What is a Compensation Agreement?
Compensation agreement contracts (also referred to as compensation agreements or profit remuneration contracts) are common contractual documents used by businesses to define the remuneration and compensation of their employees. These documents typically cover employment, commission and profit sharing on a domestic and international level (codifying how each will be calculated according to tax laws). While compensation agreements are capable of being verbal, they are not recommended due to the challenges associated with gathering evidence or proving that a written contract exists once a conflict has risen . Additionally, written compensation agreements can also be used to demonstrate to the tax authorities that the business is acting legitimately and not abusing tax regulations.
However, compensation agreements contracts aren’t only for employees and can, in fact, be tailored for a range of different agreements and relationships with the business (for example, business partners, affiliates, agents, etc). Therefore, compensation agreements contracts are often used when the concept of a profit share is used to compensate someone who is helping promote the business.
Basic Conditions of a Compensation Agreement
While each compensation agreement contract will be unique for each employee, a few items are universal. An employment contract should include the salary (or other financial compensation) for your work, whether that is hourly or by salary. The compensation agreement contract may also include any signing bonus or year-end bonuses. In addition to outlining the salary for your work, the compensation agreement contract should also discuss your benefits, such as health insurance, dental insurance, vision insurance, and 401k contributions. Health insurance and other benefits can be very valuable to your employment, and you want to make sure everything is written down in the contract so that the employer cannot later say they do not offer such a benefit.
We all like to get awards for being good at our jobs and accomplishing results in the workplace. The compensation agreement contract may discuss any bonuses that the employer will award, whether that is based on performance or tenure. You should be clear as to the amount of bonuses you will receive, when they will be paid out, and the method of payment (paycheck, check, direct deposit, etc.). Again, you want this information included as part of your employment contract so that you can be sure you are paid fairly and according to the agreement reached. How and when you are paid is an important part of your compensation agreement contract. Many employers have different schedules for paying out employees. Some will pay you bi-weekly, others monthly, or even weekly. The contract should clearly detail when you will be compensated for your work, so there are no disputes later on. If direct deposit is offered, the times the money is actually deposited can vary from employer to employer and could differ from expectations. Again, you want to make sure these details are included in your compensation agreement contract so that you are not confused later.
Legal Considerations in Compensation Agreements
Compensation agreements are not just about the money and the provisions that govern the compensation of executives or employees are not the only pieces of the legal puzzle in a compensation agreement. First, any compensation agreement is a contract entered into at law and therefore a moving target as laws change over time. Secondly, compensation represents value to the recipient and as such there are tax and other legal implications whether for the payor, the recipient or both. Finally, there are enforcement issues relative to the compensation agreement that must be kept in mind.
Regardless of whether the payor is the company, an executive or a third party, the compensation agreement must comply with all applicable laws related to the recipient and the nature of the compensation awarded. There are numerous laws, rules and regulations related to taxation, trade compliance, anti-bribery, employment, non-competition, non-solicitation, intellectual property rights, licensing, pension and retirement plans and more that must be considered when crafting a compensation agreement, whether it is an employment contract, executive bonus plan, phantom stock plan or any other type of plan. Even the name applied to the compensation can have implications, e.g., W-2 vs. 1099 reporting, expense reimbursement or taxable compensation.
Not only should the compensation be described in legal terms that fit each individual situation depending on the terms of the employment or compensation agreement itself, but also the language used in the agreement should be clear and unambiguous. Clarity in language can help ensure the enforceability of the employment agreement in the event of litigation or negotiation regarding the terms and rights contained within. A long, poorly written contract can result in ambiguity as to the intent of the parties with respect to legal rights, regulatory obligations and remedies. A clearly written compensation agreement is usually beneficial because complex matters are usually more susceptible to difference of legal opinion than less complex matters and therefore are a higher risk/benefit proposition capable of being used against either the payer or the recipient to the detriment of the other.
The legal review of any compensation agreement is one of the most important things that can be done. Not only does legal review result in a better outcome but also provides executives with the peace of mind that their compensation will withstand future challenges from management or the Board of Directors and also assures that payors will not be caught off guard by their own actions relative to the compensation awarded.
Advantages of Having a Compensation Agreement
The benefits of having compensation agreements in place can be significant. For employers, these contracts are the clearest means of establishing the terms of employment and preventing disputes between the employer and employee. Furthermore, having clear terms set out with compensation agreements helps employers plan for future income and expenses.
Compensation agreements also clarify the nature of the employment. They allow employers to create flexible compensation arrangements and provide for the event of a termination. For example, an employer may only be required to provide the statutory requirements in the event of a termination, or may limit the notice period for resignation. The agreement can also provide terms for when the employer is able to terminate employment without notice, such as in cases of serious misconduct.
Clear compensation agreements are also beneficial for employees, who will know exactly what to expect from their employment. For example, there will be no question about how much the employee is to be paid for overtime worked. Furthermore, by having the terms of employment in writing, the employee will have access to clear legal recourse should the employer breach the terms of the agreement.
The net result of having a clear compensation agreement in place is less time spent on resolving conflicts concerning the agreement. This results in money being saved, both by employers in terms of legal fees and potential damages, and by employees in being able to avoid long, drawn-out negotiations with their employer over the terms of the agreement. The time and money saved can be better spent on achieving more productive ends.
Common Pitfalls to Avoid
Failure to ensure that the separation agreement is consistent with any other form of agreement or understanding. In situations where an employee has multiple agreements with the same employer, it is important to ensure that the separation agreement is consistent with any management employment agreements or side letters. For example, if an executive employment agreement contains a provision that states that accrued vacation time will be paid out upon termination, but the separation agreement does not address accumulated vacation time, then the employee may have an argument that the vacation payout is required.
Failure to include an express release of claims. Many parties incorrectly believe that signing a separation agreement means that the employee has released claims against the employer . A proper release of claims, however, must be carefully drafted and run through various statutes to ensure adequate coverage. If a release does not encompass all claims, there is a possibility that the employee who signed the separation agreement could bring a lawsuit in the future. Therefore, the release should be broad enough to cover all claims that the employee may bring for any actions up to the point of signing.
Not making the agreement clear. The best separation agreements leave no room for interpretation. They are clear, concise, and say what they mean. Many separation agreements are too wordy and/or not drafted in plain English. It is important to use plain language so that the employee fully understands what it signed. If an agreement is too dense, the employee may not realize what he/she is actually signing.
Negotiating a Compensation Agreement
The negotiation of a compensation agreement can be a challenging part of the offer process unless you are well prepared. I always advise doctors not to rush the negotiation and instead to take the time necessary to be ready for the discussion. There are several key components to the negotiation process. First, you need to prepare. Whether you are using an attorney or not, research is the key to success during the discussion. You should have already researched the market standard for the compensation for your intended geographic area and specialty. Knowledge of the market average and range of compensation will help you set expectations and give you leverage during the discussion. If you do not have this information, your attorney should be able to provide you with some general parameters.
Second, you need to know where you can bend or be flexible to get a more favorable term – either on the request or the counter-request. For instance, a good faith negotiation is critical for a successful negotiation. If you plan to ask for a FMV increase in one area, you may also need to consider reducing another area – either the length of the term, signing bonus, CME reimbursement, etc. Knowing how and where you can bend is essential to understanding how to be able to get the compensation you desire and still be consistent with market averages and ranges. In general, if you begin to over-ask and be overly pushy, you may lose any shot you had at getting the compensation you desire down the road. Compensation agreements are just that – an agreement on compensation. Both parties need to be willing to come to the table and listen. The more you show that you are willing to discuss, the better chance you have to land the compensation you desire.
Finally, once you have the request or the counter-request from your prospective employer, you should have conversations internally. You should start by determining if the request/counter-request is industry-standard. You may be surprised to learn that some agreements are way above market averages or ranges. You should also seek to understand from the employer why they are making the request/counter-request and if you need to look at an alternative approach. These discussions are conducted by your attorney but without understanding the position of both parties, it is difficult for an attorney to determine strategy. As a result, even if you plan on using an attorney, do your best to have internal conversations so that you can understand how best to negotiate for the compensation you desire.
Revising a Compensation Agreement
It is critical to continue to review and update Compensation Agreements, as the agreement must be in compliance with all federal and state laws and the terms of the document should align with the current practices at the Client and the economic conditions of the time. For example, if an Executive’s role has changed significantly due to downsizing or other factors, it is recommended that the Compensation Agreement be reviewed and amended to reflect this new reality. Similarly, the Compensation Agreement must be in compliance with any new laws enacted after the agreement is signed, such as the March 14, 2014 amendments to the Delaware Limited Liability Act or any administrative interpretations issued by the New York State Division of Human Rights.
The process of amending a Compensation Agreement is simple; after there is agreement between the Client and the Executive regarding the changes to be made , the changes can be swiftly incorporated into a revised version of the Compensation Agreement. Simply restate the provisions that should remain unchanged from the previous version of the Compensation Agreement and add in the new terms that will take effect immediately or on a specified date. This process should also be used when an Executive leaves the Client’s employment as well. The parties may agree to amend the Compensation Agreement to reflect a reduced compensation or other benefits package after the Executive has vacated his or her position, so long as this reduction is not retaliatory and is not designed to deter the Executive from pursuing his or her rights in litigation or otherwise.