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Employment agreements 

Employees are essential to any business – and setting out clear rights and obligations of the employer and employee is very important. From the junior most employee to the CEO, everyone in an executive position are employees - and it is important to enter into employment contracts with them. This is not only for clarifying issues such as compensation package, holidays,  work hours and job description, but the company also secures important rights through the contract, such as rights over intellectual property created by an employee in course of employment, confidentiality and various warranties. Do you want your employee to be work with you exclusively while he is employed by you? Better mention that in the employment contract then.


Many organizations simply issue a unilateral letter of employment to the employee. In comparison to a letter issued by the employer, a stamped agreement which is signed by the employee is preferable, as it is a legally binding contract which is enforceable in a court. Even an employment contract in form of a letter should be signed and stamped.


An employment agreement contains typical clauses relating to the terms of employment – e.g. description of duties of the employee, salary, date of payment, work-hours, leave, bonus, termination etc. These terms will vary from one employee to another, depending on the role of the employee and the nature of his job. In addition, it contains certain other ‘standard’ terms, which are common to a broad spectrum of employees. These clauses must be carefully drafted to protect the organization’s interest. From the perspective of an employee looking to work with an organization, such clauses must not impose unreasonable restraints.


Key clauses in an employment agreement

The key clauses in an employment agreement are being discussed below, with a focus on what considerations should be kept in mind when they are drafted.


1. Job-specific terms

Some of the key aspects of employment (specific to the employee’s work profile) that must be addressed in the employment contract are descried below:


a. Description of duties – Merely specifying the designation of an employee in the organization may not adequately describe the nature of the employee’s work. It is important to define the scope of the employee’s duties clearly. This is useful when disciplinary action is taken against the employee, or when his employment is terminated on grounds of non-performance or other default by the employee, or there is dispute over misconduct/ intellectual property created by employees. Often, a detailed job description is attached as a schedule to the employment agreement. However, many employers refrain from providing a detailed and specific job description in the employment contract and rather opt for a general and broad job description.


b. Compensation – The compensation package typically consists of a salary, a bonus and certain other perquisites such as accommodation, insurance premiums, access to company car, etc.  It will also specify reimbursement procedures, or refer to internal company policies for reimbursement of expenses incurred by the employee in course of performance of his duties. For example, an employee whose task is to manage customer relationships may be required to meet clients and bear their dinner and related expenses at such meetings. The policy for reimbursement of conveyance and travel expenses (which are business related) may be specified. The quantum of salary, perquisites, time of payment, and other relevant details should be clearly specified in the contract. Here, one should look into statutes such as Payment of Wages Act or Shops and Establishment Act – as these statutes specify certain rules with respect to date of payment of wages, method of payment, etc.


Salary is usually paid by the employer after deducting TDS under the Income Tax Act and the provident fund contribution. Further, in employment contracts, it may be mentioned on a cost-to-company (CTC) basis. There are no formal guidelines to determine which costs can be included by the company. Market practices on this vary for different companies and across different industries. Therefore, from an employee’s perspective, he should specifically inquire which costs are included in CTC, and how they are valued, at the time of entering into the contract. Usually, the employer’s provident fund contribution, cost of perquisites, cost of accommodation (if provided by the employer), etc. are factored into the salary.


c. Term – For entry-level employees, usually there is no duration specified for the job. There may instead be a period of probation (when the employment is not confirmed). Some contracts may also specify a lock-in clause during which the employee is prohibited from terminating his employment (refer to the discussion on lock-in clauses below for more details).


However, contracts for hiring mid-level or senior level managers may have a fixed term, e.g. 2 years. These contracts will automatically terminate after the expiry of the term, unless they are renewed. 


d. Leave policies – The employment contract should also state how many leaves one would be entitled to take. Various labour laws specify number and nature of leaves in certain cases – and the contract must not provide for terms which are any worse than what is provided in such labour statutes which are applicable to the establishment. Leave is usually of two kinds – sick leave and privileged leave (leave for other reasons). The contract may impose a cap on the aggregate of the privileged and sick leave. It should specify that leave in excess of the cap will result in proportionate deduction of salary. The contract should also specify whether leave that is unutilized for a particular year may be carried forward to the next year, or if it may be encashed by the employee . In many contracts, unused leave will simply lapse, without conferring any benefit to employees who did not utilize their full quota.


e. Termination process – The organization may terminate the employee’s employment for some ‘fault’ of the employee, or without any reason (termination without cause is also referred to as termination for convenience).

Similarly, an employee may terminate his employment without reason (by providing a notice). In some cases, fault grounds may also be specified although these clauses are rather rare (e.g. non-payment of salary for three consecutive months).

Usually, termination without cause (on either side) requires the party terminating the employment to provide a notice of a minimum period (e.g. 30 days, 2 months, etc.). Quite often, minimum notice period for this purpose is specified in various labour laws, and employment contracts must be in conformity with such laws. The notice period serves a purpose – it helps the employee to finish any pending deliverables, it enables the company to look for substitutes (if the employee has issued the notice of termination), or the employee to look for alternative sources of employment (if the company has issued the notice), and allows for smooth transition of work to any substitute that has been appointed to replace the employee.

Any compensation that is payable to the employee on termination should be specified. This may be relevant when a contract which has a definite term has been prematurely terminated. Usually, in contracts without a pre-specified term, the employee is merely required to serve the notice period without payment of any additional compensation.

In the United States, senior officials of companies often have severance packages. The company is required to pay a heavy amount to them in case their employment is terminated.


2. Reference to company policies

An employment contract is not an ideal place for addressing internal processes observed by the company with relation to its employees. Such issues are better addressed through internal policy documents. Companies usually have policies relating to the following issues: dress-code of employees, social media policy, confidentiality policy, leave policy, reimbursement policy, policy against sexual harassment, etc.


The number and kind of policies purely depends on the nature and requirements of the company (or the industry). For example, hedge fund employees usually wear casual attire for the entire week, but accountancy firms always have a very strict dress-code. There is no ideal figure on the kind of policies a company should have.


However, the employment contract must impose an obligation on the employee to comply with the company policies that are applicable to him. Usually, these functions are performed by the Human Resources Department in a large organization. An early stage startup may simply have an employees’ manual, a copy of which may be handed over to the employee at the time of entering into the contract.


3. Non-compete clauses

A non-compete clause typically prevents the employee from competing with the business of the employer during the employment, and after termination. Although a prohibition against competing with the employer’s business for the duration of the employment is legally valid, a post-contractual restriction on employment is usually considered a restraint of trade and is not valid under Indian law. It must be limited in time and geography. For example, an employer may prevent the employee from starting a competing business within, say, a 5 kilometre radius, for a period of one year after termination of the contract. However, an absolute prohibition with respect to seeking employment with a competitor (post termination of employment) will usually be an unreasonable restraint of trade and illegal. 

Non-compete agreements with key employees, promoters, and directors may be valid. These employees are often specifically paid a consideration to prevent them from competing against the business. For example, acquirers who purchase shares from the promoters typically pay a huge ‘non-compete fee’ to the promoters for not competing with the organization for a specified period of time after their exit. The non-compete fee is the consideration for the promoter’s not competing with the investee/ target company. Such a clause would usually qualify as a reasonable restraint of trade and be valid under Indian law.


4. Lock-in and penalty clauses

It is common for organizations to impose a minimum lock-in period in employment contracts – as per the lock-in clause, the employee cannot cease employment without paying a heavy sum (the sum is stated in the contract) by way of damages. Whether a company decides to include it in an employment contract for top executives purely depends on its opinion on how easily the manager can find another job.
Legal validity of damages and penalty clauses in the event a lock-in is breached is a critical question for any employee, so we will include the discussion even here.
The damage amount typically stated in a contract is usually disproportionate to the employee’s salary, and is merely inserted to act as a deterrent for employees who plan to leave. This is done in the hope of controlling attrition rates, but has been disapproved and set aside by a number of courts across the country as unreasonable restraint.
As per the Indian Contract Act, any damages for breach of contract must be linked to the loss that the innocent party (that is, the employer) has suffered. Therefore, such clauses will only be enforceable in a court if the employer can demonstrate that the amount of damage mentioned in the damage is actually linked to the amount spent by the company on the employee, e.g. by way of training or search costs, etc. In most cases, artificially high amounts are inserted in the employment contract to deter employees from leaving the employer. Employers may include penalty clauses in order to recover costs (such as training, etc.) incurred on the development of the employee’s skillsets and to reduce attrition, but severely inflate such costs at the time of specification of the penalty amount in the employment contract. There is no linkage of the damage amount with the actual costs incurred by the employer. In the event of a dispute, whether such devices will be upheld in a court of law is questionable.
There are alternate ways to incentivise top employees to stay in the company for longer periods of time. Withholding a certain portion of discretionary bonuses is one of them. For example, an organization may pay 90% of the discretionary bonus to a fresh employee, but retain the balance 10%, which may be paid only after the employee has served the organization for a certain minimum number of years. Second, employee stock options vest in employees periodically, as they complete certain years of service. Third, a policy which serves home-grown employees for promotion may also work (if such a policy is uniformly implemented by entities in that sector).

If lock-ins are difficult to enforce, what kinds of clauses can incentivize employees and help in employee retention?

  • Withholding a discretionary bonus or performance-related reward (other than bonus which is compulsorily payable statutorily under Payment of Bonus Act, where applicable) if the employee has left the organization prior to the time stipulated in the employment contract, on grounds that the employee did not reach his targets is permissible.
  • It is also possible to structure a bonus or a cash-based incentive in such a way that it becomes payable only to employees who serve the company for a minimum threshold period.
  • As already explained, a policy encouraging career growth depending on the duration that the employee has worked in the company can also be helpful in achieving this objective. For senior management, this directly corresponds to their ambition to be groomed for COO or CEO-level positions in the company.

5. Non-solicit
A non-solicit clause prohibits the employee from encouraging the employer’s clients, consultants, agents or other employees to terminate their relationship with the employer, in the event that he ceases employment. The clause is inserted to protect the organization’s interest – the employee would by virtue of his employment learn the key operational aspects of the business, and it is against the legitimate commercial interest of the employer to have the employee leave with its customers and employees. The clause is usually applicable for a finite period of time.

For example, Apple’s employment agreement prevented any employee from entering into contract with its suppliers, if they left the company. This prevented Steve Wozniak, its co-founder from hiring the same design agency which worked for Apple, for his own startup when he left the company (although his startup was not competing with Apple and operated in a different segment). 


6. Stock options
Granting stock options is an excellent way of incentivising the employees, especially in startups and those companies which are in their growth stage. Generally, the agreement will mention the number of stocks granted to the employee (in case of senior management, number of stocks granted is heavily negotiated) or it will mention that the number of such stocks to be granted would be decided by the Board of Director or the Compensation Board. However, such stocks would have a vesting period of three to four years. We have discussed in details on how ESOPs are granted in a separate chapter.


 Note: When Steve Jobs, who had initially been fired as Apple’s CEO, returned to Apple, he had no stock in the company as he had sold all his shares shortly after being fired. He worked for an extremely low salary, but took a huge amount of options in the company. In the Indian context, a director who has more than 10 percent shares or an employee from the promoter group cannot be granted stock options. 

7. Intellectual property and relevance of ‘inventions schedule’ in the hiring process
Generally, all employment agreement will have a specific clause related to intellectual property (IP), which will state that IP in all work done for or on behalf of the organisation or using the resources of the organization shall vest with the organisation. This clause is quite important as in case of any dispute, it will be easy to prove that the intellectual property was developed under a contract of service and thus the IP strictly belongs to the organisation.
Often the employees who have been appointed (especially those in the top management of the company) have created or developed substantial intellectual property for their previous employers or might have their own IP developed independently from their past employers. In order to avoid liability and complications, companies will ask the employees to state the past intellectual property developed by them or owned by them in a separate schedule annexed to the employment agreement called the ‘inventions schedule’. They might also ask the employees not to reveal or use any of the past IP developed by them for the company.
In case the company is willing to use the independently developed IP, there should be a clause which should state that the IP mentioned in the schedule is licensed to the company as per the terms of a separate agreement or as per terms of the same agreement (as the case may be).

For example, if Microsoft hires coders who worked with Google, having an invention disclosure format will be extremely useful in clarifying and distinguishing their work with the current employer from that undertaken for the former employer.
8. Indemnity
Most employment agreements will include a clause wherein the employer will provide indemnity to the employee against lawsuits, claims, or demands against the employee resulting from the employee’s good faith performance of his duties and obligations. Note that a company cannot indemnify its directors under Indian law.
However, it can seek an indemnity from the employees for any claims arising out of their negligence, fraud or dishonest acts, contravention of the provisions of the company policies or applicable laws. In order to minimise the liabilities, companies can opt for D&O insurance which has been discussed later in a different chapter.

9. Determinations in case of disciplinary violations

Often, disciplinary violations by an employee may be decided upon by an internal committee in the organization. Employee grievances or disputes with bosses may also be decided by a senior-figure in the organization. For example, disputes raised by an employee in the Sales Department of an organization (let’s assume he works under the Vice President, Sales) relating to his workflow or his treatment in the organization may be determined by a retired Manager of the company, or even the Manager of another department. These processes are different from arbitration or expert determination, and are often mentioned in the employment contract. They are expected to reduce friction between the employee and the organization by creating consultative processes.


10. Arbitration

Arbitration clauses in employment contracts are useful in enforcing legal rights quickly  within a specified time-frame and at a convenient location. Typical questions that must be answered are:

  • Governing law of the contract – For a company with presence in multiple countries, the system whose legal principles are applicable to senior management becomes an important consideration. This may differ depending on the place of their work or the scope of their overall responsibilities. For example, a company with a US head office can appoint head of India operations who sits in New Delhi. Which law should apply to his disputes? What about the Chief Operating Officer of an Indian multinational with presence in 5 countries?
Both the company and management executives must carefully go through this provision to ensure this is aligned with their interest.
  • Place of arbitration – The place where arbitration will be held can be important as it impacts costs of dispute resolution.
  • Method of appointment of the arbitrator – in many cases the company as the employer retains the unilateral right to appoint an arbitrator, which is unenforceable in a court of law. 
Special clauses generally included in the employment agreements of senior management/key-employees of a company
1. Golden parachutes and golden handshakes
Golden handshakes or golden parachutes clauses are added in employment contracts with directors which provide for exorbitant payments to them from the company in case their services are terminated. When a director’s employment is terminated due to change of control (like acquisition or mergers) the severance protection mechanism is known as golden parachute; in other cases unrelated to change of control, such severance protection mechanism is known as golden handshake.  This is a mechanism to protect their contract with the company, and is also a deterrent for an acquirer because it makes an acquisition more expensive (known as a takeover defense) – most strategic acquirers (and private equity funds who impose their own management team on the target company) will have to pay significant money in case they fire the director post the acquisition.
2. Gardening leave clauses
Nowadays gardening leave clauses are increasingly becoming popular in employment agreements. In most cases, companies would have a provision wherein the employee who is leaving the organisation (and mostly when he is going to join a competitor) or a terminated employee is asked to stay away from work or office during his notice period or the remaining period of his service. During this period, the employee is paid his full salary and enjoys other benefits of service and remains on the payroll of the company. This is done to protect the trade secrets of the company and leakage of confidential information of the company regarding newer projects of the company.
3. Golden handcuffs
Golden handcuffs are corollary to the golden parachute – it prevents the highly talented and remunerated employees from leaving the organisation. Golden handcuffs are financial benefits in form of stock options, deferred payment mechanisms and phantom stocks issued to the employees, which act as a deterrent for the employees to leave the organisation before a fixed amount of time.
Note: Phantom stock is a contractual right which allows the employee to obtain cash compensation based on the increase in the valuation of the company. Unlike an ESOP, no shares are issued, but the corresponding gain amount is paid out in cash to the employee. 

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