Beyond Winning

by Robert H Mnookin

  Jan explains that most for-cause provisions include language to allow the company to terminate an employee without severance if the employee commits a serious crime, breaches fiduciary duties, or willfully does something that materially harms the company’s interests. “I doubt these provisions will cause much trouble,” Jan explains. “There are pretty standard clauses we can rely on. The hardest part of these negotiations will be defining whether and when the company can terminate you for not performing well. The question is always what counts as inadequate performance. They’ll want a broad provision that allows them to terminate you for cause very easily, and we’ll have to push to narrow the language to protect you.”

  Set Realistic Expectations

  Throughout their discussion, Jan tries to help Peter set realistic expectations about the upcoming negotiation. In deal-making, this is a crucial part of the communication challenge behind the table. Rather than avoiding these tough conversations or promising the moon, a lawyer needs to talk straight to her client about what the client can expect and what course of action the lawyer recommends. Clients appreciate candor, and the best way for lawyers to ensure that clients have realistic expectations is to be straightforward, clear, and truthful.

  For example, Jan and Peter talk about what severance pay Peter should expect if he was terminated without cause. “If they just fired me without cause,” Peter says, “I’d want my whole salary for the rest of the five-year term, and all my options. We should make it expensive for them to fire me without cause.” Jan agrees that Peter should get more severance if he’s terminated without cause than if he quits. She points out that it’s common to award a terminated executive one or two years’ salary, but that paying salary through the end of the five-year term (if more than two years remained) would be unusual for someone at Peter’s level in a company of Montero’s size. “We could push for that,” Jan says. “But I’d recommend against it—I think you should expect no more than a two-year salary severance. Montero isn’t going to be happy about paying you a salary long after you’ve started working for a competitor. Industry standards with respect to options are not so clear. I will certainly press for all of your options vesting immediately if there is termination without cause or you resign for good reason.”

  Understand Your Client’s Priorities

  Jan understands that some terms in Peter’s employment contract are more important to him than others. Although lawyers sometimes dig in on every term in a contract, Jan knows that searching for trades between terms is the key to creating value in deal-making. She therefore works with Peter to understand the trade-offs Peter would be willing to make between various terms. “You seem pretty concerned about getting a high severance package if they terminate you without cause,” she says. “I understand that; I’d feel that way too.” Jan and Peter then discuss what Peter’s interests are concerning a severance package. Will he be short of cash? How long does he expect that he would have to look for a job? Peter believes he could get a new job fairly quickly. “Which is more important to you—an additional year of severance pay or keeping all of your options?” Jan asks. Peter explains that continuation of his salary would be nice, but he would be most concerned about keeping all of the 100,000 options. “This company has wonderful growth prospects: those options could turn out to be worth millions.”

  Jan and Peter also talk about the possibility that Montero West may resist giving Peter a severance package if he resigns because he isn’t made CEO. She digs to find out what he cares about most. She also explains that she may not be able to get everything he wants—which is why she’s trying, and will continue to try, to understand how he views the various trade-offs they might make as the negotiations progress.

  Peter and Jan talk through a variety of other less central issues as well. Peter is concerned about signing a noncompete clause that would make it difficult for him to assume an executive position in the same industry later. “I’m obviously not going to do anything wrong like steal the company’s trade secrets,” Peter says, “but I don’t want to sign something ridiculous. Some of the agreements out there are just too broad.” Jan assures him that she’ll consider this term carefully. Peter also wants to be sure that he receives excellent health insurance coverage for his family—his wife has a hereditary kidney disease and may need dialysis in the future. In the event of termination for any reason, he needs that coverage to continue uninterrupted until he secures a new job.

  NEGOTIATING ACROSS THE TABLE

  Jan is now nearly ready to complete her preparations and to begin negotiations with the other side. She expects that there may be serious disagreements about a few key provisions in the contract—what constitutes “for cause,” for example—but she hopes that they’ll be able to resolve these disagreements amicably and efficiently. She also knows that certain value-creating opportunities are commonly exploited in executive compensation agreements. For example, sometimes by deferring compensation—having the corporation pay the employee certain sums after retirement rather than while the employee is actually working—the employee can reduce income tax because presumably he’ll be in a lower income tax bracket at a later date. Similarly, sometimes the corporation can save taxes by structuring compensation carefully. For example, although a corporation can deduct from its expenses only $1 million a year in salary for any one employee, it can deduct additional compensation if the money is paid out as bonuses contingent on performance. Jan’s goal is to try to tailor the contract to meet the interests of both sides, and in the process create value for her client.

  Lead the Way toward Problem-Solving

  When the other side in a deal starts a legal negotiation with moves that suggest they intend to be strategic, there’s no reason to be confused, surprised, or offended—this is the way the game is often played, and the other side hopes to gain distributive advantages by playing that game better than you can. You have to be prepared to defend against the other side’s distributive moves while leading the way toward a more collaborative approach.

  THE FIRST-DRAFT PROBLEM

  Often, the first question for deal-making lawyers to negotiate over is who will write the initial draft of the contract. Creating the first draft confers obvious advantages, because it gives the drafter many opportunities to shade the contract language and frame the negotiation in favor of her own client. Each side knows this, and therefore both may jockey for the opportunity to create the first draft.

  Jan, for example, knows that there is a wide range of ways to draft a for-cause provision to favor the employer or the employee. She has a stack of executive compensation agreements in her files from past clients, and she pulls several for-cause provisions from them:

  PROVISION A: The Company may terminate this Agreement in the event of repeated and demonstrable failure on the part of the Executive to perform the material duties of Executive’s management position . . . in a competent manner and failure of the Executive to substantially remedy such failure within 30 days of receiving specific written notice of such failure from the Company.3

  PROVISION B: Termination for “Cause” shall mean willful and continued failure to substantially perform his duties hereunder, provided, however, that if such cause is reasonably curable, the Company shall not terminate Executive’s employment unless the Board first gives notice of its intention to terminate and Executive has not, within 30 days following receipt of such notice, cured such cause.

  PROVISION C: The term “Cause” shall include the willful engaging by Executive in gross misconduct which is materially injurious to the Company. For purposes of this paragraph, no act or failure to act on Executive’s part shall be considered “willful” unless done in bad faith and without reasonable belief that such action or omission was in the best interest of the Company.

  The agreements set different standards of basic performance for their executives. Provision A is skewed heavily in the executive’s favor. It combines strong contract language (such as “repeated and demonstrabl
e failure”) with a 30-day notification and cure period. Provision B is also favorable to an executive. It has more moderate language but the same notification period. Provision C eliminates the notification period but strengthens the basic contractual language by requiring that the executive act in bad faith and without belief that his act was in the best interests of the company.

  HOW MUCH TO ASK FOR?

  Given the range of possible approaches to this key term (and others) in Peter’s contract, Jan sees several problem-solving ways to address the first-draft problem. First, all things being equal, Jan would like to create the first draft. If she does, in order to point the way toward problem-solving she won’t just use her draft to stake out a position but will send Montero West a letter accompanying her draft explaining Peter’s interests and how Jan designed each of her proposed draft provisions to meet those interests. She may also want to explain what she hypothesized Montero West’s interests to be, and how she tried to accommodate those interests in her draft. By linking her draft language to these interests, she can underscore that ultimately both sides are going to have to take the other’s concerns into consideration. And she can show that her draft is not merely taken from a form book but is tailored to satisfy her client’s specific needs.

  The second approach is to negotiate a process with the other side that circumvents the first-draft problem by having an initial discussion with the other side before drafts are even exchanged. If the parties discuss their concerns about the various issues involved in a deal, often they can hammer out a framework agreement that identifies the key issues and resolves many of them quite handily. They can then work together to come up with draft language for the more important terms and avoid the duel of drafts that can develop when one side rejects the other’s contractual language and advocates for its own.

  If Jan does send the first draft, how hard should she push the other side? Should she start with language that is extremely favorable to Peter? Or try to start out with a reasonable solution and stick to it? Our advice is for Jan to produce a document that serves Peter’s interests extremely well, can be justified with good reasons, but is not unreasonably onesided. Deal-makers often expect to bargain, to haggle, to make concessions, to reach an agreement somewhere in between the two opening offers. This is a pervasive ethic in the culture of legal negotiation. Therefore, Jan would be wise to ask for more than she thinks she could live with. At the same time, it is a mistake to begin negotiations with an offer that even the offeror thinks is draconian. The first rounds of a negotiation set the tone for subsequent rounds. By asking for too much, the drafter sends an implicit message that this will be a knock-down-drag-out fight over each and every term.

  WHAT IF THE OTHER SIDE STARTS WITH AN EXTREME DRAFT?

  Although Jan proposes that she write the first draft, Montero West’s lawyer insists that they use the company’s “standard” employment agreement as the basis of their negotiations. Jan alerts the other lawyer that her client has special concerns about the termination and severance provisions but says she would be glad to evaluate the company’s draft as a starting point.

  When Jan receives the draft agreement from Montero West, she reviews it, keeping Peter’s concerns in mind. The agreement provides that 20,000 options vest at the end of each year of the five-year contract. The company’s draft does not contain a good-reason clause but instead provides that Peter receives no severance package at all should he terminate his employment for any reason. The draft did contain an extremely broad termination-for-cause provision that would give the company broad discretion to fire Peter:

  TERMINATION FOR CAUSE: Executive’s employment with the Company may be terminated for cause if Executive is determined to have (1) acted incompetently or dishonestly or engaged in deliberate misconduct; (2) breached a fiduciary trust for the purpose of gaining personal profit; (3) neglected to perform or inadequately performed assigned duties; or (4) violated any law, rule, or regulation.4

  This is a common situation for deal-making lawyers. Often the other side will begin the negotiation process with an extremely partisan draft. How should Jan respond? Jan wants to give the company basic information about her client’s interests and priorities. She will want to indicate that Peter recognizes that the company should be able to terminate his employment for any reason, but that the termination should be “for cause” only if Peter has done something seriously wrong. She will want to explain her concerns about the breadth and vagueness of Montero’s termination-for-cause provision. For example, what does “acted incompetently” mean? What if Peter makes a business decision that seems sound at the time but ultimately goes awry? Chief operating officers make a huge number of such decisions every day—and many don’t work out well. Is that incompetence and cause for dismissal without severance? And what is “inadequately performed assigned duties”? Does that include trivial matters like filing an expense report on time or showing up for a meeting? Similarly, the “violated any law, rule, or regulation” language is very broad. Does this include getting a speeding ticket? Montero’s draft seems extreme.

  Jan will certainly want to send a revised draft that (a) contains a good-reason clause; (b) narrows the grounds for termination; and (c) explains why these provisions are important to Peter. With respect to the termination-for-cause provision, Jan must make a judgment about how one-sided her proposed revision should be. Should she use Montero’s provision as a base and narrow its language by, for example, adding a requirement that misconduct must have a “material effect” on the company’s fortunes? Or should she send an entirely new provision, and if so, how extreme should her counterproposal be? Should she send a termination-for-cause provision that requires “repeated failures,” written notice, and an opportunity to cure, as in Provision A above? These are matters of judgment.

  The key is to respond to an extreme draft in a way that signals an ability to defend yourself but does not provoke further escalation. You want to assert your client’s interests but continually demonstrate understanding of the other side’s interests as well. And you want to keep pointing the way toward a collaborative process for resolving disagreements.

  Explore Value-Creating Trades

  Because of the way that Peter prioritizes his concerns, Jan decides to send a new termination-for-cause provision that she thinks is reasonable while at the same time underlining the critical importance of adding a good-reason provision. Jan sends the following language, along with a letter explaining her client’s interests and proposing that she and the company’s attorney meet:

  TERMINATION FOR CAUSE: Executive’s employment with the Company may be terminated for cause if the Executive is determined to have

  (1) willfully engaged in fraud, misrepresentation, embezzlement, or other illegal conduct that is materially detrimental to the Company;

  (2) breached a fiduciary trust for the purpose of gaining personal profit, or (3) repeatedly and demonstrably failed, after adequate written notice, to perform material duties under this agreement.5

  This protects Peter, but also gives the company what it most likely wants—insurance that if Peter does anything really serious, Montero can terminate Peter.

  Jan also sends the following good-reason provision:

  TERMINATION BY OFFICER: (a) If, during the term of this agreement, the Company’s Board newly elects a person other than the Executive to the position of Chief Executive Officer, the Executive shall have the right to resign from the Company and shall receive the severance compensation provided for in Section __ above.

  (b) If the company becomes a party to a merger in which it is not the surviving company, or if the Company sells all or substantially all of its assets, or if there should occur a change in control of the Company by virtue of a change or changes in the ownership of its outstanding voting securities, then the Executive shall have the right to resign from the Company within 90 days of receiving notice of such event and shall receive the severance compensation provided for in Section __ ab
ove.

  She explains why this provision addresses Peter’s concerns.

  When Jan and Montero’s attorney sit down to negotiate, the two lawyers easily agree that in the event of termination for cause Peter will keep only his already vested options and should receive no severance pay. They are also able to agree on Jan’s definition of cause.

  The severance package poses more difficult problems. Jan asserts that Peter deserves two years’ salary and all of his options, vested and non-vested, if Montero terminates him without cause. In Peter’s mind, the options are a signing bonus—something he’s entitled to unless he is terminated for cause. Bill Stodds, the lawyer for Montero West, disagrees. “It’s not a signing bonus,” he insists. “It’s an incentive plan. The 20 percent each year is designed to keep him at the company and motivate him to perform.” He also insists that severance pay be limited to one year: “After all, Peter gets this pay even if he has a new job.”

  Jan and Bill obviously have different frames on what these shares represent—a signing bonus or an incentive plan. Jan tries to address the difference. “Clearly the company is concerned about aligning Peter’s incentives correctly, and treating the options as an incentive plan makes sense for that purpose.” But she argues that this reasoning only goes so far. If the company terminates Peter without cause, it’s the company’s decision to end his employment, through no fault of Peter’s. In that scenario, he should receive all the options as part of his severance package. Jan concedes that if Peter leaves without good reason, then he should receive no severance package. But if he leaves with good reason, Peter and Montero West then share responsibility for his termination. “He wouldn’t be leaving on a whim,” she says. “He’d be leaving because of a turn of events the board can control: either a new CEO has been brought in or there has been a change in control.”