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“Cause” for Concern? — Executive Compensation and Severance

In negotiating any senior executive’s employment agreement, particular attention must be paid to the section which defines “Cause” for termination. This section sets forth the specific, agreed-on circumstances in which the employer has legitimate grounds for terminating the executive with “Cause.” A termination with “Cause” is important because of its draconian effect on the executive’s compensation: an executive who is terminated with “Cause” does not receive severance or other benefits, so is immediately out of work without pay. Unfortunately, some executives discover too late that they unwisely accepted a benign-sounding definition of “Cause” to their own peril.

Here’s a quiz. Which of the following constitutes a legitimate reason for a Company to terminate an executive’s employment with “Cause”:

(a) any and all violations of the law?
(b) the executive’s poor or unsatisfactory performance?
(c) management’s belief that the employee has damaged the Company?
(d) None of the above?

The answer is (d): From the point of view of an executive compensation lawyer, none of these reasons should be permissible grounds for “Cause” so as to allow an employer to terminate an executive with impunity.

You may ask why. The answer depends on some careful distinctions.

Let’s look at (a). While many violations of law and even violations of certain important Company policies are usually — and properly — included in the definition of “Cause,” (a), as I have written it above, is simply too broad. It would allow an employer to terminate an executive for a minor traffic violation or an inadvertent mistake which, while technically illegal (fishing without a proper license) has no appreciable impact on the employer or the executive’s job performance.

By contrast, of course, any material violation of a law which fundamentally or inevitably impugns the character of the executive, such as financial impropriety or an act of genuine moral turpitude, usually is (and should be) included in the definition of what constitutes “Cause.”

What about (b)? The problem with this purported reason for Cause is that it is too subjective. There is no objective standard for something as vague as “poor” or “unsatisfactory” performance, nothing concrete by which a court can later assess the propriety of whether an executive’s performance is so dramatically inadequate as to warrant being fired with “Cause.” For instance, if the executive was expected to hit a target of a 100% increase in sales, and only achieves an 85% increase, is that “poor performance”?

And, when you think about it, “poor performance” is really nothing other than the customary grounds for termination without “Cause”: the employer, having decided that, for whatever reason, the executive is not doing the job which management wants or expects, is free to terminate the executive but has to pay her severance and benefits as specified in her contract.

“Poor” or “unsatisfactory” performance is different, of course, from a total lack of performance — the executive flies off to Tahiti for three months — or the executive’s failure to follow a lawful order of his superior or the Board of Directors. These things can be measured objectively.

Moreover, if the executive has been represented by a qualified executive compensation attorney, the employment contract will contain a “cure” provision. The executive must be given written notice that he is not Gaugin and must get back to work within ten business days, thereby “curing” his non-performance. If he fails to do so, he has knowingly, and justly, invited his termination for “Cause.”

As for reason (c), here, too, there is a risky element of subjectivity which could allow an unscrupulous, desperate or even merely misguided employer, just because it “believes” that an executive has engaged in conduct harmful to its interests, to terminate the executive for “Cause” — and without paying severance or benefits.

This is inequitable. As the executive compensation attorney representing the executive in the negotiation of her employment agreement, I would be willing to accept, as one of the grounds for “Cause,” circumstances in which the executive “acted so as to intentionally cause material harm to the employer,” but a more subjective definition should be strongly resisted.

Here’s the “bottom line”: Since a termination for “Cause” will deprive a senior executive of his or her anticipated severance and benefits — the legitimate cushion for the executive’s diligent, if sometimes unsuccessful, hard work — the definition of “Cause” in the executive’s employment agreement must reflect only those circumstances which objectively prove that the executive was (a) acting so as to materially harm the Company or (b) manifesting the sort of degraded character which falls below the standard which an employer can legitimately expect of its senior management team.

Any definition which does not meet these tests should truly “cause” an executive to be concerned, and no attorney representing the executive should fail to challenge a sloppy or overbroad definition of “Cause.” (In a future “Perspectives,” I will address what happens if an executive’s agreement mentions “Cause” for termination, but leaves “Cause” undefined.)

About the Author

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George Birnbaum

Since 1980, sophisticated business people have relied on George to apply the meticulous preparation, attention to detail, and devotion to his clients he learned from fabled trial lawyer Louis Nizer. A graduate of Harvard College and Harvard Law School, George has over 35 years of distinguished deal-making, litigation, mediation and arbitration experience which he has used to negotiate high-stakes agreements for senior executives and select business clients throughout the United States.