WHO OWES WHAT TO WHOM? – WHEN AN EMPLOYEE UNDER CONTRACT LEAVES EARLY

Most private sector employees in Tennessee are classified as “employees at will.” That means the employment relationship can be terminated by either the employer or employee at any time, without notice and for any reason that is not illegal or against public policy (i.e., not involving race, gender, disability or age discrimination, etc.). Thus, absent some contractual provision to the contrary, employees classified as “at will” can walk out at any time and bear no legal responsibility for losses sustained by their employer as a result of their sudden absence.

Employees who enter into employment contracts for a defined period of time (usually referred to in the contract as “the term”), do not fall under the “at will” category. Most employment contracts provide that a termination for something other than “cause” entitles the employee to continue receiving all or a portion of the compensation due under the contract for the remainder of the term. As you might imagine, an employer who terminates an employee for “cause” (which is usually defined to involve conduct of the criminal and unethical variety) is often accused of manufacturing grounds for cause to avoid paying the remaining compensation due under the contract. This type claim has been standard fare for employment lawyers for decades.

But what happens when the roles are reversed and an employee who has worked only 6 months of a 2 year contract suddenly announces he is leaving? Does he owe anything to the employer? More specifically, if the employer must pay the employee for the remainder of the term when the employee is terminated without cause, does the employee owe the employer projected net profits the employer would have made from the employee’s production for the remainder of the term? Interestingly, the answer to that question in Tennessee is “we really don’t know.” From what I can determine, neither the Tennessee Supreme Court nor any lower appellate court in Tennessee has yet to address that question directly. In fact, while there is judicial guidance from other states on this question, it is actually rather sparse. I suspect the reason for so little litigation over the damages caused by an employee’s breach of the term provision of the agreement is that historically, most employers have accepted losses associated with employee attrition as a fact of life. Attrition certainly was more tolerable when investment in employee training was minimal, finding a replacement was quick and easy and any net profit lost during the period needed to locate, hire and train a replacement was manageable.

These considerations have changed substantially for many industries in the 21st century. That is particularly true for the healthcare sector where we are witnessing a significant change in the business model for delivery of physician services. Using the physician employee as an example, a physician employed by a hospital owned practice group is expected to generate substantial net profit for his employer over a period of 2-3 years. While the practice may not invest much in the physician’s training, the recruitment period to find a qualified replacement can take months, depending on the specialty involved. For other professions, an employer may have to invest weeks of training for a new highly compensated employee to become familiar with product line capabilities or complicated new technology. That loss on the front end is expected to be recouped over the course of the entire contract period, with the greatest profitability usually expected on the back end of the term. As a result of these factors, employment lawyers are now hearing from employers about pursuing claims against departing employees for damages caused by an early voluntary departure.

The first and obvious question most employees ask me in this situation is whether they are even in breach of their contract when they decide to resign before the end of a 2 or 3 year employment contract. The answer is “yes.” The employee agreed to work for a definite period of time and failure to perform as promised is a breach of the employment contract. The more difficult issue is determining the damages an employer can recover. In these instances, many employers at least initially seek to recover the lost net profits caused by the employee’s departure. The majority of courts in other states that have considered this claim, however, have rejected it. Those courts generally hold that a damages award based on a projection of the future net profits that would be earned in the future from a single employee’s labor is entirely speculative and therefore cannot provide the basis for an award. These courts have instead limited employers to recovery of reasonable expenses incurred to recruit and if appropriate, train a replacement. In some instances, the employer may be able to recover the difference between compensation paid to the departing employee and his replacement for the remainder of the term, if the employer had to pay a higher amount to obtain a replacement for the position.

So how can an employer protect itself from the unexpected loss of a valuable income producing employee under these circumstances? There are 3 employer recovery provisions that should be considered for inclusion in employee contracts. First, if the employer paid any pre-employment compensation, such as a sign-on bonus or moving expenses, the contract may provide for reimbursement of all or a prorated portion of those should the employee resign before expiration of the term. Second, a similar reimbursement provision might be considered for out of the ordinary training expenses incurred at the outset of employment. Third, the employer should consider appropriate use of what are called “liquidated damages” for an employee’s early departure. Liquidated damages constitute an agreement by the contracting parties of the extent of damages the employer would sustain if the employee leaves early. For those of you who are college football fans, the “contract buyout” the coach your school wants to hire must pay his former school to leave is a form of liquidated damages.

These employer recovery terms are quite valuable and if drafted appropriately are clearly enforceable in Tennessee. If drafted improperly, found to be overreaching or otherwise unfair, they ultimately may be worthless once subjected to court review. Tennessee courts have developed a body of law on the issue of liquidated damages in the employment context. Experienced employment counsel should be consulted any time use of such clauses are under consideration in order to avoid the pitfalls of inappropriate drafting.