Coming to Terms

In an uncertain economy, employers and employees take a wary approach to job offers, noncompete agreements and contingent work arrangements.
By Diane Cadrain


The recession has shifted the terrain of employment agreements in every area from job offer to severance, according to experts. And some of them predict that, like the Great Depression before it, this economic crisis will affect employment relationships far into the future.

A formal document called an "employment contract" is quite rare except for executives and employees working on a limited-project basis, notes Jeffrey Tanenbaum, leader of the labor and employment law practice in the San Francisco office of law firm Nixon Peabody. "They’re typical in the entertainment industry, but also wherever there is a limited scope of engagement."

To the extent there is a written understanding at all, "most of it goes by letter of agreement, or is a contract for a specific project or a deliverable, not an employment contract," says Kevin Wheeler, CEO of Global Learning Resources, an HR consulting firm in Fremont, Calif.

But, Tanenbaum adds, certain documents may be treated like contracts. For example, an employee handbook can be "loaded with obligations, and a court may decide it’s a contract."

Here are some of the ways that agreements are evolving:

Job offers. "Certainly there’s less willingness to offer a term of employment," says John A. Snyder, a partner in the New York office of law firm Jackson Lewis. "When employment is at will, employers just use the offer letter as a contract. Or an employer might set forth job duties and chain of command in a contract, but without a definite term. Employment at will is always the rule, and now it’s even more so."

Because it is an employer’s market, "employers are less willing to make commitments than they were, such as automatic pay increases, or bonuses, or even to contract at all," says Jonathan A. Segal, a partner with the Philadelphia law firm Duane Morris.

"Employees are also more reasonable in terms of their expectations," he continues. "Three years ago, employees might have had three job offers and could use them to negotiate among employers. Now employees are asking for less, and employers have less to give."

Noncompete agreements. "At one time, employees wouldn’t sign them, but now they will," says Segal. "If it’s a choice between no job and a job with restrictions, they’ll take the job with restrictions."

Segal explains that noncompete agreements have to pass three tests. The first is the legal test: Is it enforceable? That varies from state to state. California won’t enforce noncompete agreements, except in limited circumstances. New York will if they’re reasonable.

"The second is the market test: Will the market bear this? In this market," he observes, "a noncompete agreement that passes the legal test automatically passes the marketplace test."

The third test is relational: "What will this agreement do to the employer-employee relationship?" Segal asks. An employee might sign the agreement but resent it down the line.

"Some employers ask for every legal protection in their contracts," he says, but he advises employers to consider the effect of an overly restrictive contract on the employee relationship. "If you start with ugly negotiations, or make unreasonable demands, employees will feel resentful," he observes.

His advice is to try to balance the interests of both sides. If the contract is too legally protective, it may look like the employer has gone too far. But if everyone signs it willingly, maybe the employer hasn’t gone far enough.

Executive compensation agreements. Executive compensation has seen a lot of changes, says Garry Mathiason, a shareholder in the San Francisco office of law firm Littler Mendelson. "In anticipation of this change, bonuses are being tied to performance. Before, executives had bonus structures triggered by something other than performance. You don’t want a company to take TARP [Troubled Asset Relief Program] funds and then give out unreasonable bonuses."

"There’s more compensation in base pay and less in bonuses now, because of a backlash against excessive bonuses," adds Wheeler. "We’re seeing a readjustment of how the compensation is parceled out."

Severance packages. "Severance packages are less generous. They’ve decreased by 50 percent," says Mathiason. "Companies have fewer resources, and shareholders are pushing back."

"It goes back to general public attitude about compensation," says Wheeler. "There’s a tendency to cut it way down."

But sometimes a generous severance package makes sense, Segal explains. "Though employees right now are reluctant to ask for too much, and employers don’t have as much to give, I still see applicants saying they want to help the employer make it. If a company is about to go down, and an applicant takes the risk of coming on board to help keep it afloat, they may ask for a lot of severance in that event," he says. "Employers need the best talent, and they may protect themselves by protecting the employee by making the employee less anxious—take away the reason why the employee could be nervous."

Workforce Future: Contingent?

As the economy is "just now starting to see the process of coming out of the trough of the recession, [and] as employers are starting to address the rehire process," says Tanenbaum, "there’s a greater interest in contingent workforce alternatives."

As the recession ends, "contingent workers will constitute, on average, a full 50 percent of the new source of workers to whom employers will turn," according to Mathiason. "The result of this trend will be that contingent workers will make up approximately 25 percent of the total workforce, and this percentage will continue to increase."

Since before the recession, the number of people—voluntarily or involuntarily—becoming independent contractors has been going up, says Wheeler, pointing to research by the Enterprise Center at Salem State College in Massachusetts showing that self-employment grew seven times faster than wage and salary employment between 2002 and 2006. And Wheeler points out that E-lance.com, a web site where freelancers offer their services, now has a client base of 60,000 and just passed $200 million in revenue.

"We’ll see the trend continue the rest of the decade, driven in part by the recession," Wheeler concludes. "Most companies will stay staffed lightly with full-time employees and will supplement with independent contractors. For example, the HR role is a perfect job to be contracted out. Companies will bring someone in and see how it works out."

Andrew Paley, a partner in the labor and employment department in the Los Angeles office of law firm Seyfarth Shaw, sees some companies trying new approaches with their contingent worker arrangements.

Paley says he knows of two medium-sized companies, one in health care and one in telecommunications, that sponsor health plans for their contractors. "Although health benefits aren’t required by law, sometimes they are required from a competitive standpoint," he comments. "Traditionally, independent contractors wouldn’t have benefits, but some employers, particularly with key individuals, now provide some type of benefit as part of a contractual relationship. The plans they offer may not be as good as an employee plan, but they’re better than what’s available on the individual market."

But relying on contingent workers or independent contractors has its pitfalls. Contingent workers offer flexibility and cost-savings in the short term, Tanenbaum says, but employers must continue to be aware that such short-term employment relationships can transform into regular full-time employment relationships, and that transformation can have staggering costs and implications.

"When such relationships are challenged," Tanenbaum says, "courts take a variety of factors into account in determining whether the person is a regular employee."

Duration of the relationship. One of the more important factors is the duration of the working relationship. Courts reason that independent contractors often have limited periods of employment and routinely move from one place to another, as compared to employees, who generally work exclusively for one employer, often for an indefinite and unspecified period of time.

Whether the person works for more than one employer at a time. The fact that someone has continued to hold outside work can offset a lengthy period of employment and tip the scale in favor of independent contractor status. Courts have found an employee relationship where an individual works exclusively for one employer for a considerable length of time.

Employee expectations regarding the length of employment. Independent contractors are often hired for specific or discrete projects, and therefore have an approximate completion date for their employment.

Tanenbaum advises that employers can reduce their risk by:

• Relinquishing control over independent contractors.
• Establishing discrete, short-term assignments.
• Hiring individuals who are also employed by others or who have other clients.
• Distinguishing between the work performed by contingent workers and an employer’s regular workforce.
• Using temporary employment agencies and/or professional employer organizations.

"The bottom line is that if an independent contractor does what other employees are doing, the company has a problem," says Segal. "If you misclassify a person as an independent contractor, you may be liable for taxes, workers’ compensation and health benefits. The test is whether the employer controls the means and method of doing the work. The closer the control, the greater the likelihood that the person is an employee."