Key Considerations of Executive Contract Negotiations

Summary: An executive contract is a legal employment agreement between the employer and an employee, serving in executive positions such as Chief Executive Officer, Chief Financial Officer, Chief Operations Officer, etc. The contract provides an overview of the contractual obligations of an executive towards the employees, in terms of scope it is expansive in comparison to other employment contracts.

An executive contract typically includes: -

• ?Duties and responsibilities
• ?Compensation, including salary, bonus, and severance
• Benefits and equity arrangements
• Duration of employment (also known as “term”)
• Early termination and severance terms
• Post-termination restrictions
• Mechanisms for dispute resolution

Best Practices Related to Executive Employment Agreements

1. Individual Agreements: Contracts should include all compensation and termination clauses in the initial contract to ensure a positive employee-employer relationship and prevent disagreements.
2. Protection of Intellectual Property: Contracts should include provisions of confidentiality and invention assignment contract.
3. Change in Control Agreement- Companies must clearly spell-out the impact of a change in control event on the employment status of the employee such as severance pay, post-termination benefits, equity vesting, dilution of role, etc. This ensures that the employees aren’t uncertain about their future while handling the change in control event.
4. Malus and Clawback: In case, an employee is involved in unethical conduct which can cause financial and reputational damage to the company then the provision of malus allows to cancel all further payments to the executive while clawback provision allows the recovery of payments and benefits already paid.

Negotiating Executive Contracts

The process of negotiating an employment contract is the start of what both parties hope will be a long and fruitful collaboration. The employer and executive may maximize the value of the arrangement to both parties, create a solid relationship, and retain executive talent in the future by focusing negotiations on crucial financial aspects. Well-crafted employment agreements are a clear marker of effective governance for public companies. The following factors should guide talks for executive contracts:

Pre-negotiation Steps

Determine the Party: Companies should have a clear idea about who will be the parties involved in negotiating contracts with a potential employee. The company must ensure that the parties must be comparable to the potential employee in terms of position.

Term Sheet & Tally Sheets: Use of term sheets and in case of listed companies, tally sheets, can help the negotiating parties finalize the agreement at a rapid pace.

Duties & Exclusive Services

Duties: The definition of tasks could seem formulaic at first. However, in practice, this clause might set important economic parameters, such as when or if the executive could subsequently voluntarily terminate their job for a "good reason" and get severance compensation, or when or if the employer could do so for "cause." An employer often preserves more freedom by writing this provision broadly, for instance, if the executive reports to a position rather than a specific person.

Exclusive Services: The company must understand what the additional responsibilities an executive undertakes besides working full-time with the company. It’s a good practice to have prior knowledge and provide the necessary approvals.

Components of the Compensation Plan

Components: The contract should include all the components which both the parties have agreed on in the written agreement such as base salary, bonus, leave encashment, etc. An "inducement" grant of equity outside of the shareholder-approved plan may be taken into consideration by publicly traded employers who have a finite number of shares left in the share reserve of their equity incentive plan.

Amount: The employers should understand the current market pricing and practices to provide an effective compensation package. In case of listed companies, peer benchmarking can provide the latest information.

Form of Equity Awards

If the parties intend to include equity awards in the compensation package, deciding what form or type of equity award to use will depend on the parties' intentions to structure performance incentives, share ownership, maximize capital gains, and postpone income recognition, among other goals. The shape of the award should be determined by the parties' objectives.

Severance and Employment Termination Triggers

Termination?Triggers: The contract should determine how the severance pay will get triggered in case of termination of employment under various scenarios, such as Cause. The executive may also be entitled to severance if he or she terminates employment for good reason, disability, death or other specified events. As to Cause, should the executive have the opportunity to cure the Cause condition before being terminated? And if evidence is later acquired after termination that would have supported a termination for Cause, should the employer be able to retroactively terminate the executive for Cause (thereby eliminating any future severance payments)?

Severance Pay: Severance pay is a financial incentive provided by the employer to the employee when the latter is voluntary or involuntarily terminated. Employers should determine how will the company pay to the employees i.e. a lump-sum cash payment or payments over a period.

These best practices and negotiation factors will help both executive leaders and their employers ensure they're getting into a fair deal while entering a new contract.