Hiring a new executive, especially a president or chief executive officer, is always a major undertaking for any association. A great deal of time and effort, and often monetary resources, are invested in finding quality candidates, interviewing the most promising ones, and making a decision about to whom to extend an offer.
During the courtship process, neither party, understandably, wishes to think about, or talk about, the divorce. But, sooner or (hopefully) later, the relationship between the executive and the association will end. For the protection of the association, as well as in fairness to each party, it is important that the possibilities of when and how the relationship can end be clearly expressed in the written agreement and that the executive candidate be presented with the material terms and conditions of their newly offered employment prior to their acceptance of the offer and, importantly, prior to the time they notify their existing employer that they are leaving (or prior to the time that they decline other offers).
This article touches briefly on three key elements of association executive employment contracts – term, termination (including severance pay), and compensation. While it does not endeavor to cover all of the material considerations or possible ways to address these aspects of employment contracts, it highlights some of the issues that tend to be the most important to consider. Finally, note that the provisions regarding term and termination need to be coordinated and read hand-in-hand; they are intimately related.
The Term of the Agreement
Initial Term. Often, the initial term is two or three years. A key factor for associations (and indeed, the executive) to consider when assessing the length of the term is the variety of ways in which the term can end prior to expiration, which is discussed below.
Renewal Term. The agreement should specify clearly what happens at the end of the initial term. There are several options.
First, the agreement could simply expire upon the end of the term, with no obligation on either party to continue employment (remember that parties are always free to negotiate extensions if both parties desire to continue the relationship; sometimes it is advantageous for one party or the other to set up such a renegotiation).
A common provision in executive agreements is an automatic renewal in the absence of some affirmative notice to the contrary. For example, if one party does NOT provide notice at least 180 days prior to the expiration of the initial term, the agreement might renew automatically for one year.
It is important that both the executive and the association's board remain aware of any approaching deadlines for notices and adhere carefully to the specified procedures for providing notice, as set out in the agreement. This need is particularly acute when, as is typically the case in associations, there are significant changes in director and officer composition year to year.
Termination of the Agreement
Notice by the executive, no cause or reason. Although by no means required, many agreements have provisions that allow the executive to terminate early—without the need for a reason or cause—by giving certain notice. Typically, an executive candidate will want such a provision, particularly if the association will have a similar right. If the association agrees to such a provision, the notice period should take into consideration the hiring cycle and lead time required. That is, if the search process takes six months, the agreement might specify a notice period of six months.
Notice by the association, no cause or reason. Associations should carefully consider including in the agreement a provision that allows the association to end the agreement early without cause. Establishing cause sufficient for terminating an agreement can be difficult and costly, and result in public embarrassment to the association and the executive. See the discussion below regarding severance pay that typically accompanies such a no-cause termination.
Termination for cause. The agreement should contain a provision for termination for "cause." Cause should be defined. Typically, it includes such things as malfeasance, breach of the agreement, fraud, embezzlement, dishonesty, or gross negligence. Be careful of definitions of cause that require convictions of crimes; no association wants to await the outcome of a criminal proceeding. Drafting cause provisions requires a balancing of the need for protection desired by both the executive and the association. Generally, with a termination for cause, no severance is paid to the executive, which is why the definition is so critical.
What happens when the agreement terminates? The agreement should specify what happens in each of the circumstances under which the agreement can end; in the examples outlined above, this includes four contingencies:
- Expiration of the term (and renewal terms, if any);
- Executive gives notice;
- Association gives notice (termination not for cause);
- Termination for cause.
The interests of the parties here are clearly distinct; the executive is looking for as much security as he or she can get, and the association wants to have as little expense as possible tied up in a person who is no longer performing services for the association. The negotiations should find the right balance between the needs of the parties.
If the agreement is ended early by the executive giving notice, typically there is no compensation due beyond that due during the time the executive works for the association. If the agreement expires, or if the association gives notice prior to the end of the specified term (without cause), there are two alternative approaches that are often taken. Under one approach, no compensation is due beyond the notice period and severance might be included under the second. However, it is increasingly the norm for associations to provide some severance pay in the case of separations based on both the expiration of the term and termination without cause. Severance pay is another area in which the needs of the parties need to be carefully balanced. Many factors may need to be considered, including length of service of the executive, the expected lead time for the executive to find new employment, and the impact on the association to be paying both the departed executive and a new executive, among other factors.
If the executive is terminated for cause, the agreement typically provides that the executive receives nothing beyond what was due prior to termination.
Obviously, base salary should be clearly set out in an agreement. Typically, an initial salary is specified, with provisions made for future adjustments. However, associations should be cautious about specifying guaranteed increases for future years. While an executive will want some degree of security, that interest must be balanced against the uncertainty of future budgets, the economic environment generally, and the undetermined performance of the executive. Moreover, as the past two years have demonstrated, it can be very awkward for an association to grant significant pay increases to executives while staff members are subject to pay freezes, or worse, layoffs.
Many agreements also provide a bonus opportunity, often tied to the attainment of yet-to-be-specified goals. It is important, however, that the agreement specify that other factors may be considered by the board or its designated committee. From the association's standpoint, it is important to retain discretion with respect to payment of bonuses, and to clearly spell out in the agreement that discretion is retained. The executive often will seek some level of objectivity in the bonus measurement, generally in terms of meeting specified goals or goals to be mutually determined each year. Both associations and executives should be careful regarding trying to established fixed goals in an employment contract, as it can be very difficult to project what factors may become more or less significant in future years.
Associations also must be careful if providing medical, dental or retirement benefits to an executive that are more generous than the benefits provided to non-executives. Associations should consult with a qualified benefits attorney to assess whether the associations’ plans permit such benefits and whether the benefits might run afoul of non-discrimination requirements, with potentially adverse tax consequences. Deferred compensation arrangements—more common in larger association executive employment agreements—also have to be carefully structured to not violate the IRS’ strict rules in this area, governed principally by Internal Revenue Code (“IRC”) Section 409A.
Bear in mind that total compensation provided to an executive of a tax-exempt association—whether exempt under IRC Section 501(c)(6) or 501(c)(3)—must be "reasonable" (at or below fair market value), under the IRC proscription against private inurement. Serious violations in this area can put the tax-exempt status of the association at risk. Executives of Section 501(c)(3) and 501(c)(4) organizations also are personally subject to potentially severe “intermediate sanctions” penalties should they receive either compensation that exceeds fair market value or non-business-related benefits, perks and the like that are not treated as taxable income. In addition, board members and other association leaders that approve such arrangements can be personally subject to intermediate sanctions penalties. There are certain steps that an association can take to minimize the risk that a compensation package will be deemed unreasonable (i.e., approval of the compensation by a group of disinterested decision makers, reliance on appropriate benchmarking or comparability data, and contemporaneous documentation of the same). Finally, the newly revised IRS Form 990 reporting requirements mandate disclosure of certain executive perks such as first-class travel and the payment of social or health club dues. When discussing compensation and benefits for a new executive, remember that certain extras added to sweeten the deal may be subject to public scrutiny.
There are typically many other components in an executive employment contract that are beyond the scope of this article. Some of those components include conflict of interest and ethics provisions, confidentiality, non-competition and non-solicitation, and the like. Some contracts contain alternative dispute resolution procedures, including arbitration provisions. As with the topics covered in this article, it is to the benefit of executive and association alike to have a clear understanding of those rights and obligations prior to the executive candidate accepting employment, and prior to the public announcement of the new executive’s hiring; fruitful, thoughtful negotiation and a comprehensive, well-prepared contract will address these issues and find the appropriate balance between the needs of the parties.