Executive Termination – Planning for the End

There are some phrases that show up in contracts and simultaneously amuse me and remind me of the importance of careful legal drafting. One such phrase refers to the right of a company to “terminate the Executive” on certain grounds. After conjuring up images of Arnold Schwarzenegger in one of his most famous roles, I correct the language to say “terminate the employment of the Executive” or something like that.

But that’s not what this post is about. This post is about the need to differentiate between types of terminations and, indeed, types of resignations. Whether I am representing the company or the executive, I believe it is important to think in a disciplined manner about each such type and the consequences that should follow a termination or resignation of that type.

There are seven major ways in which an executive’s employment can end:

  1. Expiration of the agreement;
  2. Termination by the company “without Cause”;
  3. Termination by the company “with Cause”;
  4. Resignation by the executive “without Good Reason”;
  5. Resignation by the executive “with Good Reason”;
  6. Death of the executive; or
  7. Disability of the executive.

Many readers may be familiar with the concept of “Cause” as a trigger for termination of employment. The key to drafting the “Cause” definition is to determine the right language along three continua:

  • how narrow (e.g., commit a crime) or broad (e.g., perform inadequately) the definition will be;
  • how easy (e.g., Board decision) or difficult (e.g., court order) the trigger will be; and
  • how soft (e.g., material breach) or hard (e.g., fail to achieve 25% growth in 2 years) the trigger will be.

To paraphrase a congressional aphorism, on these questions “where you stand depends on where you sit”.

The concept of “Good Reason” in termination provisions may be less familiar to some readers. Essentially, it is the flip side of “Cause” and forms the grounds on which an executive can terminate her employment with more favorable consequences than if she just quit for no reason. Common examples of “Good Reason” include salary reduction, demotion of position or diminution of responsibility, relocation, and the like.

In some cases, it is appropriate to hire an employee on an “at will” basis. An employment agreement can specify that the employment is at will, or it might be deemed to be the case (depending on state law) in the absence of an employment agreement. Either way, at-will employment effectively allows the company to fire the employee, or the employee to quit his employment, at any time with little or no notice and without any adverse consequences. In cases of at-will employment, the seven termination types above are not relevant.

For most executive employment relationships, however, things are not that simple. Rather, the company wants to know that it will have the long-term services of the executive, and the executive wants to know that she will have long-term job security. If either party’s long-term expectations are not met, certain meaningful consequences will follow.

Well, what can those consequences be? There are six major ones to consider:

  1. Severance – payment of additional salary and/or anticipated bonuses for a period of time (perhaps in a lump sum) following the termination;
  2. Bonuses – payment of past bonuses that have accrued but not yet been paid, and payment of current bonuses that have not yet formally accrued (fully at least);
  3. Benefits – continuation of fringe benefits (at the company’s expense) such as insurance, automobile allowance, housing expenses, memberships in health clubs or country clubs, etc.;
  4. Treatment of equity ownership or options – forfeiture of shares or options, accelerated vesting, buyback of shares (either at FMV or, in some cases, a discount or premium);
  5. Treatment of restrictive covenants – especially any non-compete or non-raid/non-solicitation covenants; and
  6. Other valuable matters in the specific employment agreement.

Without wanting to over-complicate matters, I believe it is useful to think about the seven types of terminations and the six types of consequences as a matrix, where you contemplate the reasonable answer for each box in the matrix one at a time. In a few agreements, I’ve included an actual matrix to set forth the rights, since that made them much easier to understand than the dense prose that normally appears in these sections.

One other feature that I’ve used effectively in some employment agreements, in appropriate cases, is to delineate two types of “Cause” (such as “Cause” and “Severe Cause”) and two types of “Good Reason” (such as “Good Reason” and “Severe Good Reason”). This feature should only be used when the substantial economics at issue warrant the extra complexity, but it can help to address the situation, for example, when a company would like to terminate an executive and stop paying his salary, and the executive is prepared to live with that but would not accept that such a termination would result in the forfeiture of the executive’s vested options.

While an elaboration of the arguments and counter-arguments with respect to each box in the matrix is beyond the scope of this post, they may be covered in a future post. In the meantime, readers are invited to make comments and ask questions about these topics on this page.