May 2007 Nevada Lawyer

May 2007

EMPLOYMENT CONTRACTS – REVISITING COMMON LAW CLAIMS

BY DANIEL MARKS, ESQ. & ADAM LEVINE, ESQ.

No area of law creates more confusion between attorneys and clients than the area of employment law. Clients believe that they have lifetime contracts of employment and cannot be fired without cause, or as some describe it, due process. When making these statements, they do not distinguish whether or not they are under union contracts, stand-alone employment contracts, employee handbooks, or if they are a government employees under civil service rules.

It is important to determine whether or not the at-will doctrine applies, or if there are any contractual or other exceptions that would provide a basis for an employee to state a claim for relief.

Because there is substantial literature regarding the federal causes of action, this paper will discuss contract claims in the state of Nevada with special emphasis on the standards and differences between the Vargas standard, as stated in Southwest Gas v. Vargas, 111 Nev. 1064, 901 P.2d 693 (1995) regarding employee handbooks, and a just cause standard in free-standing contracts.

Perhaps the worst misnomer and most frequently articulated mistake of law relating to employment law is the claim that “if you don’t have a contract, you are an at-will employee”. Claims of this nature are not infrequently made in publications and lectures, and have even been offered as proposed jury instructions. However, the notion that at-will employment means the absence of a contractual relationship is technically erroneous. As noted by the Nevada Supreme Court in Vancheri v. GNLV Corp., 105 Nev. 417, 777 P.2d 366 (1989), at-will employment is a form of contractual relationship. Where employment is at-will, either party has the contractual right to terminate the employment relationship at any time without liability being imposed upon either party for the decision to terminate the employment relationship.

FIXED DURATION CONTRACTS vs. CONTRACTS OF CONTINUING EMPLOYMENT: TWO VERY DIFFERENT STANDARDS FOR TWO VERY DIFFERENT TYPES OF CONTRACTS

It is virtually impossible to pigeonhole every type of contract into a neat and compact legal category. Contracts can be entered into in any number of ways with the details of the contractual agreement limited only by the imagination of the parties and/or the substantive limitations which may be imposed by law (i.e. contracts in violation of public policy, unconscionability, etc.). However, there are two primary and distinct types of contracts which attorneys will customarily encounter: (1) the fixed duration contract, and (2) the contract of continuing employment. Any attorney in breach of contract litigation must understand the fundamental distinction between the two types of contract, as these two different types of contract have very different standards of liability.

The fixed duration contract is sometimes referred to as a “traditional contract” and has been recognized for many years under the common law. A fixed duration contract for a specified term will usually provide for the principal (employer) to employ the agent (employee) for a fixed or specified period of time ending on a specific date. Unless otherwise expressly agreed by the parties, the common law recognizes, as a provision of such fixed duration contracts, that the employment cannot be terminated by the employer prior to the expiration without “good cause” or “just cause” arising to the level of a material breach. This term need not be stated in the contract. It will be implied as a matter of law, because where the parties enter into a contract for employment for a fixed duration, to permit one party to terminate the employment relationship prior to the expiration of the agreed-upon term would render a material provision of the contract - the specified term - to be meaningless or illusory. Stated another way: if the parties enter into a contract to employ a person for three years, an employer cannot fire the employee prior to the three years unless the employee has engaged in misconduct which rises to the level of a material breach. To hold otherwise would render the three-year period agreed to by the parties a sham.

The other common type of employment contract is the contract of continuing employment. Such contracts are sometimes referred to as implied contracts of continuing employment. However, the use of the term implied may be a misnomer, as contracts of continuing employment may, in fact, be created by express employer statements, whether oral or written. Stone v. Mission Bay Mortgage Co., 99 Nev. 802, 672 P.2d 629 (1983).

Stated simply, an implied contract of continuing employment is a promise by an employer to an employee otherwise employed for an indefinite period that the employee will not be terminated from their employment without “good cause” or “just cause.” Such contracts may be created in different ways. They may be created by written materials, such as those in an employee handbook, promising that no employee will be terminated “without cause.” See Southwest Gas v. Ahmad, 99 Nev. 594, 668 P.2d 261 (1983). Alternately, such contractual relationships may be created by the representations of the hiring authority or management, that so long as an employee performs his job adequately, he will keep his job, or that there will be no termination without just cause. See American Bank Stationary v. Farmer, 106 Nev. 698, 799 P.2d 1100 (1990).

Prior to 1995, most attorneys representing employees in breach of contract actions did not distinguish between traditional fixed duration contracts, and contracts of continuing employment based upon employer representations such as employee handbooks/manuals and/or oral promises. In both cases, attorneys representing a terminated employee focused on the same issue-- whether or not the employee was in fact guilty of the misconduct alleged by the employer. This analysis and focus changed dramatically with the Supreme Court of Nevada’s decision in Southwest Gas Corp. v. Vargas, 111 Nev. 1064, 901 P.2d 693 (1995).

A. The Vargas Standard: The Employer’s (Objective?) Good Faith

In Southwest Gas Corp. v. Vargas, the Nevada Supreme Court joined the modern trend of a growing number of jurisdictions in recognizing the essential and fundamental differences between traditional employment contracts and contracts of continuing employment. In Vargas, a management-level employee of Southwest Gas was accused by several female employees of engaging in conduct which potentially constituted sexual harassment in violation of both Nevada’s and/or federal anti-discrimination laws. After an in-depth and detailed investigation by Southwest Gas Corp. which included multiple interviews with both Vargas and his accusers, management at Southwest Gas Corp. met with Vargas and presented him with the evidence against him. After considering all other options, Southwest Gas Corp. management concluded that they had no other options except to terminate Vargas’ employment.

As a Southwest Gas Corp. employee, Vargas had been provided with an employee manual which included, among its other language, the statement:

A regular employee may only be terminated for cause, termination for cause will occur only after notification from the employee’s supervisor or department head of unsatisfactory performance or violation of a company rule, procedure or practice. 111 Nev. at 1069.

Vargas filed an action for breach of contract against Southwest Gas Corp. alleging the language in the employee manual created a contract of continuing employment, and further alleged that because the allegations against him were false, the company did not have just cause to terminate his employment. Southwest Gas Corp.’s Motion for Summary Judgment was denied by the trial court, and after a trial wherein Vargas presented his evidence to establish that he did not engage in the conduct he was accused of, a jury returned a verdict in Vargas’ favor.

Following an appeal by Southwest Gas Corp., the Nevada Supreme Court used the case to adopt the modern approach, which distinguishes contracts of continuing employment of the sort relied upon by Vargas, from traditional fixed duration employment contracts. Relying upon a decision of the Oregon Supreme Court in Simpson v. Western Graphics Corporation, 643 P.2d 1276 (1982), the Nevada Supreme Court drew a distinction between contracts of continuing employment based upon evidence such as oral promises or the provisions of employee handbooks, and traditional employment contracts. The Nevada Supreme Court recognized that over the years, Oregon, Nevada, and many other jurisdictions had “crafted exceptions to the common law at-will doctrine.” These exceptions give contractual effect to company termination policies “upon which employees rely” but further recognized “there are obvious policy concerns implicated in treating an employment contract implied from an employee manual in the same manner as a negotiated contract.” Southwest Gas Corp. v. Vargas, 111 Nev. at 1074-1075. Accordingly, the court Vargas sought to define “the extent to which employees should be afforded traditional contract rights in connection” and with reliance upon such promises and craft a standard which strikes the proper balance between a recognition of legitimate business judgment of employers and the contractual rights of employees impliedly or expressly grounded in employee handbooks and other forms of continuing employment. Id. at 1075.

Under this analysis, the Nevada Supreme Court recognized that the mere fact that an employer may issue an employee handbook promising that no termination will occur without just cause, should not be construed to include the employer “contracting away” the fact-finding prerogative which would normally reside with the employer under an at-will employment relationship. The Nevada Supreme Court recognized that it would be undesirable to permit a jury to “trump the factual findings of an employer” as to whether the alleged misconduct occurred because civil trial juries may be “unattuned to the practical aspects of employee suitability” and because such juries are not exposed to the “entrepreneurial risks that form a significant basis of every state’s economy.” Vargas, 111 Nev. at 1075. However, the Nevada Supreme Court further recognized that:

On the other hand, in the absence of an unequivocal at-will termination, an employer’s discretion to declare the presence of good cause for termination cannot be immune to challenge; otherwise, an employee’s contractual entitlement to continuing employment would be without substance or effect. 111 Nev. at 1075.

In order to reconcile the conflicting policies, the Nevada Supreme Court attempted to strike “the proper balance between a recognition of the legitimate business judgment of employers and the contractual rights of employees impliedly or expressly grounded in employee handbooks.” Where a contractual claim is based upon such a contract of continuing employment, “good cause” or “just cause” would be defined as a discharge which is:

One which is not for any arbitrary, capricious, or illegal reason and which is one based on facts: (1) supported by substantial evidence, and (2) reasonably believed by the employer to be true. 111 Nev. at 1078.

However, the Nevada Supreme Court further held that employers are “obligated to act in good faith and upon a reasonable belief that good cause for terminating a for-cause employee exists” and that genuine issues of material fact “casting a strong doubt on the purported good-faith of the employer” are an issue for the jury. 111 Nev. at 1076.

The practical implications of the Vargas decision redefine issues attorneys must litigate. Unlike a traditional contract, the issue for a jury is no longer whether the alleged misconduct occurred and constitutes “cause” for termination; the issue for the jury to determine is whether the employer was acting in good faith and upon a reasonable belief that good cause existed. An attorney is no longer litigating the facts alone. The attorney is litigating whether or not the employer’s response to the alleged facts was reasonable and in good faith.

Implied, but unstated, in the Nevada Supreme Court’s decision in Southwest Gas Corp. v. Vargas is a requirement that the “good faith” of the employer be evaluated under an “objective” standard as opposed to a “subjective” standard. Other jurisdictions adopting the same standard, and citing the Nevada Supreme Court’s decision in Southwest Gas Corp. v. Vargas with approval, have clarified that it is a standard of employer objective good faith which must be applied.

In Cotran v. Rollins Hudig Hall International, Inc., 948 P.2d 412 (Cal. 1998), the California Supreme Court, addressing a case factually similar to Southwest Gas Corp. v. Vargas, cited the Nevada Supreme Court’s decision in Vargas in order to overrule prior California appellate decisions which were inconsistent with the standard articulated by the Nevada Supreme Court in Southwest Gas Corp. v. Vargas. The court clarified that this standard required the utilization of an “objective” standard of good faith. After an exhaustive review of common law legal authorities the California Supreme Court clarified:

Although “good faith” is commonly thought of as subjective in essence, the use of objectified mental states as a legal standard is a familiar feature of Anglo-American law. Juries are routinely asked, for example, to place themselves in the position of the “reasonable person” in resolving questions of negligence liability. The standard is not confined to tort law. We have previously applied an objective standard in the wrongful discharge employment context [citation omitted] Prosser & Keeton have described the reasonable person - “‘this excellent but odious character’” - - as “a personification of a community ideal of reasonable behavior, determined by the jury’s social judgment.” Prosser & Keeton (5^th ed. 1984) Torts, § 32, pp. 174-175). As the case law cited in the main text makes clear, coupling “good faith” with “objectivity” is intended to place the trier of fact in the position of the “reasonable employer” in deciding whether the defendant in a wrongful termination suit acted responsibly and in conformity with prevailing social norms in deciding to terminate an employee for misconduct. 948 P.2d at 421 fn 3.

Distilled to its essence, the California Supreme Court clarified the issue for the trier of fact as follows:

The proper inquiry for the jury, in other words, is not, “Did the employee in fact commit the act leading to dismissal?” It is, “Was the factual basis on which the employer concluded a dischargeable act had been committed reached honestly, after an appropriate investigation and for reasons that are not arbitrary or pretextual?” The jury conducts a factual inquiry in both cases, but the questions are not the same. In the first, the jury decides the ultimate truth of the employee’s alleged misconduct. In the second, it focuses on the employer’s response to allegations of misconduct. Thus, to follow the Nevada Supreme Court in Vargas, we “reaffirm our ... prior rulings ... that employers are obligated to act in good faith and upon a reasonable belief that good cause for terminating a for-cause employee exists.” 948 P.2d at 422. See also Towson University v. Conte, 862 A.2d 941 (App.Md. 2004) (“the proper rule of the jury is to determine the objective motivation, i.e., whether the employer acted in objective good faith and in accordance with a reasonable employer under similar circumstances when he decided there was just cause to terminate the employee,” citing Southwest Gas Corp. v Vargas).

B. Traditional Fixed Duration Contracts are Governed by the Higher “Material Breach” Standard

In contrast to contracts of continuing employment based upon such evidence as oral promises or employee handbooks, traditional fixed duration contracts are governed by a standard much less deferential to the employer. Unlike a contract of continuing employment where the jury must evaluate the objective good faith decision-making of the employer, under a traditional fixed duration contract the issue to be determined by the jury is whether the employee’s alleged conduct rises to the level of a “material breach.”

A fixed duration employment contract cannot be terminated by an employer prior to the expiration of the term without just cause rising to the level of a material breach. This well established principle is set forth under Restatement (Second) of Agency § 409, entitled “When Principal can Properly Terminate Employment,” and which states:

A principal is privileged to discharge before the time fixed by the contract of employment an agent who has committed such a violation of duty that his conduct constitutes a material breach of contract or who, without committing a violation of duty, fails to perform or reasonably appears to be unable to perform a material part of the promised service, because of physical or mental disability.

Comment (b) further emphasizes that only a material breach of the contract by the employee will justify termination of the contract by the employer, stating:

What breach justifies dismissal. As stated in Section 118, a principal can terminate any specific authority of an agent at any time, and can also terminate the relation between them. He cannot, however, do this rightfully before the end of the period for which he has agreed to employ the agent, unless the agent has committed a material breach of contract or has failed to perform a condition. An unexcused failure substantially to perform the work which he has contracted to do, or a serious violation of the duty of loyalty or of obedience, constitutes an entire breach of contract. A willful disobedience or a violation of duty of loyalty may constitute a material breach of contract although the harm likely to arise from the breach is a matter to be considered in determining whether or not the misconduct of the agent is sufficiently serious to be a cause for discharge.

Unlike an implied contract of continuing employment evaluated under the Vargas standard, an attorney representing an employee under a traditional contract must not only focus on whether the employee engaged in the activity alleged, but even if established, whether such conduct rises to the level of a material breach. Not all breaches or violations by employees will justify discharge by an employer. In determining whether the alleged conduct rises to the level of a material breach, the following factors must be considered:

(a) The extent to which the injured party will be deprived of the benefit which he reasonably expected;

(b) The extent to which the injured party can be adequately compensated for the part of that benefit of which he will be deprived;

(d) The likelihood that the party failing to perform or to offer to perform will cure his failure, taking account of all the circumstances including any reasonable assurances;

(e) The extent to which the behavior of the party failing to perform or to offer to perform comports with standards of good faith and fair dealing. Restatement (Second) of Contracts § 241.

Not all of these factors will necessarily be applicable in every case. However, as noted by Comment(a) to Restatement § 241, these factors are “to be applied in the light of the facts of each case in such a way as to further the purpose of securing for each party his expectation of an exchange of performances.”

Unlike the contract of continuing employment, whether or not an employee’s actions rise to the level of a material breach is an issue for the jury. J. Calamari & J. Perillo, The Law of Contracts § 11-22 (West Hornbook Series 3^rd Edition 1987); 9, Williston on Contracts § 1012B (3^rd Edition 1967) at pp. 35-36. In Cottonwood Cove Corporation v. Bates, 86 Nev. 751, 476 P.2d 171 (1970) the Nevada Supreme Court affirmed a jury verdict for the plaintiff employee where the trier of fact determined that the plaintiff’s failure to secure a valid Nevada contractor’s license did not rise to the level of a material breach so as to justify the employer’s termination.

When a court is presented with motion practice, it is important for the court to clearly distinguish and utilize the appropriate standard. Contracts of continuing employment governed under the Vargas standard lack a mutuality of obligation. Employees relying upon promises in employee handbooks or employer declarations still retain the right to quit with or without notice at any time regardless of any hardship such self-termination may impose upon the employer. In contrast, an employee governed under a traditional fixed duration contract may not simply terminate their employment at-will without liability. An employee who self-terminates his employment in the absence of a material breach by the employer prior to the expiration of the fixed duration is subject to liability for the cost to the employer to find and secure a replacement for the employee, and any difference in salary. See Dobbs, The Law of Remedies, § 12.26 (West Hornbook Series 1973).

If a trial court understands that a traditional fixed duration contract has both a mutuality of consideration and mutuality of obligation, a court will quickly understand why such traditional fixed duration contracts are subject to the much more stringent “material breach” standard than the contract of continuing employment arising from an employee handbook.

Daniel Marks and Adam Levine practice with the Law Office of Daniel Marks in Las Vegas, Nevada. Mr. Marks has been selected for recognition in Best Lawyers in America for employment law. He is also certified by the State Bar of Nevada in family law. Mr. Levine practices in all areas of civil litigation including employment law, and has represented a number of professionals and executives in connection with their employment contracts.