The Pros and Cons of an Employment Contract

An employment contract sets up the terms of the working relationship. Knowing when you should, and should not ask a new employee to sign an employment contract is an important component of business ownership.

What Goes in an Employment Contract?

In addition to clearly describing what the employee’s responsibilities are and how much you are paying the employee, there are other parts of the relationship you can put into the contract.

• Duration of the job/if there is an end date

• Information about the employee's responsibilities

• What benefits the employee have like health insurance, vacation leave, disability leave, and others

• Reasons for termination of the employee

• Limitations on the employee's ability to compete with your business once the employee leaves if possible

• Protection of your trade secrets and client lists

• 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.

Written At-Will Agreements

When we refer to written employment contracts, it is often setting a term of how long that employee will be employed for.

Employers might ask employees to sign an offer letter, handbook acknowledgment, or other document agreeing to at-will employment. These documents do not limit the employer's right to fire the employee. Instead, they affirm the employer's general right to fire at will.

Advantages of Using Contracts

These contracts can be very useful if you want control over the employee's ability to leave your business. If training or finding a replacement will be costly or time-consuming for your company, you might consider a written contract. It can lock the employee into a specific term, such as two years, or require the employee to give you enough notice to find and train a suitable replacement like a two-week notice. You cannot force someone to keep working for you. However, an employee is likely to agree with the terms if there is a penalty for not signing.

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

An employment contract can sway a highly skilled employee 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.

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

Disadvantages of Using Contracts

An employment contract is a two-way street. The contract binds both the employer and the employee, so it limits the employer’s flexibility. This may become an issue if you later decide that you don't like the contract terms or the needs of your business change. In those circumstances, changing the contract or terminating it early will have to renegotiate it. With that, there is no guarantee the employee will agree to what you want.

For example, if you find that you want to end a two-year contract after six months because there is no need for the employee after all, you cannot simply terminate the employee because this would be a breach of contract. Along the same lines, if the contract promises the employee health benefits, you cannot 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.

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