Many employers are surprised to learn that the employment relationship does not automatically convert to “at-will” when an employee’s fixed employment term expires. Instead, when asking for clarification on this issue, employers are usually on the receiving end of their least favorite lawyerly answer: “It depends.”
Many jurisdictions, including New York, presume, generally, that the parties intend to extend the contract for successive one-year terms if the employee continues to provide the same services in the same way after the initial contract term expires. Employers who are not aware of this presumption often get burned, finding themselves liable for costly severance obligations that they thought were extinguished when the initial contract term expired. Other employers may be aware of the presumption, but are nevertheless surprised that certain post-employment obligations they intended to enforce against the employee are no longer effective.
The usual reason for these predicaments: inadequate contract drafting.
Employers must pay particular attention to the details at the onset of the employment relationship to overcome this common law presumption. Any employment contract should contain clear language addressing the rights and obligations that flow from the expiration of the initial employment term. Specifically, the contract should address whether the term renews unless one of the parties provides written notice of non-renewal, and what happens when the term expires — does the employee’s status convert to at-will or does the employment relationship end altogether? What happens to any post-employment obligations? May the employer still enforce a non-compete provision? Do any severance obligations to the employee remain in effect? Should the parties still settle disputes in accordance with a mandatory arbitration clause or in a specific venue as contemplated in the agreement?
These concerns become even more critical when the employee is a high-level executive. Unlike rank and file employees, executives are usually compensated through a complex combination of salary, benefits, incentive bonuses, various forms of stock ownership and/or participation in non-qualified deferred compensation plans. In many instances, failing to specify the conditions triggering payment under different scenarios can have enormous negative financial and tax consequences for the parties.
Employers often seek to ensure that an executive’s compensation will cease to accrue upon expiration of the contract’s term unless the parties execute a separate renewal agreement. Related provisions may include that the executive is to receive a pro-rata share of any target bonus, except if terminated for cause, and that the executive is entitled to severance, such as continuation of salary and benefits for a specified period, upon execution of a release waiving future claims against the company. Further, the employer may also want to maintain the benefit of any previously-negotiated restrictive covenants even after the term’s expiration. A contract that fails to sufficiently specify the nature of the parties’ relationship at the end of the term can have the unintended consequence of altering or negating many of these provisions.
Setting forth the manner in which an employment relationship shall continue, if at all, upon expiration of the agreement’s term is just one step in negotiating effective employment contracts, but it is essential to protecting an employer’s business and financial interests. As every employment relationship is different, incentives often change, and events are rarely predictable, failure to address these issues in the agreement can be very costly for employers.