Nonprofit Executive Contracts: Don't Overlook These Key Issues

Many small nonprofits and even large nonprofits, often overlook the importance of an executive employment contract. And I can't imagine a nonprofit executive taking a position without a contract...but some do. Patrick Clancy and Jeff Tenenbaum, attorneys at Venable, offer point by point advice on what should be in an executive contract. Even if you think your organization is too small, you would be well served (and could avoid potential litigation) by making sure you have an executive employment contract in place. Bunnie

(Top, Jeff Tenenbaum. Bottom, Patrick Clancy)

Nonprofit Executive Employment Contracts: Don’t Overlook These Key Issues

by Patrick Clancy and Jeff Tenenbaum, Venable LLP

Hiring a new executive, especially a president or chief executive officer, is always a major undertaking for any nonprofit organization. A great deal of time and effort are invested in finding quality candidates, interviewing the most promising ones, and making a decision about to whom to extend an offer. Often, monetary resources are invested as well using search firms and similar services.

Throughout this process, both your organization and the prospective candidates strive to appear at their best and make themselves attractive to the other. Typically, the major terms of employment are discussed, including salary, bonuses and benefits. Other details are often left for later discussion following an acceptance of an offer and the preparation of a written employment agreement.

During the courtship process, neither party, understandably, wishes to think about, much less talk about, the divorce. Sooner or (hopefully) later, the relationship between the executive and the organization will end.

For the protection of the organization, as well as in fairness to each party, it is important that the when and how the relationship can end, and what happens when it does end, should be expressly and clearly expressed in the written agreement. It is surprising how often what might seem like basic terms are either overlooked or unclear even after the new executive has been presented with an employment agreement.

Moreover, it is important 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 they decline other offers). Material terms include not only such items as compensation and benefits, the contract term, and under what circumstances employment can end, but also may include such things as post-employment restrictions (e.g., non-compete agreements) and restrictions on outside activities. Courts in some jurisdictions have held that an intentional or negligent failure to disclose a material term and condition of employment, when relied upon by the new executive in leaving their former employment (or potentially declining other employment), can result in liability for the new organization.

This article will discuss some key issues that should be addressed in an executive’s employment contract with a nonprofit organization. Those issues include, of course, the term of employment – How long does the employment last under the contract? While employment can be at-will (meaning that it can be ended at any time by either party without cause or notice), many candidates for president and high-level executive positions will not accept that sort of uncertainty when considering a position. Thus, most executive employment contracts include an express term of employment.

In addition, the agreement should address what happens at the end of the term – How does it expire? What notices, if any, must one or the other party provide? Will the term, or some variation of the term, automatically renew absent some action on the part of one or both parties?

The agreement also should address the ways in which the employment can end other than by expiration of the term. Most agreements include some provision for ending the agreement for “cause,” with varying degrees of detail as to what constitutes cause. However, agreements also can provide that one or both parties may end the employment prior to the expiration of the term upon certain notice, even without cause.

In addition, it is important that the agreement address what happens following termination. That is, are there any particular payments (such as severance) or benefits that will continue or be made to the executive or, as importantly, that no payments or other special benefits are due upon termination? The agreement needs to address this question for every way in which employment might end. These particular points are addressed in further detail below.

The Term of Agreement. As discussed above, most agreements for nonprofit organization chief executives include some fixed term of employment. Many agreements include both an initial term and a renewal term.

a. Initial Term. Often the initial term is two or three years. Many candidates will not consider less security than two years; organizations should be very careful when considering terms longer than three years. A key factor for organizations to consider when assessing the length of the term is the ways in which the term can end prior to expiration, which is discussed below.

b. 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).

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. The renewal period could be two years, if desired (although one is probably more typical); more than two years would be unusual, and in most instances, would not be recommended.

The automatic renewal provision could continue for each year of the extension as well (i.e., in the absence of notice during an extension year, the agreement automatically renews for another year). However, the automatic renewal need not continue; the agreement could contain a single renewal of one or two years. Whatever approach is adopted, the agreement should be very explicit as to what happens upon the end of the initial term or renewal term.

A cautionary note regarding automatic renewal provision – It is important that the organization'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 nonprofit organizations, there are significant changes in director and officer composition over time. Do not wait until the last month of the executive's term to consider the question of what happens at the end of the term; it may have already "renewed."

Termination of the Agreement. The agreement should specify how it can end other than by expiration of the term. There are several ways the agreement might end prior to the term expiration.

a. 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. If your organization 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. This lead time would give the organization time to conduct a search; it still might require an interim period before a new executive could come on board, but such time would be short.

b. Notice by the organization (no cause or reason). Organizations should carefully consider including in the agreement a provision that allows the organization 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 organization (and the executive). The organization may need the flexibility to end the relationship without cause. The executive, on the other hand, will negotiate for sufficient notice to enable her/him to enter the search market, and, thus, the same cycle and timing issues considered above will come into play. From the organization’s standpoint, the shorter the period, the better. If the executive has a notice provision as discussed above, it would be typical for the notice periods to be the same (i.e., perhaps 180 days). However, the organization typically will seek a provision that allows it to provide the executive with pay in lieu of the notice so that the relationship can be severed immediately if the organization deems it necessary.

Does such a "no cause" provision reduce the job security for the executive that might otherwise exist under an agreement for a term of, say, two years? Yes, however, the issue of security can be addressed through the length of notice and severance and/or other benefits.

c. 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, gross negligence, etc. Not surprisingly, executives try to negotiate more objective, higher-threshold definitions of cause. The organization would prefer a definition giving it more discretion. For example, be careful of definitions of cause that require convictions of crimes; no organization wants to await the outcome of a criminal proceeding, with the potential negative publicity and other ramifications, before acting upon the employment issue (another reason for a "no cause" provision, as discussed above). It is strongly suggested that the organization consider a definition that includes, among other things, conduct that does or is reasonably determined could bring unfavorable publicity or disrepute to the organization.

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: (1) expiration of the term (and renewal terms, if any); (2) executive gives notice; (3) organization gives notice; and (4) termination for cause. The interests of the parties here are clearly distinct; the executive is looking for as much security as she/he can get, and the organization wants to have as little expense as possible tied up in a person who is no longer performing services for the organization. The negotiations should find the right balance between the needs of the parties.

If an agreement expires, typically the departing executive does not receive any compensation beyond that earned during the term. However, some agreements include severance as a means of providing some job security to the executive (thus lowering the risk to the executive of leaving her/his current position to join the organization). The shorter the term of the agreement, the more likely there is to be a severance payment upon expiration. For example, if the initial term of the agreement is one year, the agreement might include a six-month severance payment if the agreement is not renewed by the organization. This type of provision gives the executive at least eighteen months of security. As the term of the agreement increases, there generally is less need for this type of security.

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 organization. There is typically no severance in such a situation.

If the organization gives notice (that is, notice prior to the end of the specified term, without cause), there are two alternative approaches that are often taken.

a. Under one approach, no compensation is due beyond the notice period. The theory underlying this approach is that the notice period itself provides the security the executive needs.

b. Another approach might include severance; perhaps a sliding scale of severance depending on how early in the term the notice is given. For example, the agreement might provide that if the organization gives notice during the first twelve months, the executive will receive the notice period plus severance necessary to bring the total of working compensation and severance to eighteen months (again, providing the executive with at least eighteen months’ security). Alternatively, the agreement could provide that if the organization gives notice after the first twelve months, the executive will receive the notice period plus some specified amount (perhaps three months) of severance. In one sense, this approach may be counterintuitive, as the longer the term of service, the less severance is paid. However, considered from the standpoint of how much income security it provides to the executive when viewed from the beginning of the relationship, it may serve the needs of both the organization and the executive.

If the executive is terminated for cause, the agreement typically provides that the executive receives nothing beyond what was due prior to termination.

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Protecting your nonprofit organization while attracting quality candidates for executive positions requires diligence and planning. The details of an agreement are very important, and may become critical to your organization in years to come. Failure to attend to those details prior to the signing of an agreement can lead to acrimonious (and costly) issues down the road.

Patrick Clancy is a partner in the Venable LLP law firm and focuses his practice on labor and employment law. He counsels may of the firm’s nonprofit clients on employment law matters and also represents them in the defense of litigation, arbitration and administrative proceedings. Mr. Tenenbaum is the chair of Venable’s nonprofit organizations practice. They can be reached at plclancy@venable.com, jstenenbaum@venable.com or at 202-344-4000.