Last Updated on by Admin LB
An employment agreement is a binding document entered into between the employer and the employee, which spells out the rights, responsibilities, and other terms of the employment.
When you join a company, you are made to sign an employment agreement. However, it is not always that an employee is made to sign an employment agreement for an employment, like for e.g. a worker employed in a shop might not be made to sign any formal employment agreement. It begs a question – is entering into an employment agreement, mandatory? Before we delve into the answer to that question, let us first understand what an employment agreement actually is.
An employment agreement is a binding document entered into between the employer and the employee, which spells out the rights, responsibilities, and other terms of the employment. Does this mean that the employer and employees who do not enter into a formal employment agreement, are not bound by any rules or do not have any rights or obligations in respect of the employment?
There are plenty of clauses which form part of an employment contract. They range from the most basic clauses, like, the nature of duties, remuneration, and number of leaves, to the special ones, like confidentiality, non-compete and non-solicit. Did you know that certain clauses in your employment contract are an effort on part of the employer to retain you for a longer period of time? It begs another question – what is the meaning and the rationale behind all of these clauses?
This article sheds a light on the answer to the aforementioned questions. Read on to find out.
II. Are employment agreements mandatory to be entered into?
Mandatory or discretionary?
Legally speaking, no, the employment contracts are not mandatory to be entered into. In fact, a lot of employments are merely based on implied contracts i.e. without any formal employment agreement. For example, if you visit a shop in your marketplace, you would find employees working in the shop, but would they be having a formal employment agreement? Probably not. They are on an implied contract.
Blue-collar employees vs. White-collar employees
Usually, the blue collar employees (i.e. workman, manual labour etc.) are on an implied contract, and the white collar employees (i.e. professionals, managers etc.) enter into an employment agreement. It might also be due to the fact that the interests of the blue-collar employees are protected by various labour law legislation, while that is not so in the case of white-collar employees.
Be it any employee, it is highly advised to enter into an employment agreement, given the advantages it offers to both, the employer and the employee.
III. What are the key clauses in an Employment Agreement?
There is no prescribed format of an employment contract, or an air-tight rule as to what should be included in one. The clauses of an employment contract depends upon the industry and the nature of the employment.
Usually, the employment agreements are one sided contracts, with employees having from ‘little’ to ‘no’ say in them at all, with exception being the employment contracts of Key Managerial Personnel (“KMP”), i.e. directors, managers, etc., whose employment contracts are highly negotiated.
Following is a list of the important clauses that form part of an employment contract.
1. Job description and duties
Job description is an important clause from the perspective of both, the employer and the employee. In simple terms, it describes what an employee is supposed to do for the employer. This clause enumerates the nature and scope of the duties of an employee and also provides clarity to the employee in terms of his role and duties.
As the employment contracts are mostly one sided, and employees do not have a say in them (except the employment contract of top management), therefore the employer usually keeps this clause as wide as possible, so as to possibly include almost everything.
Further, the employer also retains the right to amend the nature and scope of duties of an employee, if need be in the future. For example, if a company expands and diversifies in the future, the employer would want to retain the right to modify the job description of an employee to suit his requirement.
The importance of this clause can be emphasised more particularly in the dispute situations i.e. before court of law, or a disciplinary committee.
For example, where an employee has been accused of not performing his job, reference can be made to this clause to ascertain what were the duties of the employee.
2. Compensation (salary, bonus and other perks)
An employee provides his services to the employer in exchange for compensation. An employer provides salary, bonus and other perquisites to the employee in order to compensate him for rendering his services, and to keep him motivated enough to contribute effectively.
As this is one of the most important deliberations of any job, it can trigger a dispute in the future, if there is any ambiguity. Therefore, in order to avoid such disputes, the employer and the employee must be aptly clear about the whats, whens and hows of the salary, bonus, increment, and other perks that the employee will be entitled to. Therefore, an employment contract shall include all such things in the employment contract.
Besides this, an employment contract shall also clearly state the deductions that the employee will be subject to.
3. Term and Lock-in
Term refers to the period of employment. An employment contract might end automatically at the expiry of this period, or it might be renewed with the consent of both, the employer and the employee.
Some employment contracts also include a lock-in period. A lock-in period is a period before the expiry of which an employee cannot terminate his employment. And in case the employee leaves the employment before the expiry of the lock-in period, he is liable to pay damages to the employer.
4. Working hours and Leave entitlement
- Working hours
The employment contract shall specify the regular working hours of employment.
- Leave entitlement
There are broadly two kinds of leaves, casual and sick leave. The employment agreement shall enumerate the total number of leaves in both these categories. It shall also state whether at the end of the year, the unused leaves will carry forward, encashed or will simply lapse.
5. Termination of employment
This is a very important clause in the employment agreement. Broadly, an employment can be terminated in two ways, termination with cause and termination without cause.
- Termination without cause
Termination with cause is also known as termination at will. For this kind of termination, no reason needs to be given, and there’s generally a notice period (of 15 days or 1 month or 2 month etc.) which needs to be served before terminating the employment. If the notice period is not served, a salary amount equivalent to the notice period is to be given to the employer, or the employee, as the case may be.
- Termination with cause
Termination with cause is also known as termination in default. As the name suggests, in this kind of termination, the employment can be terminated by one party at some default of the other party. Generally that default is the breach of terms of employment contract, or corresponding company rules. For example, termination of the employment by an employer on the employee’s misconduct, or termination of employment by an employee on employer’s failure to pay salary on time.
6. Company policies
Every company has a number of policies for their employees. For example, dress-code, confidentiality, social media policy, reimbursement policy, etc. These policies shall also be made a part of the employment contract.
For the sake of brevity, it is advisable to explain these policies in a separate document, and employment contracts shall only contain a reference of such policies.
7. Non-compete clause
Non-compete clause prevents an employee from engaging in a competing business or getting employed in a competing firm, for a certain period of time, after the termination of employment. You will usually find this clause in the employment contracts of key employees.
The purpose of the non-compete clause is that it seeks to protect the interest of business, by preventing the employee from disclosing certain sensitive and confidential information of the company to a rival firm, or from misusing the same by starting a competing business.
- Difficulty in enforcement
A non-compete clause is always difficult to enforce in a court of law, as our Constitution of India, 1949 and Indian Contract Act, 1872 specifically provide the following:-
- Indian Contract Act, 1872
Section 27 of ICA, 1872 provides that “Every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void.”
- Constitution of India, 1949
Article 19(1)(g) of the Constitution of India, 1949, provides that all citizens shall have the right to practise any profession, or to carry on any occupation, trade or business. Therefore, such a right is also one’s fundamental right.
Therefore, in order to make the non-compete clause enforceable, the employer shall put only a reasonable restriction on the aforementioned right of an employee. For example, a non-compete clause restricting a key employee of Amazon India from working with a rival company, say Flipkart, for a period of one month might be reasonable in some circumstances.
8. Non-solicit clause
Non-solicit clause prevents the employee from soliciting or encouraging other employees, customers, suppliers, agents of the employer to end their relationship with the employer, when that employee himself ceases his employment. In such a way, it protects the commercial interests of the business of the employer.
For example, a sales manager of Maruti Suzuki, during his employment period, will build good relationships with the customers of Maruti Suzuki, and later if he decides to make a switch to rival Hyundai, he might as well solicit few of the regular customers of Maruti Suzuki, which will cause direct loss of revenue to Maruti Suzuki. Therefore, a non-solicitation clause prevents an employee from doing so, and thereby protects the commercial interests of the business of the employer.
9. Intellectual Property
- Meaning and Purpose
An employee, while working for the employer, might create certain work which comes under the ambit of intellectual property (“IP”). Hence, from an employer’s perspective, it becomes pertinent to bring such work under the ownership of the employer. Therefore, this clause simply states that whatever work will be created by the employee during the period of his employment, will become the property of the employer.
- Work created during working hours vs post working hours
Usually, the companies distinguish between the work created by an employee during the working hours and work created by an employee after the working hours and while the former becomes the intellectual property of the employer, the later remains the property of the employee.
Let us understand it by an example of my friend, Mayank.
Mayank, an android developer, is employed with an application developing company. Mayank, during his working hours, develops applications on behalf of his employer and after the working hours, engages into some freelancing work and develops applications for his personal clients.
In such case, the IP rights for the applications developed by Mayank, during the working hours, will vest with his employer, however, the IP rights for the applications developed after the working hours (i.e. by freelancing) will remain vested with Mayank (until he transfers them to the client for whom he is developing the app).
During the term of employment, as the employee might deal with a lot of confidential and sensitive information pertaining to the employer’s business, therefore, it makes sense to protect such information from being leaked out to the competitors. A confidentiality clause or a Non-disclosure Agreement (NDA) seeks to achieve exactly this.
A non-compete clause prevents the employee from leaking out or sharing certain confidential information pertaining to the employer’s business, both, during the term of the employment and post its termination.
Exclusivity clause prevents an employee from seeking additional employment, during the period of his employment.
The amount of restriction will depend upon the wording of this clause. Some companies only prevent the employees from seeking employment with the competitors, while allowing them the freedom to work for other companies (after the working hours). However, some companies forbid the employees from seeking any sort of additional appointment, during their employment contract with the company.
12. Dispute Resolution and Governing Law
- Dispute Resolution
Disputes are inevitable. When a dispute arises out of an employment agreement, how it would be resolved, falls under the ambit of this clause.
A well-drafted employment contract should provide that initially the efforts shall be made to settle the dispute amicably, failing which it will either go to arbitration (usually in Key Managerial Personnel’s contracts), or to courts of a particular jurisdiction.
- Governing Law
As legislation relating to an employment contract may vary from state to state, it makes sense to set out the choice of law of the parties to the contract.
For example, the governing law clause of an employment contract may state that “This agreement shall be governed and interpreted according to the laws of Maharashtra (India).”
IV. The challenge of Employee Retention and the clauses in an Employment Agreement that respond to it
The companies incur huge amounts of cost in hiring the employees and providing them with training. Therefore, every company wants to retain their employees (especially the ones who are a good talent) for a longer period of time. However, employee retention is one of the biggest issues that any company faces. From finding a better package elsewhere, to hating the work environment, reasons could be plenty.
Therefore, one can see the willingness of the company in trying to retain an employee, from the employment contract itself, which contains some or all of the following terms:-
Increase in compensation
Compensation includes salary, bonus, and other perks. Increment in any of the above heads not only prevents the employee from switching jobs but also motivates him to contribute more.
Employee Stock Option Plan (ESOP)
ESOP is another exciting incentive for luring employees to stay. Under this scheme, the company offers the stock options (i.e. share in the company) to the employees. It acts as a great retention tool, as the employee feels a sense of ownership in the company, which motivates him to contribute more.
Usually, such stock options have a vesting period (of generally 2-3 years), i.e. a waiting period, after the expiry of which, the employee can exercise such options and own the shares.
Penalty is an amount that the employees have to pay to the employer, for terminating their employment, before the expiry of a fixed period of time. It acts as a demotivation to an employee from terminating the employment.
However, it is not an effective or recommended tool for retaining the employee, as the employee will develop a negative attitude towards the company, which in turn will affect his job performance.
So we learnt that even though by law, there is no obligation on the employers to enter into employment contracts with their employees, yet they prefer to do so anyway, given the benefit that it offers. Such benefits are not only limited to the employers and they extend to the employees as well, as the employees also get certain rights and understand their duties and pay structure more clearly.
As far as employee-retainment is concerned, the penalty has been a traditional approach, but the companies are changing this approach and turning more towards giving ESOPs and increments to lure the employees to stay, which has been a welcome change amongst employees. Lastly, given the impact of Covid19, a lot of employers are cutting jobs, but in doing so, they at least have to honour the termination rights as enumerated in the employment agreements, such as giving notices or pay in lieu thereof.