Back to the Insights
Print Friendly, PDF & Email

How to hire employees

Employees can be your greatest asset. Unfortunately, if the employment relationship is not properly documented from the start, they can also be your greatest liability. Realistically, startups often hire employees without proper letters of hire or employment agreements. This does not mean that there is no agreement between the corporation and the employee. What it does mean is that, at the end of the day, a court may end up defining the agreement for the parties. A proper letter of hire or employment agreement can avoid uncertainty and unexpected liability in the terms of employment.

When drafting a letter of hire or employment agreement, consider the following:

  • Job description and responsibilities;
  • Term of employment (casual? term? indefinite?);
  • Specifics of any benefits;
  • Limitation of entitlements upon termination of employment;
  • Limitations on the employee’s ability to compete with the employer’s business once the employee leaves;
  • Protection of the employer’s intellectual property, client lists and other confidential information;
  • Ownership of the employee’s work product; and
  • Dispute resolution.

Examples of issues that are often inadequately addressed in drafting letters of hire and employment agreements include the following:

(i) Termination clause

Some startups are uncomfortable addressing the employee’s entitlements on termination at the beginning of the employment relationship. These same companies often regret this initial discomfort when a decision is made later to terminate the employee. A signed employment contract (whether a letter of hire accepted by an employee or a more formal employment agreement) can limit the amount of notice, or pay in lieu of notice, that an employee will be entitled to receive in the event of a “without cause” termination. In Ontario, this contractual notice can be limited to the statutory minimum under the Employment Standards Act, 2000 (Ontario) (the ESA), which is generally one week per year of employment up to eight weeks plus statutory severance (if applicable), or any other amount, provided that it meets or exceeds the minimum statutory requirements under the ESA.

In the absence of such a clause, an employee will be entitled on termination to notice or pay in lieu of notice calculated under common law principles, which may considerably exceed the minimum standards under the ESA. Unlike the ESA’s notice provisions, the common law does not provide a fixed measure of what constitutes reasonable notice. At the upper levels, case law has awarded two years or even more to certain senior-level, long-term employees. Even at the lower levels, employees with common law entitlements often receive three or four times the amount of notice that they would have received if they were subject to the minimum standards of the ESA. These types of potential liabilities, when disclosed as part of a due diligence process, can surprise and concern investors or acquirers. In particular, it is not uncommon for a startup to be told that the valuation will have to be reduced or, in extreme situations, that the deal is off, because the potential employee termination liability is too large. It is far easier to quantify termination liabilities up front with an employment agreement. A written agreement on notice or pay in lieu of notice, even if it is greater than the ESA minimums, will not only help to quantify termination obligations but will also help to avoid costly and time-consuming wrongful dismissal claims based on common law entitlements.

Proposed termination entitlements should be discussed with legal counsel or human resource professionals to determine to check that they are not greater than the norm. Overly generous entitlements can raise concerns for prospective investors. In addition, care must be had to ensure that the termination clause is properly drafted and the agreement has been properly entered into, as employers can otherwise find the courts setting aside the employment agreement and imposing common law in any event.

(ii) US contracts

Some corporations make the mistake of using forms of employment contracts that were originally drafted for use in other jurisdictions. For example, US concepts like “employment at will” are not recognized in Canada and will not be enforceable. Furthermore, the use of such language may render the entire employment agreement invalid and unenforceable in Ontario, including provisions relating to intellectual property. When that happens, the courts rely on common law as the default. Therefore, while company templates originating in the US can be used as a base document, these forms should be revised in order to ensure compliance with Ontario employment law.

(iii) Non-competes and other restrictive covenants

An important function of the employment contract is to restrict harmful or unfair conduct by a departing employee. This can be achieved through the use of restrictive covenants such as non-competition and/or non-solicitation clauses. It is crucial to craft such provisions with an eye to their enforceability. Sweeping, unreasonable prohibitions will generally not be enforceable in Ontario. In particular, while non-solicitation and confidentiality clauses will be honoured if properly drafted, non-competition clauses are very difficult to enforce under most circumstances. In fact, Ontario courts will often strike down all restrictive covenants if a non-competition clause was included in an agreement where a simpler non-solicitation clause would have sufficed. Therefore it is important, through proper drafting, that the issue of the enforceability of a non-competition provision not affect the validity and enforceability of other important provisions.

(iv) Confidentiality and intellectual property provisions

Employment agreements should address the employee’s obligation to protect the corporation’s confidential information from unauthorized disclosure or include an assignment of the employee’s rights and interest in any inventions, discoveries or work product conceived of or created by them during the course of their employment. While some of these issues are addressed by common law or statute, the protection of a corporation’s confidential information and intellectual property assets requires properly drafted provisions within the body of the employment agreement or in a separate intellectual property/confidentiality agreement signed at the time the employee enters into employment. As previously mentioned, care must be exercised when using forms of agreement that were created for use in other jurisdictions. For example, in Canada, the author of a copyrightable work holds “moral rights” to such work. A properly drafted employment agreement will require the employee to waive his or her moral rights in such works created during the course of their employment. The concept of moral rights is much narrower in the United States and as a result is generally not addressed in US-style agreements.

(v) Vacation entitlements

Employment contracts should address an employee’s vacation entitlements. Given that directors and officers have personal liability for certain amounts of unpaid vacation under the ESA, employment agreements must be carefully worded to avoid any uncertainty. Companies should also note their statutory obligation under the ESA to ensure that employees take a minimum of two weeks’ vacation per year, following the first year of employment. This obligation to insist on vacation time being taken cannot be avoided simply by paying out vacation pay. Lastly, it is advisable to limit the employee’s ability to carry forward unused excess non-statutory vacation time entitlements from one year to the next so that this potential liability can be managed.

(vi) Salary

It is not unusual for technology startups to hire individuals before they have sufficient funds to pay them a competitive salary. Instead of recognizing this fact in the employment agreement, however, many companies include the salary that it expects to pay the employee once it receives financing and then have the employee “forego” or “defer” payment of the salary until such time. In doing so, the company has created unnecessary potential liability for itself, and its directors, if the deferred payments are not made. Problems can also arise under the ESA, as employees have a legal entitlement to receive monetary remuneration. A preferable manner in which to deal with such circumstances is to set out the initial salary as being the minimum wage prescribed by the ESA, with a higher salary to become payable once a defined milestone event (e.g. the company receiving $X in funding) is reached. Another option is to hire individuals as contractors and later convert them to employees. However, this option has other risks, as set out in below, and should never be undertaken without legal advice.

(vii) Contract implementation

Failure to have the employee execute a letter of hire or employment agreement prior to commencing work can result in the letter of hire or employment agreement being found to be invalid and unenforceable. This is due to the fact that an employment agreement is a contract, and the employee must receive consideration in order for the contract to the enforceable. The consideration which an employee usually receives is the job itself; in other words, in exchange for the promise of the job, a contract is signed. However, if the job is started before the contract is signed, there will be no consideration for any new terms or conditions that are contained in the written contract. In this instance, the court will look to the common law in determining the employee’s contractual entitlements.

For example, a provision purporting to limit to ESA minimums the amount of notice, or pay in lieu of notice, that the employee will receive in the event of a without cause termination will likely be unenforceable and the amount of notice, or pay in lieu of notice, will be as calculated under the common law. For this reason, it is important that prospective employees be presented with the form of letter of hire or employment agreement that they are expected to sign well before they commence work, and that they be given adequate time to review the document and, if necessary, consult with their legal advisor. In the event that this is not possible or in the event that a new contract is to be entered into in the course of employment, some fresh consideration should be offered to the employee, which is most often in the form of a signing bonus, a salary increase or a new stock option grant. It should also be remembered that the consideration must have value, meaning that a new option grant may not be effective if the employee is terminated prior to vesting or if the options are under water at the relevant time.

 

Questions? Email us at startups@dentons.com.