTION………………………………………………………………………2

1. MISSING THE WIN-WIN: FAIRNESS, TRANSPARENCY
AND RESPECT………………………………………………………………………2

2. CREATING UNINTENDED CONTRACT DISPUTES………………………….2

3. MISSING OPPORTUNITIES TO GET AGREEMENTS
AND PROTECTIONS………………………………………………………………..5

4. LACK OF PLANNING AND AGREEMENTS FOR A POSSIBLE
ACQUISITION: CHANGE OF CONTROL OR SUCCESS FEE
PROVISIONS…………………………………………………………………………8

5. LACK OF PATIENCE AND ATTENTION TO DETAILS;
MISUSING FORMS AND BOILER PLATE……………………………………….8

6. OVERLY AGGRESSIVE NON-COMPETE PROTECTIONS……………….13

7. FAILING TO DETER VIOLATIONS AND PRESERVE
NON-COMPETE PROTECTIONS………………………………………………..15

8. CREATING BONUS AND COMMISSION DISPUTES………………………18

9. CREATING UNNECESSARY OWNERSHIP AND
FIDUCIARY OBLIGATIONS ………………………………………………………21

10. MISSING TAX ISSUES……………………………………………………….23

CONCLUSION ……………………………………………………………………..24

INTRODUCTION

This article and presentation will address 10 common mistakes made by employers when dealing with executives and other key employees. It is not intended to be an all-encompassing summary of any particular legal topic. Rather, it is intended to provide examples to help employers avoid common traps and missed opportunities and maintain good and cooperative relationships with their executives and other key employees – before, during and after the employment relationship.

1. MISSING THE WIN-WIN: FAIRNESS, TRANSPARENCY AND RESPECT

Successful executives and other key employees have many options. Employers often fail to recognize that and miss opportunities to hire them, manage to their strengths, retain them or obtain valuable business protections from them. Employers should focus on getting these key people to join the team, be part of the team and, if they do leave, not hurt the team.

These employees want a win-win. If they do not believe that they are being treated fairly, respectfully and transparently, they are unimpressed at best, and may take great offense – leading them to pursue other options. For example, the following situations may lead to undesired consequences:

• Having the wrong person negotiate the key business terms (which should be expressly subject to a more formal written offer or agreement).

• Trying to negotiate the best deal for the employer, rather than a fair deal for both.

• Making an offer and then following up in writing with different or new important terms that were not mentioned.

• Presenting overly aggressive, unfair and one-sided legal agreements (employment agreements, non-compete agreements, incentive plans, phantom stock plans, bonus or commission plans and more).

• Managing by heavy handed directives rather than collaboration or allowing negative office politics to damage career paths.

• Making last minute (e.g. the day before the closing of an acquisition), rushed demands that they sign agreements, which could have been provided to them far earlier or – worse yet – had been promised to them months earlier.

Any of these situations can lead to direct competition for employees or customers and/or litigation. All of them can easily be avoided.

2. CREATING UNINTENDED CONTRACT DISPUTES

Employers are well aware that a formal employment agreement creates binding contractual obligations. They may not realize, however, that many other situations can create contractual obligations and alleged breaches. General contract law formation principles (communication of a specific and definite offer, acceptance and consideration), when applied to the employment world, can create many interesting – and often unintended – controversies.

A. Oral Employment Contracts

Employment offers and agreements should always be in writing, and clearly state the agreed terms. Most communications during the recruiting and application process are oral. Unfortunately, many of the oral commitments never make it to a written agreement. Many believe that if it is not in writing there is no deal. That is not necessarily the case. Oral offers can create legally binding agreements. Regardless, if the oral offer is different from the written offer, it will create misunderstandings and distrust.

Oral offers or promises can create binding contractual obligations. Skagerberg v. Blandin Paper Co., 266 N.W. 872 (Minn. 1936); Riley Bros. Constr., Inc. v. Shuck, 704 N.W.2d 197, 203 (Minn. Ct. App. 2005). Minnesota courts have held that the law does not distinguish between contracts that are expressed in writing, that are verbal, that are completed by action or that combine all three forms of acceptance. Georgens v. Federal Deposit Ins. Corp., 406 N.W.2d 95, 97 (Minn. Ct. App. 1987).

Many oral contract claims turn on the general question of whether there was a “meeting of the minds.” In the employment context, the issue is often whether employment is guaranteed for a specific period of time, but the same principles apply to other oral commitments. The Minnesota Supreme Court long ago held that an employer’s oral promise of “permanent” employment might be an enforceable contract. Skagerberg v. Blandin Paper Co., 197 Minn. 291, 266 N.W. 872 (Minn. 1936). However, to sustain this claim, the employee must prove that there was a specific and definite offer, which was communicated and accepted by the employee. Thompson v. Campbell, 845 F. Supp. 665 (D. Minn. 1994); Schibursky v. International Business Machines Corp., 820 F. Supp. 1169 (D. Minn. 1993); Pine River State Bank v. Mettille, 333 N.W.2d 622 (Minn. 1983).

Even if there was a specific and definite oral offer, which was communicated and accepted by the employee, oral contract claims must avoid the statute of frauds, which bars enforcement of certain types of oral contracts. The statute of frauds provides that no action shall be maintained upon any “agreement that by its terms is not to be performed within one year from the making thereof” unless the agreement is in writing. Minn. Stat. Ann. § 513.01; See Amann v. Allianz Income Management Services, Inc., No. A09-1891, 2010 WL 3220061, at *2 (Minn. Ct. App. April 14, 2010). “The test is simply whether the contract by its terms is capable of full performance within a year, not whether such occurrence is likely…If either party to a contract can fulfill their obligation within a year, the statute of frauds does not apply.” Id. This can be a low bar, since the possibility of death or other employment departures within a year will often satisfy the statute of frauds. Eklund v. Vincent Brass and Aluminum Co., 351 N.W.2d 371, 375-76 (Minn. Ct. App. 1984); Bussard v. College of St. Thomas, Inc., 200 N.W.2d 155, 161 (Minn. 1972); Bolander v. Bolander, 703 N.W.2d 529, 547 (Minn. Ct. App. 2005).

B. Unintended Unilateral Contracts

Employee handbooks and other policies and procedures, if not carefully drafted, may create an employment contract between employers and employees. E.g., Pine River State Bank v. Mettille, 333 N.W.2d 622 (Minn. 1983); Feges v. Perkins Restaurants, Inc., 483 N.W.2d 701 (Minn. 1992).

In Pine River, the Minnesota Supreme Court distinguished between a specific and definite offer (enforceable as a contract), and a general statement of policy (not enforceable as a contract). The court identified four factors required for a provision in a personnel manual to be enforceable as a unilateral contract: (1) an offer which is sufficiently definite and specific, and not merely a general statement of policy; (2) communication of the offer to the employee; (3) acceptance of the offer; and (4) consideration. Pine River at 622 (Minn. 1983).

Since Pine River there have been many additional cases interpreting when an employee handbook may or may not be deemed to be a contract. See, e.g., Lindgren v. Harmon Glass Co., 489 N.W.2d 804, 810 (Minn. Ct. App. 1992), rev. denied; Hunt v. IBM Mid America Employees Federal Credit Union, 384 N.W.2d 853, 857 (Minn. 1986); Dumas v. Kessler & Maguire Funeral Home, Inc., 380 N.W.2d 544, 546–47 (Minn. Ct. App. 1986); Martens v. Minnesota Min. & Mfg. Co., 616 N.W.2d 732 (Minn. 2000).

For purposes of this article, let it suffice to say that any number of unilateral “promises” in employee handbooks or elsewhere by an employer may end up being interpreted as contractual obligations. To help avoid such claims, employers should put disclaimers in handbooks, policies, and procedures, verifying that they supersede prior handbooks, policies and procedures on the same topic; that they are general guidelines and not contracts; that there are no employment contracts unless in writing and signed by designated officers; and that the employer has the right to unilaterally make change.

C. Implied Employment Contracts; Promissory Estoppel

Contracts may also be implied from other circumstances, including course of dealing, usage of trade, or course of performance. See Minn. Stat. § 336.1-201(3) (defining “agreement”); Moga v. Shorewater Advisors, LLC, No. A08-785, 2009 WL 982237, at *4 (Minn. Ct. App. April 14, 2009) (“Not only are the words and actions of the parties relevant, but ‘the surrounding facts and circumstances in the context of the entire transaction, including the purpose, subject matter, and nature of it’ may also be considered”) (citation omitted).

Even in cases where an employment contract did not exist at all, Minnesota courts have recognized the doctrine of promissory estoppel, where the courts implied the existence of a contract. Promissory estoppel is “a creature of equity which implies ‘a contract in law where none exist in fact.’” Ruud v. Great Plains Supply, Inc., 526 N.W.2d 369, 372 (Minn. 1995), quoting Grouse v. Group Health Plan, Inc., 306 N.W.2d 114, 116 (Minn. 1981).

The doctrine of promissory estoppel provides: “[a] promise which the promisor should reasonably expect to induce action or forbearance on the part of the promisee or a third person and which does induce such action or forbearance is binding if injustice can be avoided only by enforcement of the promise.” Faimon v. Winona State University, 540 N.W.2d 879, 882 (Minn. Ct. App. 1995) (citation omitted). The elements of a claim for promissory estoppel in the employment context are: (1) the employer made a promise; (2) the employer expected or reasonably should have expected the promise to induce definite and substantial action by the employee or potential employee; (3) the promise induced such action; and (4) the promise must be enforced to avoid injustice to the employee or potential employee. Martens v. Minn. Mining & Mfg. Co., 616 N.W.2d 732, 746 (Minn. 2000); Cohen v. Cowles Media Co., 479 N.W.2d 387, 391 (Minn. 1992); Grouse v. Group Health Plan, Inc., 306 N.W.2d 114, 116 (Minn. 1981).

Generally, the promissory estoppel theory is not available when a contract exists. Gorham v. Benson Optical, 539 N.W.2d 798, 801 (Minn. Ct. App. 1995). There is an exception, however, in the case of at-will employment contracts. An at-will employee may assert a claim for promissory estoppel when the employee leaves one job in reliance on another at-will employment offer, and the new employer revokes the offer before the employee can perform. Spanier v. TCF Bank Sav., 495 N.W.2d 18, 20 (Minn. Ct. App. 1993); see also Grouse v. Group Health Plan, Inc., 306 N.W.2d 114, 116 (Minn. 1981); Lewis v. Equitable Life Assur. Soc. of the U.S., 389 N.W.2d 876, 882–83 (Minn. 1986); Eklund v. Vincent Brass and Aluminum Co., 351 N.W.2d 371, 374 (Minn. Ct. App. 1984).

The promissory estoppel doctrine can also apply to situations other than promises of employment. For example, the court applied it to enforce an employer’s promise to pay commissions to a former employee based on pending sales, as long as the employee helped transition the accounts to other sales representatives before leaving. Fiebelkorn v. IKON Office Solutions, Inc., 668 F.Supp.2d 1178, 1186 (D. Minn. 2009).

3. MISSING OPPORTUNITIES TO GET AGREEMENTS AND PROTECTIONS

It is surprisingly common for employers (intentionally or due to lack of time or focus) to avoid or postpone implementing written agreements with their executives and other key employees. This can lead to devastating consequences. For example, this author has seen dozens of situations where key people – who had never been asked to sign a non-compete agreement – have left employers to work for or start directly competitive businesses; and dozens of key employees who were critical to mergers and acquisitions, but had not been incentivized to go with the deal or prohibited from competing with the new entity.

A. Getting Employment Agreements Up Front

Despite the reasons why many employers may want to avoid employment agreements with executives and other key employees, there are more reasons why employers should enter into such agreements, or will benefit from having them. For example:

1. Market Forces. Many executives and key employees have other options, and are in high demand. They may not be willing to accept employment without contractual commitments.

2. Lock in Commitments. Although no agreement can force an employee to stay for a minimum period, employment agreements can offer incentives for people who stay for or disincentives for those that resign before, a designated period of time.

3. Incentives. Most executives and key employees are highly motivated to perform. Incentive packages in agreements can direct their energies toward desired goals.

4. Minimize Exposure, Expenses and Threats. A well drafted agreement can clarify and memorialize what is and what is not required by the parties – before, during and after the employment relationship. In addition to asserting contract-related claims, a disgruntled former executive or other key employee can create a tremendous threat to the employer – from a legal perspective, a business threat perspective, and a public relations perspective (within the company, the industry and/or the public at large). These employees often have knowledge of trade secrets and other confidential information; have knowledge which could help or hurt the company in the event of disputes with third parties; develop relationships with other employees (e.g., an entire sales force), who might “follow their leader;” develop relationships with customers who might also follow them; and can create a great deal of harmful discussions within the company, the industry, among customers, and in the media. An employment agreement can address all of these issues. It can also take the guess work and risks out of negotiations. Both parties can and should know their rights and obligations and make their decisions accordingly.

5. Planning for a Later Acquisition. The employer is in a better position to negotiate a change of control or success fee provision of some sort if it is doing so without the actual event looming overhead. If it has not done so, it may later find itself in a very bad negotiating position.

B. Proper Timing and Implementation of Non-Compete Agreements

Many defenses to non-compete agreements result from improper implementation of an otherwise legitimate and enforceable non-compete agreement. Administrative errors are common, often caused by treating the non-compete as “just another form.” This can nullify a non-compete agreement. Even if a non-compete agreement is by its terms reasonable and appears to be enforceable, it may fail for lack of sufficient consideration. The validity of consideration can depend on when it was offered to the employee.
1. Non-Compete Agreements Prior To Hire. The best time to get a signed non-compete agreement is up front. Employers should make the job offer in writing, expressly contingent on the signing of the non-compete; give the employee the non-compete agreement at the time of the offer; and make sure the acceptance of the job offer and the non-compete agreement are signed, received and preserved BEFORE employment begins.

Generally, Minnesota law treats the employee’s new job as sufficient consideration for a non-compete agreement so long as it is entered into at the commencement of the employment relationship. It is not enough for the employer to give the employee notice about the non-compete agreement without actually presenting it prior to or in tandem with the job offer. Nat’l Recruiters, Inc. v. Cashman, 323 N.W.2d 736, 740 (Minn. 1982); Davies & Davies Agency, Inc. v. Davies, 298 N.W.2d 127, 133 (Minn. 1980). Even if an employee has not physically begun to work, but has already accepted an offer of employment, a non-compete agreement following the original offer of employment cannot be enforced absent independent consideration. Sanborn Mfg. Co. v. Currie, 500 N.W.2d 161 (Minn. Ct. App.1993).

2. Mid-Stream Non-Compete Agreements. A non-compete agreement executed after an employee has commenced employment is unenforceable unless supported by “independent consideration.” Jostens, Inc. v. Nat’l Computer Sys., Inc., 318 N.W.2d 691, 703 (Minn. 1982). Independent consideration consists of real benefits that are bargained for between the employee and the employer. “Real benefits” mean more than those to which the employee is already entitled to by virtue of employee status or a separate contract. Sanborn, 500 N.W.2d, at 161. Continued employment is not sufficient consideration for a non-compete agreement. Nat’l Recruiters, Inc. v. Cashman, 323 N.W.2d 736, 740 (Minn. 1982).

a. Benefit-Related Agreements. In recent years, more employers are conditioning mid-stream or post-termination benefit agreements (for stock grants and options, bonuses, change of control benefits, severance benefits and other incentives) on the execution of non-compete agreements. The written benefits plan and all related agreements should expressly state that the benefits are conditioned on the non-compete. If an employee refuses to sign the non-compete, the employer should NOT give that employee the benefits.

To satisfy the independent consideration requirement, a critical step is distinguishing clearly between employees who sign non-compete agreements and those who do not. Otherwise, the alleged “independent consideration” may be illusory. Freeman v. Duluth Clinic, Inc., 334 N.W.2d 626 (Minn. 1983); BFI-Portable Services. Inc. v. Kemple, No. C5-89-1172, 1989 WL 138978 (Minn. Ct. App. Nov. 21, 1989).

Also, a benefit plan that allows but does not require an employer to provide benefits to an employee may not be sufficient consideration for the non-compete agreement, because it was “unilateral” and could not be enforced. Softchoice, Inc. v. Schmidt, 763 N.W.2d 660 (Minn. Ct. App. 2009) (applying Missouri law). On the other hand, one Minnesota federal district judge has commented in dicta that whether an employee “actually received the stock options is of no moment. By signing the … Agreement, [the employee] was made eligible for a benefit he could not have received without signing the Agreement. Thus, the . . . Agreement is valid.” Universal Hosp. Servs., Inc. v. Hennessey, No. Civ.01-2072, 2002 WL 192564 (D. Minn. Jan. 23, 2002). This language appears to suggest that the decline in value of stock options, even to a point where they are “underwater,” would not affect the enforcement of a non-compete agreement.
b. Promotions. A promotion to a higher position with more authority and responsibility is generally viewed as adequate consideration. Guidant Sales Corp. v. Baer, No. 09-CV-0358, 2009 WL 490052, at *2 (D. Minn. Feb. 26, 2009); cf. Davies & Davies Agency, Inc. v. Davies, 298 N.W.2d 127, 131 (Minn. 1980). However, the employer should make it clear, in writing, that the promotion is expressly conditioned on the non-compete, and tie them together. The employer should NOT put the promotion into effect until after the non-compete agreement is signed and returned. The timing of the promotion and the signing of the agreement is critical. If an employee is promoted prior to signing the non-compete agreement, then the promotion cannot serve as consideration for the agreement. See Sheehy v. Bodin, 349 N.W.2d 353, 354 (Minn. Ct. App.1984).

4. LACK OF PLANNING AND AGREEMENTS FOR A POSSIBLE ACQUISITION: CHANGE OF CONTROL OR SUCCESS FEE PROVISIONS

Change of control and success fee provisions are rarely offered to executives or other key employees. This can ultimately hurt the employer. For example, this author has seen dozens of situations where employers wanted to sell some or all of their businesses, but did not address the key employees’ issues in advance. In many of these cases, the employees did not have non-compete agreements or had non-compete agreements that could not be assigned (or could not be assigned without the employee’s permission). Then, at the last minute (typically within a week before the closing), the employer sprang non-competes and other agreements on the key people, telling them they had to sign or the deal would not go through. Many of these employees were not told to get their own counsel, and some were encouraged by the seller’s counsel to sign.

This approach can cause considerable resentment. It can also put the key people in a unique bargaining position. Many mergers and acquisitions will not take place unless the key employees go with the deal and then stay with the new entity – at least through any needed transitional period – and agree not to compete with the business for a period of time after the transaction . If the key employees are unwilling to make it work, it likely won’t work.

If the whole deal goes through – to the enormous benefit of the selling employer – key individuals (who are taking major risks of not liking or losing their jobs after the transition) often demand to benefit as well from the deal. This opens up a new round of high-stakes negotiations At that point, most employers regret not getting an agreement earlier.
Employers can proactively anticipate this situation and reach change of control or success fee agreements (along with non-compete agreements) with the key people long before a transaction is even being discussed. Employers who do this will generally get a much more favorable deal than the one they end up making by waiting until the last minute.

5. LACK OF PATIENCE AND ATTENTION TO DETAILS; MISUSING FORMS AND BOILER PLATE

When it comes to employment contracts, especially with executives and other key employees, the adage that an “ounce of prevention is worth a pound of cure” is fitting. Most litigation over employment and ownership disputes can be avoided, or at least resolved quickly and relatively inexpensively, if there is a well written, clear contract that addresses the issue. Sloppy, hurried work, and thinking that it is “only a form,” often lead to litigation; and the litigation, win or lose, can become an employer’s nightmare.

A. Existence of Contract is a Jury Question

As noted above, employers often enter into binding contracts with employees without realizing they are doing so. To complicate matters more for employers, the existence of a contract is ultimately a question of fact to be decided by the trier of fact – typically a jury. Lakeview Terrace Homeowners Ass’n v. Le Rivage, Inc., 498 N.W.2d 68, 72 (Minn. Ct. App. 1993). Also, the construction and terms of implied contracts are questions of fact. Stubbs v. North Memorial Medical Center, 448 N.W.2d 78, 82 (Minn. Ct. App. 1989).

B. Parol Evidence Rule may Allow Extrinsic Evidence

The parol evidence rule “prohibits the admission of extrinsic evidence of prior or contemporaneous oral agreements, or prior written agreements, to explain the meaning of a contract when the parties have reduced their agreement to an unambiguous integrated writing.” Alpha Real Estate Co. of Rochester v. Delta Dental Plan of Minnesota, 664 N.W.2d 303, 312 (Minn. 2003) (citation omitted). “Accordingly, ‘when parties reduce their agreement to writing, parol evidence is ordinarily inadmissible to vary, contradict, or alter the written agreement.’” Id.

However, “[i]f it appears from the circumstances surrounding the case that the parties did not intend the agreement to be a complete integration, then parol evidence can be used to prove the existence of a separate consistent oral agreement…Where a written agreement is ambiguous or incomplete, evidence of oral agreements tending to establish the intent of the parties is admissible.” Id.; See also, Redman v. Sinex, 675 F. Supp.2d 961, 965 (D. Minn. 2009).

C. Ambiguous Contracts Create a Litigation Minefield

Employers should unambiguously document any commitments, or lack of commitments, regarding terms and conditions of employment; and avoid intentionally or inadvertently making promises that it might not be willing or able to keep.

A contract is ambiguous if it is susceptible to more than one interpretation. Lamb Plumbing & Heating Co. v. Kraus-Anderson of Minneapolis, Inc., 296 N.W.2d 859, 862 (Minn. 1980). In the employment context, and particularly given the number of contract claims that are based on documents or promises that are not contained in formal written agreements, ambiguity is common. This can create a litigation minefield.

Whether a contract is ambiguous is a question of law. However, if the court determines that a provision in an employment agreement is ambiguous – and many are – parol evidence may be considered to determine the parties’ intent. Dykes v. Sukup Mfg. Co., 781 N.W.2d 578, 582 (Minn. 2010). This is a question of fact, and therefore a jury issue – and there are many facts for the jury to consider:

1. Mutual Intent. Every contract, whether written or oral, must be interpreted to give effect to the parties’ mutual intent when they made the contract. See, e.g., Travertine Corp. V. Lexington – Silverwood, 683 N.W.2d 267, 271 (Minn. 2004); Motorsports Racing Plus, Inc. v. Arctic Cat Sales, Inc.,666 N.W.2d 320, 323 (Minn. 2003); Art Goebel, Inc. v. North Suburban Agencies, Inc., 567 N.W.2d 511, 515 (Minn. 1997); Northwest Bank Minnesota North, N.A. v. Beckler, 663 N.W.2d 571, 578(Minn. Ct. App. 2003); State v. City of Brezzy Point, 394 N.W.2d 592, 596 (Minn. Ct. App. 1986).

2. Words and Conduct. “A manifestation of mutual assent ‘may be inferred wholly or partly from words spoken or written or from the conduct of the parties.” Cederstrand v. Lutheran Brotherhood, 117 N.W.2d 213, 221 (Minn. 1962). See also, Minneapolis Cablesytems v. Minneapolis, 299 N.W.2d 121, 122 (Minn. 1980); Bergstedt, Wahlberg, Berquist Associates, Inc. v. Rothchild, 225 N.W.2d 261, 263 (Minn. 1975); Riley Bros. Constr., Inc. v. Shuck, 704 N.W.2d 197, 202 (Minn. Ct. App. 2005) (citation omitted). The test is whether “one party by his words or by his conduct, or by both, leads the other to reasonably assume that he assents to and accepts the terms of the other’s offer.” Holt v. Swenson, 90 N.W.2d 724, 728 (Minn. 1958). See also Bergstrom v. Sambo’s Restaurants, Inc., 687 F.2d 1250, 1256 (8th Cir. 1982); Bergstedt, Wahlberg, Berquist Associates, Inc. v. Rothchild, 225 N.W.2d 261, 263 (Minn. 1975).

3. Negotiations. The parties’ negotiations may be considered in determining their mutual intent. Donnay v. Boulware, 144 N.W.2d 711, 716 (Minn. 1966).

4. Course of Performing and Dealing. The parties’ conduct in the course of performing the contract may be considered in determining their mutual intent. Fredrich v. Indep. Sch. Dist., 720, 465 N.W.2d 692, 696 (Minn. Ct. App. 1991); J.J. Brooksbank Co., Inc. v. Budget Rent-A-Car Corp., 337 N.W.2d 372, 375-76 (Minn. 1983); Telex Corp. v. Data Prods. Corp., 135 N.W.2d 681 (Minn. 1965).

D. Examples of Common Disputes in Executive and Key Employee Employment Agreements

This section will highlight examples of provisions in employment agreements, which if not carefully and clearly drafted can lead to misunderstandings and costly disputes. All of these disputes can be avoided with careful and clear drafting.

1. Recitals. Recitals are often erroneously viewed as insignificant “boilerplate.” Vague or incorrect recitals can lead to disputes, ambiguity determinations and expensive trials.

2. Inconsistencies with Policies and Benefit Plans. It is often unclear whether the terms and conditions of an employment policy or benefits plan trump the terms of an inconsistent agreement, particularly in the context of bonuses, severance provisions or equity grants. For example, many agreements fail to state that the severance commitment is subject to the terms and conditions of a separate severance plan. Is the benefit in addition to the plan? Trumped by the plan? Replaced by the plan?

3. Titles and Duties. Seemingly innocent descriptions of titles and duties can lead to disputes. A disenchanted executive may claim breach of contract, claiming the employer changed his/her title and/or duties. Similarly, many agreements carefully set out in the body of the agreement, or in a separate exhibit, the exact, detailed duties that are expected. That type of specificity can create problems because detailed job descriptions are rarely kept current.

Generally, this section should not create the possibility of having later good faith changes constitute a breach, or otherwise give a disenchanted and/or terminated executive an opportunity to claim that he or she should not be obligated to perform his/her post-termination obligations (non-compete, anti-solicitation, etc.). Employers should try to keep the title and/or duties flexible, so they may be changed from time to time by the employer’s appropriate representatives (e.g., the CEO, the board of directors, etc.). It should be noted, however, that many executive employment agreements clearly do – because that is the intent – identify that the executive will serve in a specific capacity throughout the term of the agreement “unless mutually agreed” otherwise. A good compromise is to have language that ensures that, if the duties or titles are materially reduced, it may give the executive grounds to resign for “good reason.”

4. Term of Employment. Many employment agreements refer to the “Term of the Agreement.” This can lead to disputes. One or both parties may want it to be clear that only the “Term of Employment” (and related obligations during employment) has a term; not the agreement itself. Termination of the “Agreement” could inadvertently terminate post-termination business protections for the employer or post-termination rights of the executive.

The agreement should clearly state the term, rather than risk vagueness or ambiguity, even if there is no intention to have an agreement for a particular period of time. There are several options here, including the following: No Term at All; “At Will” Relationship: Initial Term with Anticipated Renewals; and Specific Period of Time. Each has its own advantages and challenges.

5. Base Salary. Agreements often state the base salary, but provide no more information. Questions arise whether it is a guaranteed minimum, subject to discretionary review and changes, or presumed to increase after the first year.

6. Bonus and Other Incentive Packages. Agreements often commit employers to bonuses or other incentive packages without providing any details or specifics. Instead, they should clearly indicate whether it will considered at the discretion of the employer or is based on objective (or combined objective/subjective) criteria. Alternatively, the agreement may simply refer to other bonus or incentive programs which are in existence, and state that the executive is eligible for bonuses or incentives under those programs, subject to their terms and conditions.

The employer should not inadvertently allow the agreement to supersede the employer’s rights and obligations under the bonus or incentive plan, unless that is what the parties intend to have it do (which would rarely be the case).
Another common source of disagreement over bonuses and other incentive packages is whether they are payable if the executive leaves before a particular bonus period (e.g., fiscal year) is over. The agreement and/or applicable plan should state whether a mid-year departure will entitle the executive to a pro rata share of the annual benefit, the entire benefit, or no benefit at all. This may be written to vary, depending on the timing and/or the reason for the departure.

7. Time Off. Executives often mix business and pleasure, and generally work while traveling. Depending on an employer’s policies and practices, that can lead to large and unexpected accruals of paid time off. Employers should address all of this up front, to avoid major disputes later; and make sure its time off and accrual policies are in compliance with recent legal developments.

8. Termination. Many employment agreements fail to address different reasons for termination of the employment. The agreement should anticipate and address all possible reasons for termination of employment. The parties may have a very different view about post-termination packages and obligations, depending on the reason for and timing of the departure.

It is better to have a road map for the different options than to leave items vague or open, and subject to later disputes. The parties should consider addressing what will happen if the employment is terminated due each of the following: death; disability; termination by the employer for cause; termination by the employer without cause; and voluntary resignation by the executive. They may also want to address a resignation by the executive for good reason and a termination due to a change of control.

9. Post-Termination Payments. Many employers do provide for post-termination payments of some sort, but fail to protect themselves. If an employer agrees to pay post-termination compensation, it should clearly state when it does (e.g. termination without cause) or does not (e.g. voluntary resignation or termination for misconduct) apply. It should also make the receipt of such compensation contingent on the executive’s compliance with all post-termination obligations (non-compete agreements, trade secret and confidentiality agreements, agreements not to hire or solicit employees, cooperation with litigation clauses, etc.); and a signed release of claims. Otherwise, it may find itself inadvertently funding a former executive’s new business venture and/or law suit.

10. Merger Clause. Merger clauses are often included in agreements as “boiler plate.” They can, however, critically impact future rights and obligations of the parties. The employer should be extremely careful not to inadvertently supersede some agreement (e.g. a prior non-compete agreement) that it wants to survive.

11. Arbitration Clause. The parties can opt to have future disputes decided in an arbitration forum in lieu of traditional litigation, and they can specially design the procedures under which arbitration will be conducted. Perceived advantages to employers generally include an expedited ultimate resolution, decreased protracted discovery and court procedures, and avoidance of erratic jury verdicts.

However, depending on the format (e.g. three-arbitrator panel with busy schedules), arbitration can be very expensive and can cause severe delays. Often, resolving a claim in court is faster and cheaper than arbitration. Also, as to both issues of law and fact, the ultimate decisions are left to the arbitrator with limited grounds for appeal (e.g., award procured by corruption, fraud or other undue means). Thus, the threat of an appeal which faces a judge who erroneously applies the law does not have the same effect on an arbitrator who may couch technical applications of the law in order to “split the baby.” Also, if not properly drafted, the existence of an arbitration clause in an executive agreement, trade secret/confidentiality agreement, non-compete agreement, etc., can effectively prevent the employer from obtaining an injunction with respect to violations.

E. Unsigned Agreements

It is surprisingly common for employers to have written, but unsigned, agreements in their files. If the parties clearly agreed that there is no agreement until there is a signed agreement, i.e. it is a condition precedent, then the Minnesota courts will enforce that. “When both parties have ‘clearly indicated an intent not to be bound’ until they execute a formal document, no contract exists.” Moga v. Shorewater Advisors, LLC, No. A08-785, 2009 WL 982237, at *4 (Minn. Ct. App. 2009) (unpublished opinion) (citation omitted). Even where “one party has ‘intended and expressed the intention from the start not to be bound at all until the execution of the formal contract,’ there is no contract until the condition is fulfilled.” Id. (citation omitted).

However, employers and employees frequently engage in negotiations without expressly stating that a fully signed agreement is a condition of the contract being enforced. In those cases, a contract may be binding on a party though not signed by that party if assent or mutuality is shown by the fact that the parties accepted the writing as a binding contract and acted on it as such, even though it was not signed. Welsh v. Barnes-Duluth Shipbuilding Co., 21 N.W.2d 43, 46–47 (Minn. 1945). Even a reference to a future contract in writing will not automatically nullify the existence of the present, binding contract, if the parties have agreed to all the essential terms of the contract and proceeded to perform in reliance upon it. Asbestos Products, Inc. v. Healy Mechanical Contractors, Inc., 235 N.W.2d 807, 810 (Minn. 1975); see also Massee v. Gibbs, 169 Minn. 100, 105, 210 N.W. 872, 874 (Minn. 1926);Riley Bros. Constr., Inc. v. Shuck, 704 N.W.2d 197, 203 (Minn. Ct. App. 2005); Moga v. Shorewater Advisors, LLC, No. A08-785, 2009 WL 982237, at *5 (Minn. Ct. App. April 14, 2009).

6. OVERLY AGGRESSIVE NON-COMPETE PROTECTIONS

Overly aggressive non-compete programs and agreements are primed to be ignored and/or successfully challenged. Employers should avoid broad and long non-competes that “go too far.” They tend to get ignored or challenged; and are often fully or partially invalidated. An employer is better off being able to articulate, from the start, what it needs to protect and why its non-compete agreement is reasonable and necessary.

Attorneys can bring enormous value to their clients in drafting and implementing non-compete agreements that accomplish their clients’ goals, or they can unwittingly participate in creating a “perfect storm” for their clients.

A. Non-Compete Agreements with Employees Must Be Reasonable and Necessary

Non-compete agreements in the employment context are generally disfavored. Freeman v. Duluth Clinic, Inc., 334 N.W.2d 626 (Minn. 1983). Notwithstanding their obvious economic appeal to employers, courts consider them partial restraints of trade and construe them narrowly. Bennett v. Storz Broad. Co., 134 N.W.2d 892 (Minn. 1965); Lemon v. Gressman, No. 08-00-1739, 2001 WL 290512 at *1 (Minn. Ct. App. Mar. 27, 2001).

In Minnesota, an enforceable non-compete agreement must be both necessary to safeguard the employer’s protectable interests and reasonable as between the parties. Bennett, 134 N.W.2d at 898; Medtronic, Inc. v. Sun, Nos. C7-97-1185, C9-97-1186, 1997 WL 729168, at *3 (Minn. Ct. App., Nov. 25, 1997). Generally, companies have protectable interests in (1) customer goodwill, (2) confidential information, (3) trade secrets, and (4) customer contacts. However, the agreement must not impose any greater restriction on the employee than is necessary to protect the employer’s business. Safety-Kleen v. Hennkens, 301 F.3d 931 (8th Cir. 2002); Saliterman v. Finney, 361 N.W.2d 175, 177 (Minn. Ct. App. 1985).

B. Unreasonableness of the Restrictive Covenant

The reasonableness inquiry occurs on a case-by-case, fact-specific basis. Davies & Davies Agency, Inc. v. Davies, 298 N.W.2d 127 (Minn. 1980). Different jurisdictions use various methods of addressing overly broad and unreasonable covenants. Minnesota courts apply a modified blue pencil doctrine and will, at their discretion, rewrite portions to make them reasonable. See Davies, 298 N.W.2d at 134; Dean Van Horn Consulting Assoc. v. Wold, 395 N.W.2d 405 (Minn. Ct. App. 1986); Ikon Office Solutions, Inc. v. Dale, 170 F. Supp.2d 892, (8th Cir. 2001); Klick v. Crosstown State Bank of Ham Lake, Inc., 372 N.W.2d 85 (Minn. Ct. App. 1985).

Minnesota courts have historically reviewed two types of restrictions for their reasonableness: temporal and geographical. Metro Networks Comm. v. Zavodnick, No. Civ. 03-6198, 2004 WL 73591 (D. Minn. Jan. 15, 2004); Universal Hosp. Serv., Inc. v. Hennessy, No. Civ. 01-2072 (PAM/JGL) 2002 WL 192564, (D. Minn. Jan. 23, 2002). A covenant whose restriction extends too far into the future or across too broad of a geographical area might be invalidated or modified. See, e.g., Ikon Office Solutions, Inc., 170 F. Supp.2d 892, at 895 (8th Cir. 2001); Dean Van Horn, 395 N.W.2d at 410 (Minn. Ct. App. 1986).

1. Time. Requiring more than a one-year non-compete period is inviting a challenge; and a partial victory is likely not worth the time and expense. Non-compete agreements must be reasonable in their temporal scope, or they will not be enforced. See, e.g., Webb Publishing Co. v. Fosshage, 426 N.W.2d 445, 448 (Minn. Ct. App.1988) (citing Dahlberg Brothers, Inc. v. Ford Motor Co., 137 N.W.2d 314, 321 22 (Minn. 1965)).

Although Minnesota courts have enforced non-compete agreements for periods of two or three years after the termination of employment, these cases are more likely the exception than the rule. In a traditional employment setting (as compared to a sale-of-business setting), the courts are generally reluctant to enforce non-compete agreements for periods longer than one year. See, e.g., Medtronic v. Hughes and St. Jude Medical, A10-998, 2011 WL 134973 (Minn. Ct. App. Jan. 18, 2011). In contrast the Court “has consistently found one-year restrictions that are limited to a former employee’s sales area to be reasonable.” Boston Scientific Corporation v. Kean, Civ. No. 11-419 (SRN/FLN), 2011 WL 853644 (D. Minn. March 9, 2011) (quoting Guidant Sales Corp v. Baer, No. 09-CV-0358 (PJS/FLN), 2009 WL 490052, at *4 (D. Minn. Feb. 26, 2009).

2. Geographical Territory. Geographical restrictions should be clearly tied to the employer’s legitimate business interests, keeping in mind that the increased roles of telephones, emails, and the Internet can make geographic restrictions irrelevant in many industries. Employers should avoid using classic geographical restrictions except for local businesses that only serve local customers.

Employment-related covenants restricting competition must be reasonable from a geographic standpoint, or they will not be enforced. See, e.g., Ring Computer Sys. v. Paradata Computer Networks, No. C4-90-889, 1990 WL 132615 (Minn. Ct. App. Sept. 18, 1990). In the past, global restrictions have generally been unenforceable as unreasonably broad, See, e.g., Dynamic Air, Inc. v. Bloch, 502 N.W.2d 796, 800 (Minn. Ct. App. 1993). This is changing as the world marketplace develops.

Under the right circumstances, even a global restriction may be deemed reasonable. Medtronic v. Hedemark, No. A08-0987, 2009 WL 511760, at *3–5 (Minn. Ct. App. Mar. 3, 2009). The Court of Appeals has declined to enunciate a per se rule barring the enforceability of non-compete covenants that contained no territorial limitation at all. “Territorial limitations…are but one of several factors a [district] court is to consider in determining the reasonableness of a restrictive covenant.” Dynamic Air, Inc. v. Bloch, 502 N.W.2d 796, 799 (Minn. Ct. App. 1993). (Instead of a per se rule, “[t]he covenant must be scrutinized as a whole to determine whether it is reasonable.” Id. at 800. Medtronic v. Hughes and St. Jude Medical, A10-998, 2011 WL 134973 (Minn. Ct. App. Jan. 18, 2011).

3. Customer-Based and Product-Based Restrictions. Employers should consider customer-based restrictions for businesses that extend beyond a local geographic market. Customer restrictions may substitute for or complement a geographic restriction. Often, these make far more sense than pure geographic restrictions since customers may be all over the country or even the world. Basing a territorial restriction on the presence of customers in a certain area enhances the reasonableness of a non-compete agreement. Cook Sign Co. v. Combs, No. A07-1907, 2008 WL 3898267, at *7 (Minn. Ct. App. Aug. 26, 2008); Salon 2000, Inc. v. Dauwalter, No. A06-1227, 2007 WL 1599223, at *2 (Minn. Ct. App. June 5, 2007); Madsen v. Spectro Alloys Corp., No. C7-98-225, 1998 WL 373067, at *2 (Minn. Ct. App. July 7, 1998).

Under the right circumstances, product-based restrictions may also substitute for or compliment a geographic restriction. Even a world-wide non-compete agreement may be deemed reasonable under the circumstances of the case, where the non-compete covenant prevents the employee from working on competitive products. Medtronic v. Hughes and St. Jude Medical, A10-998, 2011 WL 134973 *2 (Minn. Ct. App. Jan. 18, 2011).

4. Non-Solicitation Provisions. Employers should consider customer non-solicitation restrictions in lieu of broad non-compete provisions, where the employee may go to work for a competitor, but may not directly or indirectly solicit or serve its customers (or employees, or improperly use or share confidential information, etc.). While a non-solicitation provision may not provide as much protection as a full non-compete agreement, the likelihood of it being enforced is greatly enhanced.

7. FAILING TO DETER VIOLATIONS AND PRESERVE NON-COMPETE PROTECTIONS

A. Remedies that Deter Violations

In addition to the traditional language that an injunction is possible, employers should add (reasonable) “sticks” to their non-compete agreements. If the employer’s non-compete agreement contains sufficient “remedies with teeth,” it has a much better chance of protecting its interests.

1. Attorney Fees. Many non-compete agreements now include provision for the recovery of legal fees. Generally, attorney fees are recoverable against a former employee only if a statute or contract authorizes such recovery. See Tenant Const., Inc. v. Mason, No. A07-0413, 2008 WL 314515 (Minn. Ct. App. Feb. 5, 2008); Tonna Heating Cooling, Inc. v. Waraxa, No. CX-02-368, 2002 WL 31687601 at *5 (Minn. Ct. App. Dec. 3, 2002); Barr/Nelson, Inc. v. Tonto’s, Inc., 336 N.W.2d 46, 53 (Minn. 1983). However, Minnesota state courts have held that if an employer succeeds on a claim of tortious interference against the new employer, the new employer may be forced to pay the employer’s attorney fees. Kallok v. Medtronic, Inc., 573 N.W.2d 356, 363 (Minn. 1998).

2. Forfeiture of Benefits. Increasingly, employers are including provisions in benefit plans and agreements conditioning an employee’s retention of stock, stock options, or other benefits on not competing with the employer for a certain time period following the employee’s termination. Sometimes the plan/agreement states that the benefit will not be provided (e.g. the employee cannot exercise a stock option) if there is a violation of a non-compete agreement. Other plans/agreements contain claw-back provisions, requiring the violating employee to pay back any prior benefit received.

Although decisions in other states vary dramatically (from full enforcements, with no scrutiny to complete bars), Minnesota courts to date have been willing to enforce forfeiture provisions only if they pass a test of reasonableness. Medtronic v. Hedemark, No. A08-0987, 2009 WL 511760, at *3–5 (Minn. Ct. App. Mar. 3, 2009); Harris v. Bolin, 247 N.W.2d 600, 603 (Minn. 1976).

If an employer uses forfeiture provisions in benefit plans/agreements, it should include clear and reasonable language in the plans/agreements up front. It should also avoid language preserving the employer’s right, in its sole discretion, not to provide any benefit or that may make the consideration illusory. It should state that the forfeiture provisions are NOT the employer’s sole remedy and are NOT to be considered to be liquidated damages; but rather are in addition to any other injunctive and legal relief available to the employer. Finally, the employer should NOT give the benefit to otherwise eligible employees unless and until they sign the required non-compete agreement.

3. Liquidated damages. Generally, an employer is better off preserving all injunctive rights, as well as all rights to seek a full accounting and recover any and all lost profits, lost business opportunities and other damages, as well as legal fees and costs. If the employer does include a liquidated damages clause, it should be “reasonable” but also provide the employer with a full recovery of its damages.

A liquidated-damages clause is prima facie valid, based on the assumption that it does not represent a penalty for nonperformance but rather fair compensation for breach-related damages caused by a party’s nonperformance. Gorco Constr. Co. v. Stein, 99 N.W.2d 69, 74 (Minn. 1959). Enforcement of a liquidated-damages clause is dependent on satisfaction of two elements: (1) the fixed amount is a reasonable forecast of just compensation for the harm caused by the breach; and (2) the harm is incapable of accurate estimation or is very difficult to estimate. Bellboy Seafood Corp. v. Nathanson, 410 N.W.2d 349, 352 (Minn. Ct. App. 1987).

An interesting question that arises is whether the existence of a liquidated-damages provision in a non-compete would preclude an employer from seeking injunctive relief or additional damage claims. Arguably, an employee who breaches a non-compete agreement should not have to suffer the further damage of an injunction. The employee has already contracted with the employer for a possible future breach, so there is no need for further relief by way of an injunction. See Timm & Assocs., Inc. v. Broad, No. 05-2370, 2005 WL 3241832 (D. Minn. Nov. 30, 2005); Bromen Office 1, Inc. v. Coens, No. A04-946, 2004 WL 2984374 (Minn. Ct. App. Dec. 28, 2004). However, the law is not entirely settled on the issue: other cases appear to conclude that a liquidated-damages provision does not preclude pursuit of injunctive relief. See Frank B. Hall & Co. v. Alexander & Alexander, Inc., 974 F.2d 1020 (8th Cir. 1992); H&R Block Enterprises, Inc. v. Short, No. Civ. 06-608, 2006 WL 3437491 (D. Minn. Nov. 29, 2006). Also, if the contract spells out the damages in advance, the employee and the new employer can assess the risk in advance with a higher degree of predictability, which may make the choice easier for them and more detrimental to the former employer.

B. Preserving the Non-Compete Agreement

One of the most frustrating things that can happen to an employer occurs when it prepares and implements an otherwise perfectly enforceable non-compete agreement that later becomes null and void or cannot as a practical matter be enforced. There are many provisions and steps that can be taken to ensure that the non-compete agreement will survive the occurrence of future events or new contractual obligations.

1. Non-Compete Covenant Must Survive the Termination of Employment. If the non-compete clause is part of a larger agreement – for example, an employment agreement – which contemplates and allows for termination “of the agreement,” it may not be clear that the non-compete obligations survive termination of the underlying agreement. Post-termination obligations must expressly survive termination of employment. See, e.g., Burke v. Fine, 608 N.W.2d 909, 912 (Minn. Ct. App. 2000) (review denied June 13, 2000). Also, an employer should avoid language that allows either party to “terminate the Agreement,” since this might apply to the non-compete.

2. The Employer Must Preserve Right to Assign. The Employer should reserve the right to assign the non-compete agreement without the employee’s consent. Non-compete agreements are assignable in Minnesota. Saliterman v. Finney, 361 N.W.2d 175, 178 (Minn. Ct. App. 1985). However, Minnesota courts will not allow the assignment of a non-compete absent explicit language permitting assignment. Inter-Tel, Inc. v. CA Commc’ns, Inc., No. Civ. 02-1864PAMRLE, 2003 WL 23119384, at *4 (D. Minn. Dec. 29, 2003).

3. The Employer Must Not Supersede Non-Compete. Employers often include merger clauses in subsequent agreements – for example, a separation agreement or release of claims – which by their terms supersede and thus render unenforceable an employee’s continuing non-competition obligations. Cf. Western Form, Inc. v. Pickell, 308 F.3d 930 (8th Cir. 2002). In cases where the later writing contains a merger clause, the Minnesota Supreme Court has noted that the merger clause “establishes that the parties intended the writing to be an integration of their agreement.” Alpha Real Estate Co. of Rochester v. Delta Dental Plan of Minn., 664 N.W.2d 303, 312 (Minn. 2003). In other words, if there is a merger clause, integration is presumed.

Even if there is not a merger clause, the court may find that integration was intended. “Where there is no written merger agreement, a determination of whether the written document is a complete and accurate “integration” of the terms of the contract is not made solely by an inspection of the writing itself, important as that is, for the writing must be read in light of the situation of the parties, the subject matter and purposes of the transaction, and the attendant circumstances.” Great America Leasing Corporation v. Dolan, Civ. No. 10-4631 JRTJJK, 2011 WL 334829 (D. Minn. Jan. 31, 2011). (citing Arizant Holdings, Inc. v. Gust, 668 F.Supp.2d 1194, 1202 (D. Minn. 2009).

4. Choice of Law and Forum Selection Clauses. The employer should include both choice of law and forum selection clauses to minimize the risk of litigation across the country – perhaps under another state’s less favorable laws.

There are many conflicts among state laws pertaining to non-compete agreements. This has led to creative efforts by transitioning employees and their new employers to relocate the employee to a state that refuses to enforce restrictive covenants. See, e.g., Advanced Bionics Corp. v. Medtronic, 29 Cal. 697 (2002). There have been many “race to the courthouse” cases and fascinating legal and strategic disputes. See, e.g., St. Jude Medical S.C., Inc. v. Hasty, No. Civ. 06-4547, 2007 WL 128856 (D. Minn. Jan. 12, 2007); Metro Networks Comm’cns L.P. v. Zavodnick, No. Civ. 03-6198 (RHF/AJB), 2004 WL 73591 at *4 (D. Minn. Jan. 15, 2004); Medtronic, Inc. v. Camp, No. Civ. 02-285 (PAM/JGL), 2002 WL 539073 (D. Minn. Apr. 1, 2002); Medtronic, Inc. v. Advanced Bionics Corp., 630 N.W.2d 438, 452-453 (Minn. Ct. App. 2001); ELA Medical, Inc. v. Arrhythmia Management Associates, Inc., Civ. No. 06-3580, 2007 WL 892517 at *1 (D. Minn. March 21, 2007); Cook Sign v. Combs, A07-1907, 2008 WL 3898267 (Minn. Ct. App. Aug. 26, 2008).
Employers should include a choice of law provision and a forum selection clause, to best protect it from multi-state issues. Generally, courts have enforced such provisions. E.g. CH Robinson Worldwide, Inc. v. FLS Transportation, Inc., 772 N.W.2d 528 (Minn. Ct. App. 2009). Further, the Minnesota Court of Appeals concluded that forum selection clauses in non-compete agreements bind not only the former employee but the new employer as well, where the new employer is “closely related” to the dispute between an employer and the employee. Id.

5. Notice Provisions. An employer should require the employee to disclose potential violations and provide the agreement to the new employer. Best case: the employer learns of potential problems in advance and can deal with them. Worst case: the employee and/or the new employer are on notice of the obligation and breached it. Either way, it helps the employer protect its interests.

8. CREATING BONUS AND COMMISSION DISPUTES

As discussed previously, bonus and commission agreements are often incomplete or unclear. To minimize the risk of litigation and legal exposure, the bonus/commission agreement should clearly state whether it is discretionary or a firm commitment, the amount or the formula to determine the amount, when it is earned, when it is to be paid, and whether an early departure will entitle the employee to a pro rata share of the payment, the entire payment or no payment at all. This may be written to vary, depending on the timing and/or the reason for the departure.

A. Common Bonus/Commission Disputes

The possible disputes over bonus and commission plans and agreements are many. They are also surprisingly common, especially when they are considered in the context of an employment termination. Common commission/bonus disputes include the following:

1. Discretionary Benefit vs. Binding Contract. There is a big difference between an employer’s discretionary bonus and a binding contractual obligation. Many disputes arise out of this distinction because the agreement is not clear.

2. Unilateral Changes. Many employers reserve the right to unilaterally change the bonus/commission plan or the interpretation of that plan. Although rare, some do unilaterally exercise this option. Others change them without having reserved the right. Do they have that right? Does that negate obligations the employee may have, including non-compete obligations?

3. When Was the Payment “Earned.” Commission payments may be “earned” at the time of contract with the customer, the time of delivery/invoicing to the customer or the time of payment by the customer. Bonus awards, similarly, may be “earned” after the work has been done or on some other select date, such as the end of the year. Contracts often fail to clarify these issues, leaving a wide path for disagreements.

4. Post-Termination Payments. A common source of disagreement over commissions and bonuses (and other incentive packages) is whether they are payable if the employee leaves before a particular bonus/commission period (e.g., fiscal year) is over. Similarly, does the employee still have to be employed or under contract at the time of payment (e.g. quarterly) in order to receive it?

Whether a bonus or commission has been earned at the time of termination is generally determined by the language in the agreement or plan. For example, if a commission agreement clearly states that a commission is not earned until the third party renders payment, then the salesperson is not entitled to the commission when it was received after termination; and may not even be entitled to it ever. See Reiter v. Recall Corp., 542 F. Supp.2d 945 (D. Minn. 2008).

However, equitable doctrines may be asserted in an attempt by an employee to recover commissions and bonuses when no contract exists. For example, the court applied the promissory estoppel doctrine to enforce an employer’s promise to pay commissions to a former employee based on pending sales, as long as the employee helped transition the accounts to other sales representatives before leaving. Fiebelkorn v. IKON Office Solutions, Inc., 668 F.Supp.2d 1178, 1186 (D. Minn. 2009). Also, if there is no clear contractual or plan language, there is room for a former employee to seek payment for post-termination commissions based on either an unjust enrichment theory, Holman v. CPT Corp., 457 N.W. 2d. 740 (Minn. Ct. App. 1990), or a “procuring cause” contract theory, Rosenberg v. Heritage Renovations, LLC, 685 N.W. 2d. 320, 324 (Minn. 2004).

5. Interplay with Other Agreements. An employer’s failure to pay commissions or bonus obligations may bar the employer from enforcing non-compete and other post-termination agreements.

B. Employers Risk Statutory Penalties for Improper Withholding of Wages, Commissions and/or Bonuses

In addition to contract language, the payment of wages or commissions after the termination of the employment relationship is governed by Minn. Stat. §181.13 or §181.14. With some exceptions, employers are required to pay terminated employees for all commissions and/or wages that the employee earned prior to termination. The time limits and penalties change depending on the relationship and the type of separation, both leading to a right to make a statutory demand for payment within 24 hours.

There are two major penalties for an employer’s failure to timely pay any earned wages and/or commissions to an employee within 24 hours of a statutory written demand. First, there is a penalty equal to the average daily earning of the employee for each day in default for up to 15 days, in addition to the actual payment due. Minn. Stat. §181.13 (a); Stat. §181.14, subd. 2. Second, attorney fees and costs are recoverable when an employer is found to have violated Minn. Stat. §181.13 or §181.14. Minn. Stat. §181.171, subd. 3; Galbraith v. U.S. Premise Networking Services, Inc., No. 01-15262, 2003 WL 23691204 at *1 (D. Minn. July 14, 2003) (unpublished opinion).

An employee’s bonus is considered a wage under Minn. Stat. §181.13. Kvidera v. Rotation Engineering and Manufacturing Co., 705 N.W.2d 416 (Minn. App. 2005). Thus, the penalties for failure to pay as required under Minn. Stat. §181.13, and presumably Minn. Stat. §181.14, apply to bonus payments in addition to wages and commissions.
Minn. Stat. §181.13 (and similarly Minn. Stat. §181.14) requires payment of wages or commissions (and presumably bonuses) actually earned at the time of termination. Minn. Stat. §181.13 (a); see Kvidera v. Rotation Engineering and Manufacturing Co., 705 N.W.2d 416 (Minn. App. 2005). Whether wages, commissions or bonuses have actually been earned or not, however, is governed by the employment contract. See, e.g. Reiter v. Recall Corp., 542 F. Supp.2d 945 (D. Minn. 2008); Ehlen v. Hanratty & Associates, Inc., No. A08-2290, 2009 WL 3255399 (Minn. App. Oct. 13, 2009). Once again, the language in the contract is the key to the ultimate resolution.

C. Draws Against Commissions are a Matter of Contract

Employers often provide their key sales employees with draws. Typically, the understanding is that draw will be applied against commissions actually earned. Often, the commission account gets overdrawn, and remains overdrawn as of the employee’s termination of employment.

The Minnesota courts have held that, “[where] a salesman working on commission has a draw account against commissions, there can be no recovery against him for overdrafts received in the absence of a specific contractual obligation, or an express or implied agreement of repayment.” St. Cloud Aviation, Inc. v. Hubbell, 356 N.W.2d 749, 751 (Minn. Ct. App. 1984) (citation omitted); see also St. Anthony Motor Co. v. Patterson, 175 Minn. 624, 625, 221 N.W. 719, 720 (Minn. 1928) (citing same rule and adding that “[i]n the absence of either an express or implied agreement or promise to repay such excess, the employer has no remedy against the employee, even though the contract in terms provides that there shall be settlements between them monthly”); see Custom Communications, Inc. v. Vega, A10-1123, 2011 WL 1466385 (Minn. Ct. App. April 19, 2011).

D. Employers May Not Make Payment of Commissions or Bonus Conditioned on a Release of Claims that is not a Contractual Requirement

Many employers who dispute commissions or bonus claims want to make the disputed payment contingent on a release of claims. While this desire is understandable, it may be unenforceable. See Dougan v. Niedermaier, 419 N.W.2d 112 (Minn. Ct. App. 1988) (noncompliance with Minn. Stat. §181.145 “results in penalties to be paid appellant thereby making appellant the prevailing party in this matter. As prevailing party, appellant is entitled to attorney’s fees.” Id. at 115.) Even though the principle had offered to pay the same amount in commissions that the salesperson ultimately received (before penalties), the Court imposed penalties and attorney fees because a principal cannot make prompt payment contingent upon any release of future claims. Id.

9. CREATING UNNECESSARY OWNERSHIP AND FIDUCIARY OBLIGATIONS

Many smaller employers offer to give their key employees a small ownership interest, without considering the ramifications of having a minority owner or considering other alternatives. This can lead to trouble, especially if they are used to doing things their own way, and not accustomed to working with minority owners. In addition to traditional employment claims and contract claims, minority owners may assert additional claims against their employer/partnership, and their fellow shareholders/partners.

Regardless of the form of the business, there may be a statute that provides protections to minority shareholders/partners, fiduciary obligations and equitable rights and remedies. Minn. Stat. § 302A.751 (close corporations); Minn. Stat. § 322B.833 (limited liability companies); Minn. Stat. § 323A.0404 (partnerships); and Minn. Stat. § 321.0408 (limited liability partnerships).

For example, Minn. Stat. § 302A.751 provides forced buyouts and other equitable remedies to minority shareholders in closely held corporations when the majority shareholders have acted “fraudulently or illegally” or have otherwise acted “in a manner unfairly prejudicial,” toward them. Gunderson v. Alliance of Computer Professionals, 628 N.W.2d 173, 184 (Minn. App. 2001). This is because, due to the lack of a ready market for the shares, minority shareholders require enhanced protections. Id. “Unfairly prejudicial” means conduct that frustrates the reasonable expectations of all shareholders in their capacity as shareholders or directors of a corporation that is not publicly held or as officers or employees of a closely held corporation.” Id., at 184.

In determining whether to order a buyout or other equitable relief, a court must consider “the duty which all shareholders in a closely held corporation owe one another to act in an honest, fair, and reasonable manner in the operation of the corporation and the reasonable expectations of all shareholders as they exist at the inception and develop during the course of the shareholder’s relationship with the corporation and with each other.” Minn. Stat. § 302A.751, subd. 3a. When such buyouts are ordered, the court is required to set the price at “fair value” (rather than a discounted “fair market value”) unless prior documents provide otherwise.

Partners also have a common law fiduciary duty to each other as well as to the partnership. Minnesota law imposes the highest duty of integrity and good faith on partners in their dealings with each other. E.g. Triple Five of Minnesota, Inc. v. Simon, 404 F.3d 1088, 1095 (8th Cir. 2005) (citing Venier v. Forbes, 25 N.W.2d 704, 708 (Minn. 1946)). The Minnesota Supreme Court has compared closely held corporations to a “partnership in corporate guise.” Westland Capitol Corp. v. Lucht Eng’g Inc., 308 N.W.2d 709, 712 (Minn. 1981). Thus, shareholders in closely held corporations have a fiduciary duty to each other. Pedro v. Pedro, 489 N.W.2d 798, 801 (Minn. App. 1992) (“Pedro II”); Pedro v. Pedro, 463 N.W.2d 285, 288 (Minn. App. 1990) (“Pedro I”). The fiduciary relationship imposes upon shareholders the “highest standards of integrity and good faith in their dealings with each other.” Pedro II, 489 N.W.2d at 801 (quoting Prince v. Sonnesyn, 25 N.W.2d 468, 472 (Minn. 1946)). A shareholder’s claim for breach of common law fiduciary duty can be brought in addition to claims for minority shareholder relief pursuant to Minn. Stat. § 302A.751. Berreman v. West Publishing Co., 615 N.W.2d 362, 369 (Minn. App. 2000), rev. denied (Minn. Sept. 26, 2000).

Minnesota courts have addressed several actions, which the courts have held or commented to be violations of fiduciary duties, such as: honesty and disclosure of material facts, Klein v. First Edina Nat’l Bank, 196 N.W.2d 619, 622 (Minn. 1972); Berreman, 615 N.W.2d at 371; v. Tappan, 27 N.W.2d 648, 654 (Minn. 1947); conflicts of interest, Gunderson v. Alliance of Computer Professionals, 628 N.W.2d 173, 186 (Minn. App. 2001); “freeze-out” situations, Berreman, 615 N.W.2d at 370; preferential financial treatment, Gunderson, 628 N.W.2d at 185); interfering with rights, such as with the fellow shareholder’s ability to perform his job, and defaming and threatening the fellow shareholder, Pedro II at 801-802; and under the right circumstances, an employee/shareholder may have an additional and separate claim for wrongful termination based on a reasonable expectation that his or her employment was not terminable at will, or even that there was an agreement to provide lifetime employment. Pedro I; Pedro II. In the Pedro cases, the Court made it clear that the plaintiff in that case (which involved unique facts) had a reasonable expectation as a shareholder in a closely held corporation “that his employment was not terminable at will.” Pedro I at 289.

Employers can avoid the risk of minority ownership claims, and still share the wealth, by providing the employee with contractual rewards for success, such as guaranteed bonuses, payments for a percentage of the growth of the business, phantom stock agreements, retention agreements, and awards for helping sell the company. These alternatives are usually less expensive to implement, and can easily avoid the creation of minority owner obligations and the issues that may flow from those obligations.

10. MISSING TAX ISSUES

It is beyond the scope of this article to discuss tax issues in depth, but some unique tax issues that may pertain to executive compensation should be noted.

A. IRC §§ 280G and 4999 Impact Severance Packages

Large severance packages to executives, often in conjunction with early termination of employment, change in control or success fee provisions, have frequently been called “parachutes.” Parachutes are often part of the negotiations with executives, and may be necessary to recruit them, retain then, or address their concerns about takeovers or other changes in control. Unfortunately, many companies and executives do not carefully analyze the tax treatment of potential parachute plans, and risk devastating tax results.

Generally, “golden parachutes” are those that exceed the IRS threshold for excessive severance payments, which are payments that equal or exceed three times the recipient’s average salary for the prior five years. IRC §§ 280G and 4999. If there is an “excess parachute payment,” IRC § 280G makes it nondeductible to the payor, and IRC § 4999 imposes a 20% nondeductible excise tax on the recipient. To the extent the employer has a “gross-up” provision in the severance agreement (essentially agreeing to pay for the executive’s tax consequences); the employer would become obligated to increase the golden parachute by an amount sufficient to offset the excise tax liability as well as the underlying tax liability. Further, the money paid out for the gross-up itself would be taxed, requiring further payments to cover the “gross-up” on the “gross-up.”

B. IRC §§ 280G and 4999 Impact Other Compensation/Benefits

The excise taxes discussed above may apply to compensation and benefits other than severance payments. For example, the value of any stock options or restricted stock, the value of accelerated SERP accrual investing, agreements to pay post-termination welfare benefits such as health and/or life insurance premiums, agreements to pay other benefits such as automobile or club memberships and other post-termination payments could be subject to the golden parachute taxes. See 26 C.F.R. § 1.280G-1 (Treas. Reg. § 1.280G) (IRS Regulations pertaining to §§ 280G and 4999).

C. IRC § 409A May Also Apply

Executive compensation was complicated more by the enactment of Internal Revenue Code § 409A, which was passed in 2004 and imposed new rules on nonqualified deferred compensation arrangements. These new rules institute substantial penalties on taxpayers who are not in compliance.

Although § 409A, on its face, deals with “deferred compensation” arrangements, it has become clear that many types of compensation, which were not necessarily considered by many to be “deferred compensation” may be subject to § 409A. Section 409A might apply to severance agreements, employment agreements, bonus or incentive plans, change in control/success fee agreements or other agreements that create an enforceable right to compensation to be paid at a later date. If § 409A is triggered, the compensation could be deemed taxable to the employee (and possibly trigger a tax gross-up obligation to the employer) prior to the time that the money is actually paid, along with a 20% penalty on the compensation.

Section 409A generally applies to any binding promise to pay compensation in a subsequent tax year. See IRS Notice 2005-1, Q&A-4(a). In addition to deferred compensation such as elective deferrals or supplemental retirement arrangements, Section 409A may apply to arrangements not typically considered to be deferred compensation, such as stock option and other equity grants, severance and change in control arrangements, reimbursements of post-termination expenses and provision of in-kind benefits after termination of employment. See Internal Revenue Code § 409A and related regulations.

D. Tax Planning is Critical

Careful planning with a tax lawyer or an accountant is critical! Any time a large compensation package of any sort is negotiated, the parties should consult with a tax lawyer or accountant.

E. Acceptance of Risks

Many executives seek an agreement that the employer will pay for their tax advice, and/or will agree to indemnification and tax gross-up provisions, in the event tax penalties are triggered.

CONCLUSION

An ounce of prevention is worth a pound of cure. Employers and their attorneys have an opportunity to proactively and cooperatively address all issues with executives and other key employees up front and avoid creating a “perfect storm” at a later date. Carefully drafted agreements and benefit plans can and should anticipate and clearly state the parties’ agreements, obligations and expectations under all foreseeable circumstances. It is far easier to cooperatively negotiate and clarify possible issues up front than it is to argue – or worse yet litigate – them after a dispute arises.

© 2013 by Jeffrey B. Oberman

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