Key Takeaways

  • A compensation agreement outlines how and when an employee will be paid.
  • It can include base salary, commissions, bonuses, stock options, and fringe benefits.
  • Executive and real estate professionals often require highly customized compensation agreements.
  • Legal review is essential to ensure compliance, clarity, and protection for both parties.
  • Including termination clauses, tax implications, and regulatory adherence can strengthen the agreement’s enforceability.

A compensation agreement ensures that an individual will get paid for the services he or she provides to a company as an employee. This document is often used for those who work on commission and those in high-level positions who receive a combination of executive salary, stock options, performance bonuses, and other benefits.

Elements of a Compensation Agreement

The compensation agreement delineates the terms of an individual's employment with the company, including when an employee is newly hired or receives a raise. Contract employees are generally not used for at-will employees. If you are asked to sign a compensation agreement by a new company, review it carefully to make sure you agree with the stated terms.

In most cases, a compensation agreement is used in conjunction with an employment contract. It includes details such as:

  • The form and amount of compensation
  • How often wages will be paid
  • The terms of performance incentives
  • Bonus information if applicable

It's especially important to have a detailed compensation agreement if you are paid on commission. This type of contract should include:

  • How commissions are calculated
  • Gross profits
  • Payment periods
  • Sales
  • Revenues

Contracts should include specific, clear language along with definitions of legal terms or other jargon that may be unfamiliar. In many cases, the contract will note that the worker is employed at will. You may want to have an employment attorney review your compensation agreement before signing.

In cases in which an employee can take a draw on commission, these terms must be clearly dictated in the compensation agreement. These details should include the repayment schedule, maximum draw amount, and procedures if the employee quits, is fired, or becomes disabled.

If employees are offered special benefits or perks, such as extra vacation time, stock options, a company car, or stock purchase programs, these should be detailed in the compensation agreement as well.

Compensation Agreements in Real Estate Transactions

In real estate, compensation agreements are common between agents, brokers, and clients. They outline:

  • Commission Rates: A fixed percentage or flat fee for completed transactions
  • Payment Triggers: Often tied to closing dates or buyer performance
  • Dual Agency Compensation: Clarifies how agents are paid when representing both buyer and seller
  • Exclusive Representation: Ensures the agent gets paid even if the client finds the property independently

These agreements must comply with state real estate laws and should be in writing to avoid disputes.

Executive Compensation Agreements

Executive compensation agreements are specialized contracts tailored to high-level roles like CEOs, CFOs, and other corporate officers. They often include:

  • Base Salary and Guaranteed Bonuses
  • Performance-Based Incentives: Tied to specific metrics like EBITDA or stock performance
  • Golden Parachutes: Predefined benefits upon termination due to mergers or restructuring
  • Clawback Provisions: Allow the company to recover bonuses if misconduct or financial restatements occur
  • Non-Disparagement and Confidentiality Clauses

These agreements typically require board approval and involve negotiation with legal counsel to align with the company’s strategic and governance policies.

Additional Provisions to Include in a Compensation Agreement

Beyond the basics, a comprehensive compensation agreement should also address the following elements to prevent disputes and ensure clarity:

  • Termination Terms: Define severance pay, continuation of benefits, or limitations on post-termination compensation.
  • Equity Compensation: Outline how stock options or equity awards will vest, and what happens upon termination or sale of the company.
  • Tax Implications: Specify who is responsible for tax withholding and reporting, especially with incentive-based or deferred compensation.
  • Reimbursement of Expenses: State whether the employee will be reimbursed for work-related travel, education, or client development costs.
  • Regulatory Compliance: Ensure the agreement complies with applicable labor laws, IRS rules (especially Section 409A for deferred comp), and securities regulations for equity.

These terms are especially important in executive, commission-based, or highly regulated industries.

Advantages of Employment Contracts

Tools such as compensation agreements and employment contracts allow you to control an employee's ability to leave the company. A written contract can establish a definite term of employment or require the employee to give a specific term of notice before resigning, such as 90 days. This can also specify a penalty for not abiding by these terms.

You can also include a confidentiality clause in the employment contract if the employee will be exposed to sensitive company information. This will prevent the employee from using this data for personal gain or sharing it with people outside the organization.

If you want to attract a skilled employee who currently works for another company, an employment contract can be used to craft a compelling offer with benefits such as job security and bonuses.

The employee agreement can also specify productivity goals that the employee must meet and establish grounds for termination.

Disadvantages of Employment Contracts

Employment contracts limit a company's flexibility to change the terms of employment if they no longer fit business needs. To change a contract, you will need to negotiate new terms with the employee, and he or she may not necessarily agree.

Employment contracts also require employers to act in good faith. If the employee feels he or she is being treated unfairly and the courts agree, you may need to pay legal damages for violating the contract.

Common Employment Contract Terms

  • Non-compete clauses prevent employees from working for a direct competitor within a designated geographic area for a specific period of time, such as two years.
  • Intellectual property (IP) ownership clauses are used with employees who invent products for the company. They state that any inventions created at work and for a set time after employment termination are the property of the company, that the employee will cooperate with the patent process, and that royalties will be assigned to the company.
  • A best efforts provision indicates that the employee will work hard on behalf of the company.
  • An exclusive employment clause means that the employee will not work at another company in the same or similar industry at the same time.
  • A no extra compensation clause indicates that the employee will not be paid extra for serving on a board or committee.

Legal Considerations for Enforceability

To ensure a compensation agreement is enforceable, it must meet legal standards such as:

  • Mutual Consent: Both parties must understand and agree to the terms.
  • Clarity and Specificity: Vague compensation terms can render the agreement unenforceable.
  • Written Format: Especially important for commission-based or executive roles.
  • Compliance with State and Federal Law: Including wage laws, IRS codes, and employment regulations.
  • Consideration: Each party must receive something of value—typically, work in exchange for pay.

Seeking legal advice before executing a compensation agreement is critical to protecting the interests of both the employer and the employee.

Frequently Asked Questions

  1. What is a compensation agreement?
    A compensation agreement is a legal document outlining how and when an employee or contractor will be paid, including salary, bonuses, and other benefits.
  2. Do I need a lawyer to review a compensation agreement?
    While not legally required, legal review is strongly recommended to ensure fairness, clarity, and compliance with employment laws.
  3. Can compensation agreements include non-monetary benefits?
    Yes. Common non-monetary benefits include stock options, company vehicles, paid vacation, and continuing education reimbursements.
  4. How are commissions handled in a compensation agreement?
    Commission terms should define how payments are calculated, when they are due, and what happens if a deal falls through or the employee leaves.
  5. Are compensation agreements legally binding?
    Yes, if properly executed and compliant with relevant laws, compensation agreements are enforceable in court.

If you need help with creating or negotiating an employment compensation agreement, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.