Employment Contracts: How to Cut the Best Deal

You've negotiated debt covenants, mergers, and supply contracts — but do you know what should be included, and struck, from your employment contract?

Hallas points out that non-compete laws vary by state and that they are banned in California. They can range from six months to two years depending on the industry, and they usually specify that the departing executive cannot solicit the company’s customers, raid the staff (even if the staff member approaches the former executive), make disparaging remarks about the company, or disclose critical information.

Should You Be Perky?

Perks are part of every executive employment contract, but they can “be a lightening rod for criticism,” says Poerio. Now that perks must be disclosed under the new SEC rules, investors typically judge them more harshly than a large salary, even though the value is insubstantial by comparison. “My tendency is to forget the perks, and make it up in salary,” posits Poerio.

He reckons that if the executive needs security protection, that’s easy to explain to investors. But a compensation package that includes a Mercedes-Benz and a country club membership is harder for the public to swallow than a $100,000 bump in salary from the previous year.

For private companies, load up on perks if the investors and board are comfortable with them, Poerio continues. They still have to be “critical and justifiable,” but that definition usually encompasses reimbursement for moving expenses, country club or other club memberships, company cars and drivers, life insurance, and reimbursement for legal expenses.

New hires should also keep an eye out for clauses that relate to claims release. “It is a critical company protection,” maintains Poerio, who says that if it is not included in the contract, “don’t mention it.” A claims release provision promises candidates a set payout — usually a multiple of salary — if they agree not to sue the company for firing them without cause. Companies often attach claims releases to the contract, and stipulate that if the law changes, it has the right to rework the agreement. “Say no,” insists Poerio. The deal at the time you sign the employment contract should remain in place until the contract expires.

Snagged Parachutes

The New York Stock Exchange gave Richard Grasso a $139.5 million severance package, Disney gave Michael Ovitz $140 million, and Home Depot paid out $210 million to Robert Nardelli. “People remember the numbers,” asserts Poerio, who says the market and investors are very sensitive to lucrative severance packages, known as golden parachutes.

The only reason packages were disclosed was because the severance clauses were triggered and these top executives received their payouts. Now, however, the SEC requires disclosure of pay packages for the top brass at public companies, and that’s likely to affect the negotiating position of executives, who won’t be able to ink big golden parachute deals in private, contends Poerio. Boards are probably going to benchmark severance deals to market based on peer company review, he adds.

A smattering of executives also may be treated to what’s known as a 280G tax gross-up provision, although this perk is falling out of favor because, again, the new SEC rule exposes it. A gross-up relates to the tax code’s rule that allows companies to pay an executive additional compensation to cover the excise tax imposed on “excessive” golden parachute payouts, says Graham. The IRS determined in 1984 that departure bonus packages that exceeded three times the executive’s annual average compensation for the last five years was “excessive” and therefore imposed an excise tax on the extra amount. The perk is popular because the tax can be brutal. The rule of thumb regarding the excise tax is that when combined with the regular income taxes, it can reach 50 percent, according to Graham.

Many companies also offer severance payments through “rabbi trusts,” which protect a former executive from losing deferred compensation in case the company becomes financially distressed or there is a problem that delays payment. For instance, trust payments could be triggered when a company buys a target and immediately fires all the executives and does not allow them to collect severance. Or payment would flow out of the trust if executives are laid off, and then revenues dip precipitously before they are paid their severance. The company funds the trust with enough assets to pay the severance and deferred benefits outlined in the agreement. The assets stay on the company’s books and appear in its financial statements, but remain beyond the control of the company.

Even when the perfect candidate walks through the door, there are a few things related to contract negotiations that really hurt his chances of landing the job. “Companies don’t like executives to bring attorneys [on site] to negotiate. It’s a little disarming,” says Hallas. Further, potential hires have to learn to pick their battles. Bickering over tiny issues — such as a $5,000 cut in the salary offer on a $500,000 salary — is not worth angering people you will soon be working with or appearing greedy. “Let it go,” Hallas advises.

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