What are Retention Agreements?
A retention agreement is a form of contract between a company and an employee or other service provider whereby the company (or acquiring company) agrees to continue the employee’s employment with the company, generally for a specific period. A retention agreement typically states that if the employee or service provider does not voluntarily terminate the relationship by its stated expiration date, the employee will either receive a lump sum payment or salary exclusive of all benefits, bonuses, perquisites or commissions. It is also common for a retention agreement to require that the employee or service provider voluntarily terminate his or her employment to receive payments under the agreement, particularly if the company’s contract with the employee or service provider coterminates after the retention period expires or upon a change in control (the latter being the usual form of agreement with executive officers, who are generally not "at will" employees) and the employee decides to terminate his or her employment in order to receive severance benefits in accordance with the agreement .
Retention agreements are sometimes used in connection with mergers or acquisitions and are therefore included in proxy statements and the associated SEC filings. An example of this is the merger agreement between former X-Rite, Incorporated (pre-merger) and Danaher. Another example is the Restatement Agreement and Amendment to Employment Agreement dated November 6, 2009, between BMC Software, Inc. and Arvind Krishna, which sets forth Mr. Krishna’s compensation and benefits as Senior Vice President and Chief Strategy Officer of BMC Software and contains a provision for his payment for his continuous service at least until October 1, 2010. Other industries that commonly use retention agreements include financial services, retail and real estate.
Concerns have been raised over retention agreements because they may be viewed as a way for a takeover target to "golden parachute" the executive officers, rewards for failure at the cost of the shareholders. Nevertheless, a retention agreement gives the acquiring company clarity over the annual compensation paid to the key individual, rules out large new obligations (such as for any fresh equity awards to be made outside of a change in control), and can reduce any possible integration hurdles.
Essential Aspects of Retention Agreements
Although the specific language in a retention agreement can vary significantly by transaction, client needs and other factors, there are some core elements. The following is an explanation of some of the more common terms included in a retention agreement:
Retention Agreement Term – The period at which the retention engagement will last. Typical terms are 9-12 months or a term that coincides with the sale process. A shorter term may limit the impression that a retention agreement is a long-term deal while also focusing the provider on completing the matter in a timely manner. Alternatively, a longer term may allow the provider to focus on sales alternatives in a seamless manner without disruption.
Compensation Terms – The most commonly used arrangement includes monthly fees and a "success" fee to be paid upon a sale of the company or a strategic transaction. Monthly fees change from situation to situation, but monthly fees to retain independent advisors for middle-market companies typically range from $10,000-$25,000 depending on the size and complexity of the client company and the agreed upon work plan. Success fees can take various forms. Many times a flat fee is negotiated based on the target sale price, or in rarer cases, success fees are percentage-based and applied to the value of the transaction. If success fees are negotiated based on the value of the transaction, it is important to clearly define the transaction value.
Duties – This section specifically sets forth the scope of work that will be done during the retention engagement. The duties should reflect all the services you may be asked to perform as a part of the sale process.
Payments – It is important to set forth the timing of payments, how often fees will be billed (monthly being the generally accepted standard), and other payment provisions.
Exclusivity – Retainer agreements should have a clause that specifies that during the retention term, the client will not retain any other firms for investment banking services.
Termination Clause – A termination clause is important because it provides certainty to both parties regarding the duration of the engagement. Without a termination clause, a retention agreement could potentially last indefinitely.
Confidentiality – Typically, certain provisions of a retention agreement will remain confidential. Because of the sensitive nature of the subject matter, the contents of most retention agreements and agreements of confidentiality are not publicly filed. However, if parts of a retention agreement are to be disclosed, it is important for the provider that disclosure decisions are at the provider’s discretion, if possible.
Dispute Resolution – Similar to many other agreements, it is important to set forth a dispute resolution process that provides for meaningful remedies that can be exercised in the event of a breach.
Advantages of Employing Retention Agreements
Retention agreements offer significant advantages for employers. Employers experienced in the use of retention agreements will recognize that a well-drafted retention agreement enhances the employer’s ability to respond to its business needs by eliminating or minimizing challenges to professionalism, productivity and cooperation. Said differently, retention agreements may prevent controversies over the enforceability of non-compete agreements, non-solicitation agreements and confidentiality agreements. Retention agreements also provide the convenience of having all of these provisions under one document. And, the retention agreement is less vulnerable to being voided if it is challenged in court as opposed to being rejected in advance by an employee.
In addition, the retention agreement benefits employees, who have common ground with employers in pragmatic business interests that cut across the employer-employee relationship. Many employees are actively interested – for their own ferociously self-interested reasons – in guaranteeing their employers’ ability to continue as going concerns, because this gives employees the peace of mind that their employers would not terminate their employment without cause, i.e., absent misconduct, malfeasance or malcontent, simply because it was not conveniently profitable. Also, jobs are generally more stable when companies operate as profitable and efficiently functioning going concerns than when companies are free to cut jobs to suit their desired profit levels or meet their desired level of efficiency. Healthy operations also give employees the comfort of knowing that the services they provide will likely continue to be needed and compensated, while unhealthy operations and tumultuous economies can leave employees unsure of whether there will be a continuing need and market for the services they provide, and can even tempt employers to cut costs at employees’ expense.
Legal Aspects of Retention Agreements
Retention Agreements often contain a number of legal clauses that help establish the framework of the relationship between the attorney and the client. Common provisions include:
Termination of Services
Many agreements will outline the conditions under which a client and attorney can terminate the relationship. Under most circumstances, the attorney has the ability to terminate a relationship with a client and withdraw from any pending matters. However, a client can only terminate a contract in specific situations and is subject to penalties if it has filed an action in any court. When the client terminates a matter, they are also responsible for paying an attorney for any work done previous to the termination.
Confidentiality or Non-Disclosure
Retention Agreements often contain confidentiality and non-disclosure agreements that ensure an attorney is subject to their state’s ethical rules that mandate client confidentiality. If an attorney is a member of a specific industry, the client may be bound by specific confidentiality rules as well.
Anticipated Outcome
Retention Agreements sometimes anticipate a result based on facts known at the time of signing. This clause helps set expectations for clients who are filing lawsuits or other legal matters.
Mediation and Arbitration
In order to save time and money, some Retention Agreements contain clauses that mandate mediation of disputes before they can be subjected to a court. This clause is typical in cases where the dispute between a client and attorney is strictly for money.
Severability
Retention agreements will often contain clauses that perform the function of a severability clause to protect parties from contradictory or illegal clauses.
Choice of Law
The agreement may state under which jurisdiction’s laws disputes will be governed. The following clauses may also be present in an agreement:
Mediation Clause
This clause states the method by which two parties can come to an agreement if a dispute arises. Mediation is a form of alternative dispute resolution and can often save a client time and money.
Indemnification
This provision protects a party when another party is sued, charged or otherwise injured.
Notice
This clause outlines the process by which each party becomes officially notified of any concerns. This is typically required in case a law suit arises or to terminate representation.
Limitation of Remedies/Fee Cap
A Limitation of Remedies clause limits the damages a party can recover from a contract breach. A fee cap in a Retention Agreement sets a maximum amount of fees a client can be charged for services.
Conflicts of Interest
This provision discloses the situations in which the parties recognize that a conflict of interest may arise. This document will also detail how the parties can resolve this conflict.
Retainer Renewal
This reverts back to the idea that clients must maintain funds in their trust account for any outstanding retainer obligations with the law firm. Unless otherwise agreed to, Retention Agreements will state that the client must "renew" their retainer periodically.
Conciliation Court or Small Claims Court
These clauses state a forum where disputes can be resolved if they are less than a certain threshold amount.
Retention Agreement or Employment Contract?
Retention arrangements should not be confused with employment contracts, but may often work together as part of the same corporate strategy.
An employment contract is a contract an employer enters into with an employee which controls the terms under which that worker will be employed. This sets out the contract of employment and covers areas such as hours of work, pay, and notice on termination of employment, permissible deductions, and any other expectations about the employee’s conduct. It also sets out the employee’s length of employment.
A retention arrangement is not a contract of employment. It is a contract entered into when an employer wishes to purchase the services of a currently employed individual for a period of time which is in addition to the terms of the employee’s contract of employment. It is common when the company would like a particular employee to continue with the company for a longer period than otherwise contemplated.
Retention arrangements are common when a company does not wish a high performing employee to leave, or when the company is engaged in some major change such as a merger or acquisition , or when the company takes on a high-cost project.
Retention arrangements often include a provision for an employee to repay the amounts received if certain milestones are not achieved, or if the employee resigns, within a certain period of time after the money is paid.
Given that the retention arrangement is not a contract of employment, it is arguable that the protections of the Employment Rights Act, 1996 do not apply to it. The retention payment is the purchase price for a number of additional weeks of work, or a guarantee of work.
Retention agreements seek to compensate the employee for what the employee gives up by continuing to participate in the business. The costs may well justify the value of retaining the employee, but if it is not clear that the total cost of paying the retention bonus and the employee’s salary is worth the effort, the company should probably sit down and consider its options.
Retention agreements may be linked with a new development or an acquisition by the employer, or may be a part of a plan of re-organisation of the employer. In that case, it may be appropriate to offer the employee a new contract of employment and set aside the previous one.
Creating a Comprehensive Retention Agreement
Guidelines for Drafting an Effective Retention Agreement
From the outset, a retention agreement should contain a clear and detailed description of the scope of services provided by the advisor from the initial consultation through the conclusion of the assignment, whether that is by completion of the engagement or termination of the agreement. The parties should also include a form of reference for the client and confirm the advisor’s availability to the reference.
The retention agreement should include a description of the services, an explicit commitment to confidentiality, an acknowledgment of the protections afforded by the attorney work product and attorney client privileges, and a clear explanation of the advisor’s fee and payment of expenses, including the advice on whether a client should consider retaining independent counsel concerning the advisor’s fees.
A provision disclosing the scope of the consultant’s role and the potential that a conflict of interest may exist by virtue of the advisor’s association with other clients should be included in the retention agreement, together with an acknowledgment on the part of the advisor that any preexisting duties owing to other clients would not interfere with the advisor’s loyalty or commitment to the current client. This provision would be in addition to a provision that the retention agreement will be effective until the conclusion of the client’s need for the advisor’s services or that the client will notify the advisor in writing that no further services are needed.
Enforcement of Retention Agreements
If a party to a retention and escrow agreement fails to abide by the terms of the agreement and/or the agreed to exclusivity period, the other party to the agreement is entitled to seek specific performance to hold the breaching party to its obligations under the agreement and enforce the contemplated closing transaction. In the absence of circumstances warranting specific performance, a court has the ability to assess whether, upon dismissal of the breaching party from the LLC, the parties have an unperformed asset and if so, summarily tie off the deal and eliminate membership interests within the LLC in order to compensate the nonbreaching party. In the event that the retained stakeholder has already left the jurisdiction, then the court may take steps to enforce the retention agreement in its entirety.
To illustrate the aforementioned, in 2018, EC Technology Investment, LLC ("EC") sued two of its members claiming, among other things, breach of contract due to the two members’ failure to leave EC and therefore, prevent closure of the contemplated transaction in the sale of EC’s assets. EC argued specifically that the two members’ refusal to vacate the company stalled EC’s ability to close its recently negotiated deal with an acquiring entity. As a result, EC sought damages for breach of contract related to the two members’ failure to leave EC and enforcement of the terms of the retention agreement. By way of order entered on September 26 , 2019, the Delaware Chancery Court acknowledged evidence that the member defendants, despite their pre-closing agreements, discouraged buyers and others from doing business with EC, as well as extorted money from EC in exchange for them completing their resignations. Id. 389-91. The Court held that: The Court further held that the member defendants undermined the purpose of the agreement between them and the retained stakeholder, which was to consummate a sale of EC’s assets to a buyer, by breaching their obligations under the retention agreement, failing to timely vacate EC, and engaging in unfavorable conduct regarding the sale process. The Court also noted that the sale was delayed due to the members’ interference and therefore, decided to enforce the terms of the retention agreements as if the members complied with the post-closing conditions. The Court explained that: In sum, the Court enforced the retention agreements in their entirety and instructed the parties to return to the court in the event of a need for further orders. Id. 392. EC ultimately sold its assets and the proceeds were deposited with the Court. In this way, a court may opt to sever all or certain sections of an agreement thereby enforcing the agreement with the members of an LLC when contract rights and pre-existing obligations of the parties are not fully carried out.