Labor and Employment

What Are the Benefits and Risks of Employment Contracts?

By Lisa Guerin, ​J.D., Boalt Hall at the University of California at Berkeley
Learn when it makes sense to create an employment contract with your company's employees.

Should your company use employment contracts with some or all of its employees? The answer depends on the type of contract you use and the type of employment relationship you want to create. Most employers prefer to maintain their right to fire employees at will, and an employment contract can undo that right. However, there may be certain employees for whom you are willing to give up your at-will rights.

At-Will Employment

In the United States, employees are generally considered to work at will unless they have a contract changing that status. An at-will employee is free to quit at any time, for any reason. You may also fire an at-will employee at any time, for any legal reason. (Federal and state laws place certain reasons for firing off limits, including discrimination and retaliation. Even an at-will employee can sue for wrongful termination if you fire the employee for illegal reasons. To learn more, see our article on at-will employment.)

Employers generally want to retain their at-will rights. It’s much easier to fire an at-will employee—and less likely to lead to legal trouble. If an employee just isn’t working out, you can terminate the relationship and move on, without having to prove that you had “good cause” to fire.

Some employers ask employees to sign at-will agreements. An at-will agreement simply makes it crystal clear that the employee works at will and that the employer has done nothing to change that status. Some employers include this in the form new employees are asked to sign to acknowledge receipt of the employee handbook. Other employers use a separate at-will employment contract or include at-will language in the offer letter applicants must sign to accept a position.

Types of Employment Contracts

Employment contracts restrict an employer’s ability to fire an employee at will, by agreeing to hire an employee for a specific period of time or by agreeing not to fire an employee without good cause. Employment contracts can be made in three ways: in writing, orally, or by implication. A written contract is just what it sounds like: a document setting out the agreement between the employer and employee. An oral contract is made aloud rather than in writing. For example, an employer might close a job interview by saying, “I’ll hire you for one year at a salary of $50,000.”

Implied contracts are trickier. These contracts are cobbled together from the employer’s statements, actions, policies, and other employment documents. If all of the facts, considered together, imply that the employee will not be fired without good cause, you have created an enforceable contract limiting your right to fire at will. Not all states allow implied contract claims. In those that do, such as California, courts consider several factors in determining whether an implied contract has been created, including:

  • promises of job security (for example, “You’ll always have a job here as long as I own the company”)
  • policies that limit the employer’s right to fire (such as progressive discipline policies limiting termination to very serious misconduct or probationary periods during which employees may not be fired)
  • statements made during performance reviews (“I’ll give you six months to get these numbers up”), and
  • treatment of other employees (for example, an employer that has only ever fired employees in cases of extreme misconduct might have set a precedent that undermines its at-will rights).

Implied contracts are often based on statements or policies found in an employee handbook. To learn more see Does Your Employee Handbook Compromise At-Will Employment?

Should You Use Employment Contracts?

An employment contract that limits your right to fire at will restricts your flexibility. You will no longer be able to quickly and easily terminate an employee who is a poor fit with your workplace culture, who shows early signs of performance trouble, or who simply isn’t working out. You might be able to accumulate enough evidence of problems to show good cause to fire, but the process will take time and managerial effort —and you could still end up in court.

Employment contracts make sense when there’s something you want from the employee in return. Here are some situations where you might want to ask a particular employee to sign a contract:

  • To attract a truly hot prospect. If you want to sign a superstar applicant who has other job opportunities, offering job security is one way to make your offer attractive. Even if you can’t offer a higher salary than competitors, agreeing not to fire the employee except for good cause for the first year or two of employment might make your job offer stand out.
  • To keep an employee. If you enter into a contract with a term of a year or two, you can limit the employee’s right to quit at will during that time, as well. This can make sense if you are hiring for an especially important position (the CEO who will lead your company through a merger, for example) or if you will spend a lot of time training the employee.
  • To exact other promises. In your contract, you can include other provisions, such as a non-compete clause, in which the employee agrees not to work for or start a competing business for a period of time after leaving your employ.

If you are considering creating an employment contract with a particular employee, it’s always best to put it in writing. That way, both you and the employee are clear on what you have agreed, and you have written proof should you need it later. An employment attorney can draft an agreement that will protect your rights and stand up in court.

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