Hiring employees presents unique challenges for tech companies that do not confront other American businesses. In our experience as outside counsel to tech companies, legal mis-steps typically result from oversight rather than a deliberate intention to flout the law. The checklist below is a structured guide to avoiding these common pitfalls in the hiring process. It applies to Software-as-a-Service providers, custom software developers, mobile app developers, I.T. consulting firms and other tech employers.
1. Decide whether you’re hiring an employee or an independent contractor.
Some roles in a tech company can be filled by either an employee or an independent contractor. Engineers and designers in particular are often freelancers, but we’ve seen freelance CFOs, COOs and plenty of other contracted personnel.
From the company’s perspective, contractors can seem like an attractive option because they generally don’t have a legal right to benefits (like health insurance or overtime pay) and don’t receive the post-employment health care benefits that federal law sometimes requires for employees. And indeed, tech companies have embraced freelance workforces. (Google may be an extreme example, with reportedly more contractors than employees, but smaller software companies use contractors widely, too).
Contractors are a perfectly legal and appropriate option for many roles, but they must be hired and managed in a legally compliant way. State laws generally presume a worker is an employee unless the company can prove to a state agency that they’re really a contractor. And changing state laws, driven partly by concerns that tech companies are abusing contractors economically, increasingly make it harder to classify contractors as such. State agencies do, in fact, routinely audit companies to ensure that the personnel they call “contractors” are not in fact working like employees. If found to be mis-classifying people as contractors, an employer can be liable for unpaid benefits, retroactive withholding of payroll taxes and other financial penalties. State regulators generally want to ensure that contractors are truly specialists consulted for their specific subject-matter expertise, and not just workers to whom a company does not want to provide benefits.
In short, a threshold question to discuss with legal counsel is whether the right person for the job is a W2 employee or a 1099 contractor. Either is fine, but the decision should be made and documented with the right contract.
2. Confirm whether the employee is exempt from fair labor standards laws.
If you have determined that your next hire will be an employee, the next step is deciding whether she will be “exempt” or “non-exempt.” This language, which often is written right into employment offer letters, refers to whether the employee is exempt from the federal Fair Labor Standards Act (FLSA) and related state laws. These laws provide non-exempt employees with a host of protections, from minimum wage and overtime pay to child labor rules.
Not all employees are covered by these laws, though. Depending on the employee’s salary, the nature of her work, whether she supervises other employees and other factors, she may be exempt. Some tech workers will be exempt because of the law’s carve-out for “computer-related occupations.” Others may be exempt because their annual wages exceed a certain amount. Decide whether the position is exempt before offering the job to the employee.
3. Decide whether the employee is at-will or has an employment agreement.
Most U.S. employees are “at will,” meaning that the employer and employee can both terminate their relationship at any time and for any legal reason. To hire at-will employees, employers typically use an offer letter that becomes binding only when countersigned by the new employee. These letters usually are short, become binding only when countersigned by the employee, and list any prerequisites to employment (e.g. passing drug tests or proving the employee may legally work in the U.S.). They should clearly state the at-will relationship to prevent any future argument that the employee had a guaranteed employment term.
In rare cases, typically with senior executives, a company may use an agreement that provides a guaranteed employment term. An incoming executive might also negotiate for provisions such as a guaranteed title and minimum salary, performance bonuses, stock or stock options and other benefits.
4. Be cautious when using non-compete agreements.
Non-compete agreements bar employees from working with an employer’s competitors — usually for several years after the employment relationship ends. Non-competes are notoriously controversial in tech companies; many employers find them contrary to the free circulation of knowledge, while others call them a necessary protection for their trade secrets.
Non-compete agreements are generally enforceable in most states, but state legislatures in recent years have made them increasingly harder to enforce. Some states forbid them altogether; some allow them only for highly-paid workers; some states fine employers for using non-compete contracts improperly. Some laws allow employees a one-year grace period after joining the company before they can be bound by non-competes.
Finally, some states require that employers give new hires a minimum amount of time (e.g. several days) to review a non-compete agreement before being asked to sign. These laws apply regardless of whether the non-compete is a stand-alone contract or just one clause in a longer employment agreement. If the waiting period is not observed, the result could be that the employee is not bound by her employment contract. In some states, employers can even be fined for failure to provide the waiting period.
In summary, non-compete laws vary by state, change often, and should be discussed with legal counsel before using non-competes with new hires.
5. Ensure that your hiring practices comply with other applicable laws.
A patchwork of federal laws and varying state laws governs the way that companies hire employees. Most businesses have some awareness of anti-discrimination laws, but what about rules relating to pre-employment drug testing? Where and how should companies publish job listings? Do employment agreements need to be in writing? Laws vary by state and change often. A quick consultation with legal counsel before hiring an employee can save time and legal fees later.
Beware of re-using document templates that your counsel has prepared for other employees. The necessary documents vary depending on a host of variables – compensation, job duties, benefits, the state where the employee works and more. Re-using templates invites legal problems.
6. Ensure your employees assign their intellectual property to the company.
Virtually every tech company sells or licenses intellectual property (I.P.). The product is I.P., whether it’s Software-as-a-Service (SaaS) or custom-written code. While default copyright laws hold that employers sometimes own employee-generated I.P., those laws have significant gaps — in short, an employer cannot rely on them.
Rather than hope the default copyright laws apply, every tech employer should have its employees sign agreements assigning (giving) their I.P. to the company. Otherwise, the company may be selling or licensing I.P. that it does not even own – because the owner is the employee. This in turn means the company may be violating its own customer-facing contracts in which it must promise that the customer will not be sued for infringement by third parties. This legal problem often does not become evident until an employee leaves the company, at which point employers sometimes realize for the first time that they have spent years selling I.P. that they don’t own. This can expose the company to expensive lawsuits from either a former employee or a customer.
Employees should sign I.P. assignment contracts at the start of the employment relationship – either as a stand-alone document or as one part of a longer agreement that often includes confidentiality and non-compete clauses. If your current employees have never signed these assignment agreements, fear not: it is possible to have them sign them retroactively. It will require some additional “consideration,” or payment, to make the contract binding, but that can generally be done by offering those employees a small token payment or gift card to make the contract binding.
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The checklist above is not exhaustive, but it covers the more common mistakes that we help tech employers fix. Fortunately, all of these pitfalls are easily dodged with some advance planning. Keep this checklist handy for reference as you hire employees and consult with your legal counsel for more detailed guidance.
