Agreement to maintain confidentiality
Employers may require that employees sign an agreement to keep secret the employer’s confidential information. A violation of the confidentiality agreement may be a basis for termination of employment and provide a cause of action for the employer to sue the employee for breach of contract.
A benefit of a contract to maintain confidentiality is that information that may not qualify for protection as a patent or a trade secret may still be covered under the confidentiality agreement. All information treated as confidential under the terms of an agreement must in fact be treated as confidential by the employer.
Employees, however, should not be able to infer from a contract of confidentiality that they have a contract that guarantees them continued employment. To avoid ambiguity, the confidentiality agreement should include a statement affirming the employee’s at-will status.
Covenants not to compete
Covenants not to compete are agreements between two parties, typically an employer and employee or a purchaser and seller of a business, that prohibits one of the parties from competing in a similar field of business with the other party for a specified duration of time and in a specified area. The covenant not to compete may not be overly restrictive, otherwise it will likely be unenforceable. The Illinois Freedom to Work Act specifically forbids employers from entering into noncompete agreements with employees who earn less than $13/hour.
In addition to this requirement, Illinois law also requires that noncompete agreements are based on a legitimate business interest of the employer and narrowly tailored with regard to time, geographic location and activity.
This area of law often changes and your business’s noncompete agreement must adapt to constantly evolving and interpretable laws of each relevant state.
As a general rule, courts generally uphold limitations of one year or less. To alleviate the hardship on the employee and to enhance the likelihood of the enforcement of the covenant, some employers provide their former employees with partial pay for the duration of the covenant during which the employee is unable to work in some positions without violating the terms of a covenant. A company must provide a business necessity that demonstrates the reasonableness of the duration (e.g., training).
The overuse or over-breadth of covenants not to compete precludes their enforceability. If a company wants all of its employees at every level to sign restrictive covenants, it should consider drafting several versions of the agreements differing in the degree of restriction. A more restrictive covenant would apply to employees directly involved with the company’s research, development or marketing. A less restrictive covenant would apply to employees unlikely to have access to the company’s confidential or proprietary information.
Each covenant should recite that the employment relationship is at-will so that no implication can be drawn that there is a fixed term of employment created by the covenants. Covenants that provide for more extensive restrictions should also include a statement acknowledging that the employee had an opportunity to seek the advice of independent counsel.
In order to improve the likelihood that a court will enforce a restrictive covenant against a former employee, the agreement should be tailored to the level of protection that is necessary to protect the employer’s interests upon the departure of the particular employee. A higher level of restriction is justified for a sales representative with substantial customer relationships than for most other employees.
The likelihood of enforcement of a restrictive covenant will be increased if it does not attempt to prevent a former employee from continuing to work in his or her profession, but merely prevents the former employee from taking advantage of the confidential information about the former employer’s business on behalf of a new employer.
Employers should consider whether their interests can be protected adequately through an “anti-piracy” or anti-solicitation agreement rather than a noncompete agreement. An anti-piracy agreement prevents a former employee from soliciting any of the employer’s customers or prospects or helping others to solicit them but would not prevent him or her from working in the same industry. An “anti-piracy” agreement is in general more narrowly tailored than a covenant not to compete and consequently more likely to be enforceable.
Hiring a new employee who formerly worked for a competitor presents potential issues with respect to covenants not to compete. If a newly hired employee was subject to a restrictive covenant with the employee’s prior employer, the hiring company might find itself involved in litigation with the past employer. The past employer may sue not only the departed employee, but that employee’s new employer, contending that the new employer induced the employee to violate the employee’s contract with the past employer, misappropriated the trade secrets of the previous employer or interfered with the previous employer’s contracts.
An inquiry into whether a new employee has contractual confidentiality or noncompetition responsibilities to a former employer should be a regular hiring procedure. Particularly with new employees who previously worked for a competitor, this investigation might reveal potential problems involving covenants not to compete and provides evidence that the hiring company took reasonable care to avoid misappropriating the competitor’s secrets in the event the employee misuses information on the hiring company’s behalf.
Litigation between employers and their departed employees regarding alleged breaches of restrictive covenants or misappropriation of trade secrets often has the undesirable side effect of involving one’s customers in litigation. In order to establish whether a departed employee has contacted customers of the past employer about whom the employee possesses confidential information, it is often necessary to conduct discovery and litigate about who the customers were of the past employer and who the customers are of the new employer.
Such lawsuits often involve issues regarding whether the new employer is doing business with the customer because of the relationship of the new employee and the knowledge that the new employee possesses from the past employer or whether there are other independent reasons that the customer is doing business with the new employer. Often neither the past employer nor the new employer wants to have the customers inconvenienced and involved in the litigation. Customers may react negatively to such disputes and almost invariably prefer not to be involved.
Litigation regarding restrictive covenants most commonly involves motions to seek injunctive relief to block an employee from engaging in particular activities for the new employer and after the initial flurry of motions and discovery to attempt to obtain an injunction, cases are typically resolved, often by working out agreements regarding what the employee will or will not be permitted to do for his or her new employer.
Agreements entered into after January 1, 2022
The Illinois Freedom to Work Act was amended in 2021 to expand the limitations in restrictive covenants employers require of their employees, such as covenants not to compete and covenants not to solicit.
- For example, a covenant not to compete is void and unenforceable unless the employee's actual or expected annualized rate of earnings exceeds $75,000 per year.
- Similarly, a covenant not to solicit is void and unenforceable unless the employee’s actual or expected annualized rate of earnings exceeds $45,000 per year.
- The amendments define “earnings” as “the compensation, including earned salary, earned bonuses, earned commissions, or any other form of taxable compensation, reflected or that is expected to be reflected as wages, tips, and other compensation on the employee's IRS Form W-2 plus any elective deferrals not reflected as wages, tips, and other compensation on the employee's IRS Form W-2, such as, without limitation, employee contributions to a 401(k) plan, a 403(b) plan, a flexible spending account, or a health savings account, or commuter benefit-related deductions.”
The amendments further provide that “[a] covenant not to compete or a covenant not to solicit is illegal and void unless:
- the employee receives adequate consideration
- the covenant is ancillary to a valid employment relationship
- the covenant is no greater than is required for the protection of a legitimate business interest of the employer
- the covenant does not impose undue hardship on the employee
- the covenant is not injurious to the public.
Under the amendments, “adequate consideration” means either:
- the employee worked for the employer for at least two years after the employee signed an agreement containing a covenant not to compete or a covenant not to solicit
- the employer otherwise provided consideration adequate to support an agreement to not compete or to not solicit, which consideration can consist of a period of employment plus additional professional or financial benefits or merely professional or financial benefits adequate by themselves.
The amendments also provide guidance as to what is a “legitimate business interest of the employer,” noting that a totality of the circumstances must be considered, including but not limited to “the employee's exposure to the employer's customer relationships or other employees, the near-permanence of customer relationships, the employee's acquisition, use, or knowledge of confidential information through the employee's employment, the time restrictions, the place restrictions, and the scope of the activity restrictions.”
The amendments further provide that a covenant not to compete or a covenant not to solicit is illegal and void unless:
- the employer advises the employee in writing to consult with an attorney before entering into the covenant
- the employer provides the employee 14 calendar days to review the covenant.
The bill also expands remedies available to employees, providing that “if an employee prevails on a claim to enforce a covenant not to compete or a covenant not to solicit, the employee shall recover from the employer all costs and all reasonable attorney's fees regarding such claim to enforce a covenant not to compete or a covenant not to solicit, and the court or arbitrator may award appropriate relief.”
Finally, the Attorney General may initiate or intervene in a civil action whenever they have “reasonable cause to believe that any person or entity is engaged in a pattern and practice prohibited by this act.”
Relatedly, employers should review the earnings levels of the positions with whom the employer currently uses restrictive covenants and discontinue entering into, amending or renewing such agreements with employees whose earnings do not meet the minimum earnings thresholds described by the amendments.
The nature of the right
The Illinois Trade Secrets Act is largely identical to the federal the Uniform Trade Secrets Act which describes a trade secret as “information, including a formula, pattern, compilation, program, device, method, technique or process that both:
- derives independent economic value, actual or potential, from not being generally known to and not being readily ascertainable by proper means by, the public or to other persons who can obtain economic value from its disclosure or use
- is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.
Some examples of typical trade secrets are chemical formulas, customer lists, market strategies and manufacturing processes. Even reports about unsuccessful research may be trade secrets as “negative information” if the information has commercial value from not being generally known.
The benefit of treating information as a trade secret is that it will enable the company to sue others for using or even threatening to use the trade secret if it was obtained by improper means and the information is protected from public disclosure.
The duration of trade secret protection, unlike patents, is potentially infinite, as long as the information retains the requisite value and secrecy qualities of a trade secret. Thus, companies sometimes will not seek patent status because a patent expires after a set period, whereas a trade secret can be maintained indefinitely. Sometimes, companies that are seeking a patent will maintain the information as a trade secret in case the patent is ultimately denied (and the patent application has not been published).
Requirements to maintain trade secret status
Information must meet two requirements to be considered a trade secret:
- the information must derive economic value from not being already generally known or discoverable by proper means
- the company must take reasonable efforts to maintain the secrecy of the information.
Information that is known or readily obtainable by proper means is not a secret and cannot be considered to be a trade secret. Proper means of discovery include review of published patent applications, reverse engineering and discovery through a plant tour, trade publication or company brochure, to name a few.
Whether a company has taken adequate measures to protect its trade secret is determined on a case-by-case basis depending on the nature of the business and the information. Some examples of security measures include, but are not limited to:
- marking the information and all copies of the information “confidential,” "secret," "trade secret," etc.
- in the case of information stored on computers, marking the files containing the information “confidential” and “trade secret” and instituting various levels of access (for example, management team only)
- requiring employees to sign agreements to keep company information confidential and enforcing them as necessary
- limiting disclosure to a need-to-know basis
- keeping track of any copies of the information, for example by numbering copies and having employees acknowledge receipt in writing
- establishing a nondisclosure policy in an employee handbook that outlines a process for securing documentary confidential information and a requirement to turn over all confidential information upon request or termination
- making sure guests, such as tourists or reporters, are never allowed to view the trade secret while it is being used
- requiring other guests who must be exposed to the information as a part of the business to sign confidentiality agreements
- limited access to certain areas of the business office
- requiring any vendors who may have a need to know the trade secret to sign confidentiality agreements
- notifying any government compliance officers, such as OSHA inspectors, whenever they have the opportunity to observe or receive trade secret information and insist that the government maintain the confidentiality
- enforcing violations of the company’s confidentiality and trade secret rights.
In short, the company should take all measures to ensure that the confidential information is not unintentionally disclosed to the public.
Federal Defend Trade Secrets Act
On May 11, 2016, President Obama signed the Defend Trade Secrets Act (DTSA), which is the first federal protection for trade secrets. The act became effective immediately. For the first time, employers have a uniform definition of trade secret and a federal court civil remedy for trade secret appropriation if such appropriation relates to a product or service used in or intended for use in, interstate or foreign commerce. The act does not displace any state laws that provide greater trade secret protection than the federal act. The DTSA defines trade secret as follows:
The term “trade secret” means all forms and types of financial, business, scientific, technical, economic or engineering information, including patterns, plans, compilations, program devices, formulas, designs, prototypes, methods, techniques, processes, procedures, programs or codes, whether tangible or intangible and whether or how stored, compiled or memorialized physically, electronically, graphically, photographically or in writing if both:
- the owner thereof has taken reasonable measures to keep such information secret
- the information derives independent economic value, actual or potential, from not being generally known to and not being readily ascertainable through proper means by, the public.
Although this definition of trade secrets is not as broad as many state definitions that are based on the Uniform Trade Secrets Act, it provides the owners of the trade secret the ability to take action in federal court if there are misappropriations of their trade secrets.
Under the DTSA, a number of remedies are available to owners of trade secrets. Remedies can include injunctive relief, money damages for any harm and exemplary damages of up to two times the amount of the damages. Prevailing parties may also be able to recover attorneys’ fees. The statute of limitations for claims under the DTSA is three years. DTSA also provides protections for whistleblowers who disclose trade secrets “in confidence” to a federal, state or local government official or attorney “solely for the purpose of” reporting or investigating a potential violation of law or is made in a complaint or other document filed under seal in a legal proceeding. If an employer wants to be eligible to recover exemplary damages and attorneys’ fees under the DTSA, it must include notice of this whistleblower immunity to employees. Many employers choose to do this in their whistleblower policy, as well as in any confidentiality agreement.
Employees and assignment agreements
An employee has a common-law duty to maintain the confidentiality of the employer’s trade secrets. It is advisable for employers to take additional measures such as requiring employees to sign nondisclosure or confidentiality agreements to protect the company’s trade secrets. These measures, however, concern protection of a trade secret and do not concern ownership. Subject to some exceptions, absent an agreement to assign, the originator and creator of the trade secret owns it, but there are exceptions to the general rule.
An exception exists when an employee is hired specifically to complete research that leads to the creation of the trade secret. Under those circumstances, the trade secret is the property of the employer. However, absent those special circumstances, the most an employer possesses is a “shop right” to the trade secret if the trade secret was discovered during working hours or with the employer’s materials. The “shop right” gives the employer a non-exclusive license to use the trade secret in the normal course of business. It, however, does not prevent the employee from disclosing the information to others.
Therefore, employers should require employees to sign “assignment agreements” which transfer in advance all trade secrets developed by employees during their employment.
Employers should consider whether or not they want to include all of the terms of the employment relationship in the agreement or limit the scope of the agreement to certain specific terms. As stated above, an agreement also can state that the employer and employee acknowledge that there is no agreement on any additional terms, such as termination, compensation or benefits, other than what is stated in the contract. That type of provision can prevent claims from being brought based on alleged oral agreements. An employer should exercise care when drafting an agreement that if it does not include all the terms of their employment, then the agreement.
Type and level of employee to be covered
For a variety of reasons, employers generally do not use written employment agreements with employees who are not higher-level management employees or sales employees. First, written agreements for higher level employees are simply more prevalent. Higher level employees are more accustomed to written agreements and therefore request them more frequently. Executives have more bargaining leverage when entering into employment agreements and are therefore in a better position to request and receive written employment agreements. Higher level employees also may have multiple attractive employment alternatives and employers run the risk that executives may leave for other employers if the employer does not provide an agreement with some job security or severance benefits for the employee. Attracting and retaining the best executives is one of the primary reasons for employers to use written employment agreements.
The use of written agreements also more common among sales or sales management employees because a significant part of their compensation is usually received through commissions and those commissions often are a primary point of contact between the company and the clients. If a written agreement defining the commissions is not used, there is a greater opportunity for the parties to have a dispute regarding the amount of the commission due, the method for determining the commission, the length of time during which the commission will be paid and the payment of commissions upon separation of employment. Compensation agreements are discussed in more detail later in this chapter. Additionally, employers often request sales staff to sign non-solicitation agreements, either as part of the employment agreement or in a separate agreement that is incorporated by reference into the employment agreement.
Advantages and disadvantages of a written agreement
Before an employer enters into a written employment agreement, the employer should weigh the potential benefits of a written agreement against the costs or reduced flexibility to the employer with regard to the employment relationship.
Advantages to employees
The employee may gain greater employment security because the employee can obtain written protection against termination without notice or cause.
The employee may be able to negotiate for the terms of the contract, such as special benefits (education, expense reimbursement, company car, etc.), severance pay or method of dispute resolution.
The agreement may protect the employee against losing a job or may provide for payments to the employee if the employer is sold or taken over by another company or there is a change in control.
The employee’s efficiency, enthusiasm and loyalty toward work may increase because of the job security the agreement provides.
Advantages to employers
The agreement may set a definite period of time for which the employer will receive the employee’s services or may require the employee to provide advance notice before resigning. This can ease the transition in replacing an employee, particularly for specialized or high-ranking employees who can be hard to replace.
A written employment agreement is generally clearer than an oral contract; thus, the employer can more readily establish the terms of the contract to avoid disputes.
An employment agreement may establish the rights the employer may have against employees who breach their employment agreement.
An agreement that restricts key employees from leaving may help the company sell itself or increase the sales value of the business because the purchaser will be more likely to receive the benefit of the continued services of key employees.
An agreement that provides extra payments to employees in the event the company is sold or experiences a change in control can keep the key executives working for a company that is a takeover target or is the object of rumors of a potential takeover. Without those special protections, key employees may opt to look for or accept other positions in order to protect themselves from losing their jobs upon an acquisition of the company or change in control.
The agreement could protect the employer’s customer relationships or other business interests by preventing an employee from soliciting the employer’s customers or employees, competing with the employer for a defined period of time in a defined geographic area or using the employer’s information or property or engaging in other improper competitive activities after leaving.
The agreement could provide for arbitration or other methods to resolve disputes other than litigation. Although a small number of employment claims may be brought in court regardless of what an employment contract says, breach of contract and many other claims may be made subject to an arbitration or similar alternative dispute provision.
A written employment may be used to attract highly skilled candidates to work for one company over a competitor company that does not offer written employment guarantees.
Disadvantages to employees
The employee may lose the flexibility to end the employment at any time without advance notice or other penalties.
An employee may lack leverage or influence to negotiate favorable contract terms; therefore, the employer could impose upon the employee terms that are unfavorable to the employee.
The agreement may limit the employee’s ability to engage in other business activities without advance consent of the employer.
The agreement may restrict the employee’s ability to accept certain jobs or engage in certain competitive activities after employment ends.
Disadvantages to employers
The employer may lose the ability to terminate employees without restrictions (in addition to restrictions provided by law, such as the restriction on terminating employment for discriminatory or other unlawful reasons) if the agreement does not maintain the at-will relationship.
If drafted incorrectly, the employment agreement can become too restrictive, causing the employer to lose the flexibility to take immediate action regarding its employees. The employer may also lose the flexibility to change its benefits plans or other policies and procedures applicable to the employees if the agreement is not properly drafted to maintain employer discretion.
If the employment agreement provides that the employer may terminate an employee only for “cause” or “good reason,” there can be litigation regarding whether the employer’s termination of the employee was for “cause” or “good reason,” depending on how those terms are defined in the employment agreement and depending upon what the reasons were for the termination. Most employers would not want to undergo the cost and risk of having a judge or jury decide if there was a good enough reason to discharge an employee.
Elements of the employment agreement
The terms of the agreement should be written in a way that is understandable to all parties to the contract. It is advisable for the employer to consult with legal counsel when drafting a written employment agreement.
The following are the most common terms that are included in written employment agreements:
- duration or term of employment and renewal terms, if any – if the agreement is not for a term, it should clearly state that employment remains at-will
- employment duties and responsibilities
- employee compensation, including but not limited to salary, commissions or bonus payments
- employee benefits, such as insurance, retirement, leaves, car allowance, educational reimbursements, employer-provided cell phone, tablet or laptop, etc.
- termination of employment, including any notice requirements or cause provisions
- severance provisions
- confidentiality and use of company information
- restrictive covenants governing competitive activities after separation
- alternative dispute resolution.
Term and renewal
It is important to establish in the employment agreement both the beginning and the end of the employment relationship. If the agreement is at-will, it should expressly state that the employment remains at-will. Some agreements define an initial term (for example one year), then provide for the automatic renewal of the employment agreement unless one of the parties gives advance notice of non-renewal. Even without a renewal provision, courts may presume that the contract has been renewed automatically if an employee hired for a specified term continues to work past the end of that specified term. To prevent automatic renewals, the contract may use language that designates that the provisions of the employment agreement will end unless extended in writing by both the company and the employee.
If an employee quits before the end of the contract term, if the agreement is for a fixed term, the employer cannot obtain specific performance of the contract and cannot force the employee to continue to work for the employer. The employer could possibly, however, obtain money damages for the employee’s failure to work for the full contract term. Damages may include, but are not limited to, the cost of recruiting a replacement for the departing employee and any higher salary paid to the new employee during the original term of the employment agreement.
Employment duties and expectations
Communicating job expectations to the employee before the employment relationship begins can prevent misunderstandings that sometimes become the basis of a breach of contract lawsuit. The employer will generally want to retain the right to reassign the employee, assign additional duties and to require the employee to comply with company rules and policies. Employees will want to protect themselves from an employer stripping them of their job responsibilities or assigning them to undesirable jobs. It is important that the employer and employee understand and agree upon the duties the employee will be responsible for performing, as well as any other duties the employee may occasionally be assigned to complete. The description of job duties should be broadly stated so as to allow the employer flexibility when delegating responsibility to the employee. The description of job duties should also include a clause requiring the employee to “perform other duties as assigned” to allow the employer to assign duties that were not discussed in the written agreement.
Employee compensation and benefits
- Base compensation - The employment agreement should specifically indicate the amount the employee will receive for his or her base compensation and the timing of such payments. As explained in Wages and hours salary must be paid on designated paydays at least twice per month, no more than 16 days apart. The agreement should also specify that applicable federal, state and local taxes will be withheld from the base salary. Employers may consider adding a provision to allow them flexibility to adjust the payday or make wage adjustments without having to renegotiate the agreement.
- Bonus provisions - There are a variety of bonuses that an employee may receive. The most favorable way for an employer to handle the topic of bonuses is to reserve sole discretion to determine whether to pay the bonus, the amount of the bonus and the timing of any bonus payment. However, some agreements specify minimum dollar amounts for bonuses, objective formulas to calculate the bonus or even specific bonus programs. If bonuses are based on a formula and are not discretionary, the amount will have to be included when calculating an employee’s regular rate of pay for determining overtime compensation for nonexempt employees. See Wages and hours. The formula or standards for nondiscretionary bonuses should be clearly set forth and understandable to both the employer and employee. The bonus provision should address the timing of paying the bonus, the requirements for earning the bonus and what happens if the individual is no longer employed on that date that the bonus would otherwise become due.
- Revising or updating compensation - A format that employers may want to use for stating the compensation terms of a contract is to have a compensation schedule attached as an exhibit to the employment agreement and to have the employment agreement reference and incorporate the compensation schedule. The employment agreement should also state that the compensation schedule is subject to change and that if the employee continues to work for the company after a new compensation schedule is issued, the employee’s actions in continuing to work for the company shall be deemed an acceptance of the new compensation schedule. Alternatively, the agreements could identify the starting base compensation and reserve the right for the employer to provide raises in its sole discretion. By including the compensation terms in a schedule attached to the employment agreement, the employer can avoid having to go back to employees to get them to sign new employment agreements when the employer wants to change the compensation terms.
- Employee benefit programs - The employment agreement should also indicate what employee benefit programs are available to the employee. The easiest way to accomplish this is by giving the employee the same benefits that other similarly situated employees receive. In the provisions regarding employee benefits, the agreement should reference the summary plan descriptions for eligibility criteria. An employer may also want to reserve the right to change or amend benefits plans.
- Retirement benefits - The employment agreement is usually silent with respect to retirement benefits because those are generally left to separate Employment Retirement Income Security Act (ERISA) or non-ERISA plans. Furthermore, employers will want to have flexibility to make changes or to discontinue certain retirement programs, if advisable. See Benefits.
- Perquisites - Employment agreements may address the issue of perquisites by specifically listing them or the agreements may remain silent on the issue and allow the employer to provide perks in its sole discretion. Still other agreements refer to the general perks that similarly situated employees receive. It is generally up to the employer whether or not to mention perquisites. The most common perks are company provided transportation, company provided cellular phones, tablets or computers, employee purchase discounts and expense accounts or company credit cards.
- Expenses -The agreement may also specify what types of expenses will be paid by the company, such as travel, cellular phone or other telecommunications or computer equipment. This provision may also address the requirements for obtaining advance approval or submitting expense requests and receipts prior to reimbursement.
The purpose of a termination section of the employment agreement is to specify who has the right to terminate, under what circumstances termination is permitted and the different obligations of each party in each situation.
- Death and disability - Every employment agreement, other than at-will, should state that the contract terminates upon the death of the employee. Also, it is important for the agreement to address the issue of disabilities and to recognize that the employee may be unable to perform because of a disability. When addressing termination due to disability, the agreement must comply with ADA and FMLA requirements, as well as state and local laws regarding the issue of disability. See Disabilities and reasonable accommodations and Family and medical leave.
- Notice period or prescribed term of employment - Employers must decide whether to include a notice period that allows the employer to terminate the employee after that period of time has expired or to contract only for a specified period of time of employment. If the employer decides to establish a notice period, the length of that period must be determined. It is usually better to have either a relatively short notice period or none at all, unless the employer needs advance planning to fill a departing employee’s position and the employer believes that the departing employee could function effectively and with loyalty even after he or she has given notice of an upcoming departure.
- Notice without cause - A provision for termination with notice but without cause allows the employer to terminate the employee’s employment for no reason upon the condition that a specified period of time elapses once the employee is given notice. The language of this provision should be such that it works to release the employer from all obligations.
- What constitutes sufficient cause for termination - Termination for cause permits the employer or employee to end the relationship without being held liable for the remaining terms of the agreement. An employer should indicate in the contract what constitutes sufficient cause for termination of employment so as to avoid a court’s unpredictable interpretation of cause. Lawsuits over whether the employer had cause for termination of a written agreement are one of the most common disputes relating to employment agreements. Typical definitions of cause include, but are not limited to, the following:
- insubordinate behavior
- willful misconduct
- willful or habitual breach of duty
- theft and embezzlement
- conflict of interest
- abuse of leaves
- violating the employer’s policies or standards of conduct
- failure to perform job duties satisfactorily, sometimes after the employee has been given a certain amount of time to “cure” the deficiency
- misuse of company information or property
- breach of contract
- engaging in actions the reflect adversely on the employer
- drug or alcohol abuse
- criminal conviction.
- Termination by employee with good reason - Actions by the employer that may permit the non-at-will employee to terminate his or her employment include, but are not limited to, a material breach in the contract by the employer, a change in who controls the company, a change in location or a substantial reduction in job duties. An employer and employee can negotiate these terms when drafting the employment agreement.
Severance provisions typically apply to executive employees. The agreement should clearly specify the amount of the severance and how long the employer will continue to make severance payments. Sometimes the employer may require the employee to seek other employment to receive the benefits. The agreement should provide that the employee will receive the severance only if the employee signs a release of all possible claims against the employer. See the discussion of releases in Termination. The severance provision should also include a statement that the severance will not be considered wages and is not subject to trebling in the event of a dispute over the severance.
Alternative dispute resolution
Many employers are now including arbitration agreements as a condition of employment. Arbitration agreements are a form of alternative dispute resolution that has the advantage of deciding disputes more quickly, less costly and without a jury. The process usually begins with an employee who files an internal grievance that is referred to an arbitrator. Once the arbitrator has reviewed the situation and listened to both sides, the arbitrator reaches a decision that is final and binding upon both the employer and employee. Some judges resist the use of arbitration agreements covering all employment matters and have held that employees have the right to file suit over discrimination and certain other claims despite an arbitration clause in a contract. The EEOC has taken the position that an employee cannot be prohibited from filing a charge of discrimination with the EEOC, but the employee may be required to arbitrate the claim rather than filing a lawsuit in court after the EEOC finishes its investigation and issues a right to sue letter.
Other provisions that may be included in employment agreements
- Provisions requiring compliance with laws, such as safety and anti-harassment, anti-discrimination and no retaliation laws and compliance with employer policies, practices and procedures as they may be amended from time to time.
- Indemnification clauses, which provide that the company will defend and pay for any claims against the employee arising out of his or her performance of duties for the company.
- Non-disparagement clauses, which provide that neither party will say anything uncomplimentary about the other.
- Conflict of interest clauses, which require that the employee not do anything detrimental to the employer’s interests.
- Entire agreement clauses, which provide that the written agreement is the entire agreement between the parties and changes must be in writing. This helps to protect the employer from claims based on alleged oral promises not contained in the agreement or contradictory to the agreement.
- Choice of law, which typically specifies that Illinois law will govern the employment contract.
- Forum-selection clauses, which provide that lawsuits shall be filed in the courts of a particular jurisdiction.
- Attorneys’ fee provision, which provide that in the event of a lawsuit, the prevailing party would be entitled to collect their attorneys’ fees and costs from the party that did not prevail in the litigation.
Under the Illinois Workplace Transparency Act (WTA), employment agreements cannot impose nonnegotiable, unilateral conditions (i.e., conditions that prospective or current employees must accept to obtain or keep their jobs) that:
- prevent prospective or current employees from making truthful statements about alleged unlawful discrimination, harassment or retaliation
- require prospective or current employees to arbitrate claims relating to alleged unlawful discrimination, harassment or retaliation
- waive or otherwise diminish existing or future claims, rights or benefits relating to unlawful discrimination, harassment or retaliation.
These conditions may be allowed if they are part of a mutual agreement between the employer and the employee that is:
- reflects “actual, knowing, and bargained-for consideration from both parties”
- acknowledges the employee’s right to:
- report a good-faith allegation of an unlawful employment practice or criminal conduct to the appropriate government authorities
- participate in any appropriate governmental agency’s enforcement of discrimination laws
- make truthful statements or disclosures required by law, regulation, or legal process
- request or receive confidential legal advice.
See Workplace Transparency Act below for more information.
Compensation is usually paid to employees in the form of wages, salaries, commissions, bonuses, retirement plans, profit sharing, vacation, severance and other benefits. Employee benefit plans are discussed in Benefits. Generally, the amount and time of payment are agreed upon verbally for some types of compensation such as wages, salaries or bonuses. Employment handbooks, manuals or other policies often set forth in writing other forms of compensation, such as vacation pay and other benefits.
In ordinary circumstances, there should be little room for disputes to arise regarding the amount of compensation that is due to an employee, because the employer’s standard payroll practices will conclusively establish the rate of pay and the benefits. If an employee is paid at the same regular rate, the employer’s payment at that rate and the employee’s acceptance of that rate will be very persuasive that the employee was paid at the correct rate previously agreed upon between the employer and the employee. In some circumstances, however, employers should use written compensation agreements to prevent disputes from arising regarding the proper compensation for the employee. Situations in which the amount of compensation may not be readily apparent from the regular rate of pay include some executive compensation arrangements and commission payment plans.
This chapter addresses some of the issues that are involved with the use of compensation agreements. The primary situations in which compensation agreements are used – executive compensation and commissioned employees – are discussed. Commission payment plans also raise special issues under the Fair Labor Standards Act (FLSA). Wage and hour issues are generally addressed in Wages and hours; however, this chapter includes a discussion of how commission payment plans are treated under the FLSA.
The terms of a compensation agreement
In addition to the special types of compensation agreements discussed below, there are general terms that most compensation agreements contain, such as the following:
- base salary
- commission payments
- bonus and incentive compensation
- employee benefits
- vacation and leaves
- withholding from salary and benefits
- severance or other payments at the end of employment
- disclaimer that the compensation agreement does not change the employee’s at-will status, alter the termination or other provisions of an employment agreement.
An employer has discretion when structuring and developing a compensation agreement. It is more important to tailor an executive compensation agreement to the individualized needs of the employer than to use a form or follow a general design created by someone who does not know about the unique aspects of the employer’s company. The employer’s discretion to decide how much to pay its employees is, of course, subject to regulation by discrimination laws and wage and hour laws.
Differences in the compensation of employees must be based on differences in the employee’s job duties, working conditions or qualifications, not gender, age or other factors protected by law. If an employer’s female or minority senior managers are paid at a rate less than their male or Caucasian counterparts, the employer should examine the job duties of the positions to make sure that the salary differences are based on the duties of the positions, not the characteristics of the people.
The most convenient and flexible way for an employer to structure a compensation agreement is to have an employment agreement provide that the employee will be compensated in accordance with a compensation plan that is attached and to have the compensation plan be an exhibit or addendum to the employment agreement. It is much easier to change the compensation plan and have the parties document the use of a changed compensation plan than to enter into a new employment agreement, which could be necessary if the compensation is spelled out in the language of the employment agreement.
Executive compensation agreements
Drafting an executive compensation agreement can be a complex task, utilizing experts in employee benefits, tax and other areas. It is a good idea for an employer to seek professional guidance and assistance in designing an executive compensation plan, unless the employer intends for the terms to be simple and straightforward or unless the employer is using a form previously prepared by a professional and confirmed to be appropriate for re-use. Employers should consider the following factors when making the decision to design an executive compensation agreement:
- the complexity of the executive compensation arrangement
- the amount of compensation to be paid
- the different forms of compensation to be used in addition to salary, such as bonus, profit sharing, stock options, severance, pension and other benefits
- the number of executive compensation agreements the employer will maintain
- the potential effect on the executive’s employment or the executive’s compensation, of a sale or takeover of a business or a reorganization or change in leadership
- the anticipated need for modifications to the agreement and method for the employee to accept the modification
- type of compensation agreement the employer wants to establish
- the incentives or measures of performance that will be used as a basis for compensation
- whether there will be restrictions on the executive’s business activities after the end of the employment.
Some special types of executive compensation agreements
- Deferred compensation agreement - This plan delays the distribution of cash payments to an employee. The goal is to spread part of the employee’s current earnings over a future time period when the employee will be in a lower tax bracket. These agreements are often unfunded promises by the employer to pay the employee at a future date. However, it is possible that an employer will not be able to meet its obligations at the time they become due. If this happens, the employee will not receive the intended payments because the plan was unfunded. Employees are beginning to demand more assurances of payment under deferred compensation agreements. Consequently, there are now funded deferred compensation agreements. A problem with a funded agreement is dealing with the adverse tax consequences it can have on the employer.
- Profit-sharing plan - This plan is a unilateral offer by the employer to the employee to share in the profits of the company. The employee’s acceptance of the offer is evidenced by his or her continued service for the employer. The amount owed to the employee through the plan and who benefits from the plan depends on the language of the agreement. The term “net profits,” when used in a compensation agreement, is generally defined as profits before the payment of taxes but should be specifically defined in the agreement.
- Non-elective retirement plan - This plan is similar to a qualified retirement plan, except it is unfunded and only applies to highly compensated employees. There are two variations of such plans.
- Excess benefit plan - A non-elective retirement plan that complements a qualified retirement plan and is exempt from ERISA coverage. This plan may provide for benefits under the qualified plan’s formula that are normally limited by the Internal Revenue Code.
- Top hat plan - A non-elective, unfunded retirement plan that covers highly compensated employees and is subject to ERISA, but not the Internal Revenue Code. This plan is not limited to excess benefits.
Under the Tax Cuts and Jobs Act of 2017, tax-exempt organizations will pay a 21% excise tax on compensation greater than $1 million paid to their five highest-paid employees. The provision took effect in 2018.
Commission payment plans
When employers compensate employees through wages or salary, there is little room for dispute regarding the amount of compensation due the employee. Even when there is not a written agreement and the salary is set through conversations between employers and employees, there will always be documents by the employer that establish the rate of pay. If the employee accepts payments without asserting that a mistake has been made and demanding more, the evidence is compelling that the rate actually paid to the employee is the rate that had been agreed upon.
However, the area of commission payment plans, however, presents a different picture. If commissions are paid based upon weekly or monthly sales, the documentation will resemble the situation described above with respect to salaries and wages. The documents will show a payment history of the employee’s acceptance of compensation using the employer’s method for calculating the payment of commissions. Nonetheless, some employees will accept commissions at a particular rate for years without raising an issue but will sue after they leave demanding that they should have received higher commissions.
Defining the amount of commissions
In the case of commissions that are paid based upon an annual total of sales or profits, there is a much greater opportunity for dispute. The employee would not be expected to demand payment until after annual sales or profits are determined. An employee who was planning to leave anyway may not communicate about a potential dispute while employed and may make an aggressive or outrageous demand upon an employer when the employment ends. To protect against such claims, employers should use a written commission payment agreement or policy that clearly establishes the following:
- The economic activity on which commissions will be paid, such as:
- sales made by the employee
- sales made by those supervised by the employee
- net profits of a business or business unit
- increases in sales or profits compared to a base
- achievement of certain performance goals
- the payment by the customer
- the rate or percentage of commissions.
- Any other criteria for calculating the rate of commission.
- A definition of what actions entitle the employee to the commission, such as:
- when the employee, as opposed to another employee, must perform certain tasks, such as being the sales representatives who “closed” a sale, accepted an order or provided certain service to a customer
- a method for splitting the commission with another employee, if another employee also participated in selling to or servicing the customer.
- The date commission payments are due.
- A method for resolving disputes over the amount of commissions.
- What payments, if any, the employee will receive at or after termination.
- Any “draw” that will be paid in advance of commissions and the time and method for repaying the amount of the draw.
Additionally, the agreement should contain a disclaimer that it does not alter the employee’s at-will status.
Commissions upon or following termination
Employers should have written agreements or commission payment plans that clearly state what payments, if any, the employee will be entitled to receive after the date of termination of employment. After an employee has quit or has been terminated by the employer, the employee will sometimes be very aggressive making demands for additional payments, even when the amounts demanded are outlandish and are inconsistent with the way the employee was paid during employment or the way other employees were paid. Without a written agreement, employees are free to make a claim that they were orally promised additional commission payments. A court may be required to conduct a trial in order to resolve the credibility issue of whether the employee or the employer is correct in asserting their position regarding the demand for additional payments.
In addition to guarding against demands for additional compensation after an employee leaves, the provisions regarding post-termination compensation should also take care of the issue of how to handle business that is “in the pipeline.” The commission payment plan or agreement should determine how to handle any commission payments based upon sales to customers that are not completed or paid for until after the employee’s departure. It is common for commissions to be paid based upon the amounts actually paid by the customer, not merely the orders obtained by the employee. That means that when the commissioned employee terminates, there will be some sales made prior to the employee’s departure, but which are not paid until after departure.
In those situations, employees generally regard themselves as being entitled to payments for such sales, since they believe the sales resulted from their own efforts prior to departure. Employers often take a different view, however. In many cases, there is substantial customer service work involved after the order was initially placed and that service work may have been performed by others after the employee’s departure. A common way to resolve this situation is for commission compensation agreements to provide that an employee will be paid for all sales placed by the employee before termination if the sale is paid by the customer within a certain period of time following the employee’s departure, such as 30, 60 or 90 days, but that after that time, no further payments will be made.
Without an agreement defining a cut-off date for any future commission payments, some former employees will assert claims that they should continue to receive commissions for orders or re-orders from certain customers. For example, if a sales representative developed a new customer who places orders regularly and if those orders continue after the sales representative leaves the employment, the former sales representative may allege that he or she should continue to receive commissions on sales to the customer after the termination. To protect against those claims, the employer should have a provision that clearly terminates the employee’s right to receive a commission payment after a certain time or upon a certain event.
Even more dangerous to the employer than a claim for commission payments, the sales representative may allege that the employer was motivated to terminate the employee to avoid paying commission payments that the employee had earned but not yet received. If an employee places a large order and is terminated before the customer pays for the order, the employee may allege that the employer terminated the employee in order to avoid paying the commission when the customer pays for the order. Courts may find an employer to have acted in bad faith if it terminated an employee in order to deprive the employee from receiving the benefits the employee has already earned. The law imposes on each employer the duty to act in good faith in its dealings with employees, otherwise employees may have a claim against the employer.
Employers should be reasonable in treating employees fairly regarding any commissions at issue around the time of termination. One way of showing the reasonableness of the employer is to treat employees at the beginning of the employment relationship in the same manner as employees are treated at the end of employment. In many situations, new salespeople are given existing accounts that have been developed by other employees. Just as the employee received the benefit at the beginning of the employment by earning commissions on sales to customers developed by others, the accounts developed by the departing employee are later passed on to other employees who service those accounts after an employee has departed.
Outside commissioned salespersons
The FLSA, which is discussed in Wages and hours, contains special provisions for overtime and minimum wage issues for commissioned sales employees. Issues include whether a sales employee is exempt from wage and hour laws under the outside sales employee exemption, whether commission payments may be counted to fulfill the employer’s obligation to pay minimum wage and whether the commissions must be included as wages so that an employer must pay one and one-half times those amounts for overtime hours worked.
Commissions as sole compensation
An employee may be employed on a commission basis as long as the payments for each workweek meet the minimum wage requirements for that week. (See below for exception under Outside sales employee exemption.) The law does not prevent an employer from entering into an agreement with the employee that provides for the employee to receive minimum wage for all hours worked along with any additional amount by which the commissions may exceed the minimum wage required for the workweek.
Computation of commissions
The computation and recording of hours worked must be kept on a workweek basis. The employee must be paid compensation that is at least equal to the applicable minimum wage for every hour worked during the workweek. However, the law does not prevent the employer from using a monthly commission period to determine the employee’s earnings.
Because the FLSA requires an employee’s regular rate to be expressed as an hourly rate, earnings paid on commission must be converted to the hourly-rate basis. The calculation is simple if an employee is paid a weekly commission. In that situation, the regular rate is obtained by adding the weekly commission payment to other earnings for the week and the total is divided by the number of hours worked during that week. However, if the commission payments are deferred beyond the workweek in which they were earned, the employer must apportion the commission payments back over this time period to calculate the regular rate. When allocating the commission payments to the workweeks in which they were earned, the employer can assume that the employee earned equal commissions each week.
Combination of wages and commission payments
An employer who pays an employee on an hourly rate for a portion of the workweek and pays a commission for the balance, cannot use hourly earnings which exceed the minimum wage to make up a deficiency in the minimum commission wage rate for the commissions earned for the other part of the week. Thus, the minimum wage requirement is satisfied only when both the earnings from the hourly wages and the amount of commissions received per hour each average at least the minimum wage rate.
Outside sales employee exemption
Even though coverage of the FLSA is intended to be broad, the law recognizes the difficulty of regulating the hours of sales representatives who spend their time outside of the office. Outside sales employees are exempt from minimum wage and overtime pay requirements of the FLSA.
Definition of outside salesperson
Under the FLSA, the exemption for outside salespersons is available for employees whose jobs meet both of the following criteria:
- the employee customarily or regularly works away from the employer’s premises with the purpose of making sales or obtaining orders or contracts
- the amount of time the employee spends on other types of work not covered above cannot exceed 20% of the hours worked in a workweek by the employer’s nonexempt workers. Exempt work includes work incidental to and in conjunction with, sales activity, including writing sales reports or making incidental deliveries and collections.
Inside sales employee
Inside commissioned sales employees are any sales employees paid by commission who do not qualify as outside sales representatives. Wage and hour laws apply to inside sales employees. Commissioned sales representatives who do not qualify as outside sales employees generally must be paid the statutory minimum wage as well as overtime pay. There is an exception for overtime pay for retail or service sales employees, as explained below. There are also industry-specific exceptions, such as for salespeople at automobile dealerships.
Overtime pay exemption for inside salesperson in retail or service
Inside sales employees who work in the retail or service industry are exempt from the FLSA’s overtime requirements, but not minimum wage, if they meet the following specifications:
- more than one-half the employee’s income is from commissions on the sale of goods and services during a “representative period”
- the employee’s regular rate of pay is more than one and one-half times the minimum wage.
The “representative period,” used to measure whether one-half of the employee’s income is from commissions, must be a period that reflects all of the characteristics of an employee’s earning patterns in his or her job.
If commission checks are paid once per month, the employee’s compensation for a period of one or more months must be considered as the representative period. The employer could not use just the week in which commissions are paid as the representative period. Otherwise, an employer could assert that the employee received more than one-half of his or her income in the form of commissions by counting the entire monthly commission check against only one week of other income to calculate whether commissions accounted for more than one-half of total income.
To qualify for the inside sales exemption for retail businesses, the employer must be recognized within its industry as being a retail sales or service business and at least 75% of the annual dollar volume of the business must be the sale of goods and services not for resale.
The use of mandatory, enforceable arbitration provisions in contractual agreements has a long and established history as a vehicle for settling commercial business contract disputes and workplace disputes involving collective bargaining agreements between employers and union representatives of their employees. The Federal Arbitration Act (FAA) governs commercial arbitration and the statutes regulating collective bargaining have been found by the courts to encourage arbitration and mediation as an alternative to administrative or court litigation of workplace disputes.
The National Labor Relations Board (NLRB) has also adopted policies of deferring to union vs. employer arbitration proceedings, even when these proceedings deal with the same issues protected or prohibited by the collective bargaining laws administered by the NLRB. A 2009 U.S. Supreme Court decision touched on this issue, holding that workers could not sue their employer for age discrimination practices when their collective bargaining agreement “clearly and unmistakably” requires arbitration of such claims. Deference is given when standards or requirements are being observed in the arbitration proceeding, essentially:
- when the proceedings are fair and regular
- all parties agree to be bound
- the decision is not repugnant to the purposes and policies of the National Labor Relations Act (NRLA).
During the 1980s and 1990s, the employment at-will doctrine eroded, and more state courts developed contract and tort theories of wrongful discharge claims. As litigation of workplace disputes by individuals became commonplace, both employees and employers experienced the rising costs, expenses and delays of the litigation process, crowded court dockets, the unpredictability of jury and court trials and the risk of large tort damage awards, such as pain and suffering and punitive damages, which were not usually available in an arbitration forum.
As a result of the drawbacks of litigation, what is known as ADR (Alternative Dispute Resolution) has received a lot of attention as a more efficient and less expensive way to resolve workplace disputes. Arbitration and mediation are two of the main forms of ADR. There are many different forms of arbitration agreements (binding, advisory or a hybrid type known as “interest” arbitration in labor relations). This chapter reviews agreements to submit workplace disputes to mandatory arbitration as an alternative to a lawsuit in court.
The best way to resolve employee disputes
Arbitration is essentially a less formal hearing of evidence and argument, resulting in a binding decision by an impartial arbitrator who acts as a judge and jury and issues a decision and award, usually written, that is usually binding on all parties. Arbitration awards can be reviewed by a court on only very narrow grounds such as fraud, corruption or undue duress. Arbitration awards can be enforced in court by the prevailing party and have the legal effect of a judgment once confirmed by a court.
Mediation also involves the assistance of a neutral third party, called the mediator. The mediator’s role is only to help the parties reach agreement. A mediator, unlike an arbitrator, has no power to make a decision that is binding on the parties.
The pros and cons of arbitration
Those supporting mandatory, binding arbitration as an alternative to civil litigation argue that it is a way employers can avoid the risks, costs, delay, inefficiency and inconvenience of civil litigation. A common assumption of proponents of arbitration is that employers will receive fairer treatment in arbitration because an arbitrator will be less antagonistic or prejudicial towards an employer.
Opponents question whether those assumptions are true. Opponents point out delay, pre-arbitration challenges to the validity of the arbitration agreement itself and focus on procedural issues unrelated to the merits of the dispute as downsides to arbitration. Cost savings, say the opponents, can be overstated. In addition, opponents point to the loss of the ability to present in court proceedings motions to narrow or eliminate issues, which often are not available in arbitration. Furthermore, the grounds for appeal of an arbitration decision are generally narrower than those in an ordinary court proceeding.
Another other disadvantage cited by opponents is the loss of complete victories. Although damage awards in arbitration may be less than in court, arbitrators frequently ignore burdens of proof and compromise by “splitting the baby,” by giving everyone something rather than denying the claim outright with no recovery.
Opponents also contend that making arbitration readily available encourages argumentative employees to bring frivolous claims or use the availability of an inexpensive forum as a tactic to intimidate supervisors and undermine morale. Supporters counter that it is better to have disputes resolved promptly than it is to fail to deal with disputes directly.
Illinois Workplace Transparency Act
The Illinois Workplace Transparency Act (WTA) took effect on January 1, 2020, and protects employees, consultants and contractors who report alleged unlawful discrimination and harassment or criminal conduct in the workplace. The WTA prohibits:
- non-negotiable confidentiality obligations
- mandatory arbitration of allegations of discrimination, harassment or retaliation.
The WTA applies to any employer with one or more employees within Illinois during 20 or more calendar weeks in a calendar year.
The WTA’s protections apply to employees including:
- full and part-time employees
- unpaid interns
- consultants and contractors who perform work for the employer pursuant to a contract.
The WTA does not apply to collective bargaining agreements.
Under the WTA, a settlement and termination agreement can require confidentiality relating to alleged unlawful discrimination, harassment or retaliation, only if the following requirements are met:
- The agreement states that confidentiality is the employee’s preference and beneficial to both parties,
- The employer notifies the employee in writing of the employee’s right to have an attorney or representative of the employee’s choice review the agreement before it is executed.
- There is valid, bargained-for consideration in exchange for confidentiality.
- The settlement or termination agreement does not waive claims of unlawful discrimination, harassment, or retaliation that arise after the settlement or termination agreement is executed.
- The employee is given 21 calendar days to consider the written agreement (but the employee may execute the agreement waiving any remaining time to consider it).
- The employee has seven calendar days after executing the agreement to revoke it, and the agreement is not enforceable until the revocation period has expired.
Employers cannot include any clause that prohibits the employee from making truthful statements or disclosures regarding unlawful discrimination, harassment or retaliation