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Written Employment Contracts: Pros and Cons

By | Small Business

A written employment contract is a document that you and your employee sign setting forth the terms of your relationship. You don't have to enter into a written contract with every employee you hire. In fact, written employment contracts are generally the exception, rather than the rule. In some situations, however, it makes good sense to ask an employee to sign a contract.

What Goes in an Employment Contract

In addition to clearly describing what the employee is going to do for you (the job) and what you are going to do for the employee (the salary), the contract can address many other aspects of the employment relationship, such as:

  • duration of the job (one year, two years, or indefinitely)
  • information about the employee's responsibilities
  • what benefits (such as health insurance, vacation leave, disability leave, and so on) the employee will receive
  • grounds for termination
  • limitations on the employee's ability to compete with your business once the employee leaves
  • protection of your trade secrets and client lists
  • your ownership of the employee's work product (for example, if the employee writes books or invents gadgets for you), or
  • a method for resolving any disputes that arise about the agreement.

Advantages of Using Contracts

Employment contracts can be very useful if you want control over the employee's ability to leave your business. For example, if finding or training a replacement will be very costly or time-consuming for your company, you might want a written contract. It can lock the employee into a specific term (for example, two years) or require the employee to give you enough notice to find and train a suitable replacement (for example, 90 days' notice). While you can't force someone to keep working for you, an employee is likely to comply with the agreement's terms if there's a penalty for not doing so.

Employment contracts might also make sense if the employee will be learning confidential and sensitive information about your business. You can insert confidentiality clauses that prevent the employee from disclosing the information or using it for personal gain. Similarly, a contract can protect you by preventing an employee from competing against you after leaving your company.

Sometimes, you can use an employment contract to entice a highly skilled candidate to come work for you instead of the competition. By promising the individual job security and beneficial terms in an employment contract, you can "sweeten the deal."

Finally, using an employment contract can give you greater control over the employee. For example, if the contract specifies standards for the employee's performance and grounds for termination, you may have an easier time terminating an employee who doesn't live up to your standards.

Disadvantages

An employment contract is not a one-way street. The contract binds both you and the employee, so it limits your flexibility. This may pose a problem if you later decide that you don't like the contract terms or the needs of your business change. In those circumstances, if you want to change the contract or terminate it early, you'll have to renegotiate it -- and there's no guarantee the employee will agree to what you want. 

For example, if you decide you want to end a two-year contract after six months because you don't really need the employee after all, you can't simply terminate the employee -- this would be a breach of contract. Similarly, if the contract promises the employee health benefits, you can't later stop paying for these health benefits as a way to save money. The only way to change the terms of the contract is to renegotiate them. This can be done, but it's time-consuming and requires the employee's consent.

Another disadvantage of using employment contracts is that they bring with them a special obligation to deal fairly with the employee. In legal terms, this is called the "covenant of good faith and fair dealing." If you end up treating the employee in a way that a judge or jury finds unfair, you may be legally responsible not only for violating the contract, but also for breaching your duty to act in good faith.

For detailed information on hiring, firing, and everything in between, see The Manager's Legal Handbook, by Amy DelPo and Lisa Guerin (Nolo).

If you want some advice from a lawyer, Nolo's Lawyer Directory can help you find a local employment lawyer.

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