Legal area: Contract Law

Task:
You are the General Counsel of Acme Corporation, a non-profit organization based in Northern Virginia, with annual revenue of Five Million Dollars. Your organization is recognized by the Internal Revenue Service as a 501(c)(3) tax exempt organization.

The Board of Directors has told you that the current CEO is retiring, and that they have recruited a new CEO to take her place. The new CEO will (as was the retiring one) be an ex officio voting member of the Board.

The Board is quite excited as the incoming CEO has a very impressive resume, with extensive experience in the industry, and a proven track record in negotiating and implementing mergers. The latter is important, as the company is considering several consolidation offers.

The Board has negotiated the following terms with the incoming CEO:
One Million Dollar ($1,000,000) annual salary
50% bonus potential, based on performance
Three year initial term, commencing July 1, 2026, with the possibility of extension based on mutual agreement.

The Board has asked you to (1) prepare a draft employment agreement for its review, addressing the above deal terms, and (2) prepare a memo identifying any legal issues you see with the proposed agreement and deal terms, and also identifying any issues that require clarification by the Board. The latter should identify the sources relied upon, state any assumptions used, and provide your analysis of those issues and your recommendations to the Board.

The Board has asked that, in this first draft of the agreement, you focus on the key employment agreement provisions. The Board wants a draft quickly, and has told you that the boilerplate provisions can be added later. In this first draft, the Board has asked that you pay particular attention to the non-compete required from the new CEO. Given the importance of this position, and the skills and proprietary knowledge he will gain, the Board does not want him leaving the company and taking those skills and that knowledge to any other company in the United States, Canada or Mexico. The Board wants to strictly limit his ability to do so, for a period of five years after he leaves the company.

Reference answer:
To: Board of Directors
From: General Counsel
Date: February 27, 2026
Subject: Draft Employment Agreement; Potential Legal Issues with Proposed Agreement

**A. Introduction: **

You have asked for a draft employment agreement for the hiring of the new CEO. That draft is attached.

You have also asked for this memo identifying and analyzing any significant legal issues associated with the proposed deal terms, and identifying any deal terms that require clarification.

**B. Summary Answer: **

The key legal issue raised by the hiring are the proposed compensation terms. As a 501(c)(3) tax exempt organization, Acme is subject to the Internal Revenue Service ("IRS") "intermediate sanctions" rule, which can impose significant personal liability on the individual directors approving any compensation deemed excessive. The applicable Federal law is **Internal Revenue Code ("IRC") § 4958. **Therefore, before entering into this agreement, the Board should take the steps outlined in IRS regulations to confirm and document the reasonableness of the proposed compensation, so as to position the Board for the "safe harbor" provided under the Federal tax regulations in **Treas. Reg. 53.4958-6**.

A second compensation issue is the excise tax imposed on tax exempt organizations under IRC § 4960, given that the proposed CEO compensation is over $1 Million.

A third issue is presented by the proposed non-compete terms. For a non-compete to be enforceable, it must be reasonable in scope and duration. Here, the proposed non-compete is very broad in its scope and in its duration.

Some of the deal terms require further clarification, as indicated in the draft agreement, and below in this memorandum.

**C. Discussion:**

1\. Executive Compensation:

The proposed One Million U.S. Dollars base salary (plus the $500,000 USD bonus) for the CEO of a $5 million dollar revenue organization raises concerns under the intermediate sanctions rules. Pursuant to **IRC § 4958**, the IRS imposes significant excise taxes on the recipient of excessive compensation, AS WELL AS the directors of the tax exempt organization that approved such compensation.

The penalties for violating this provision are severe. Pursuant to **Treas. Reg. 3.4958-1(d), **a director could face a penalty of 10% of the excess compensation:

"(d) **_Tax paid by organization managers_** —
(1) **_In general._** In any case in which section 4958(a)(1) imposes a tax, section 4958(a)(2) imposes a tax equal to 10 percent of the excess benefit on the participation of any organization manager who knowingly participated in the excess benefit transaction, unless such participation was not willful and was due to reasonable cause. Any organization manager who so participated in the excess benefit transaction must pay the tax."

Given the severe and personal penalties, it is critical to follow the steps outlined in the IRS regulations to document that the Board's compensation decisions were reasonable and the compensation awarded was not excessive. If the specified steps are taken, the directors can position themselves for a "safe harbor" or, more specifically, obtain a "rebuttable presumption of reasonableness" for their compensation decisions. **Treas. Reg. §53.4958-6**.

In summary, the three essential steps under **Treas. Reg. §53.4958-6 **to obtain this rebuttable presumption are (i) the compensation must be approved in advance by the Board (excluding any individuals who have a conflict of interest in the transaction), (ii) the decision-makers must have obtained and relied upon data and opinions that show the compensation was reasonable, and (iii) the Board must timely and properly document its compensation decisions.

For (ii), the Board should retain the services of a specialized compensation expert and obtain a written opinion from such compensation expert that deems the compensation reasonable and that the Board may point to as showing the Board's due diligence. Per **Treas. Reg. §53.4958-6(c)(2)(i)**,** **the Board must obtain and rely on information showing that **"**the compensation arrangement in its entirety is reasonable or the property transfer is at fair market value. In the case of compensation, relevant information includes, but is not limited to, compensation levels paid by similarly situated organizations, both taxable and tax-exempt, for functionally comparable positions; the availability of similar services in the geographic area of the applicable tax-exempt organization; current compensation surveys compiled by independent firms; and actual written offers from similar institutions competing for the services of the disqualified person."

2\. Excise Tax on Compensation Above $1 Million: The Internal Revenue Service imposes an excise tax on tax exempt organizations that pay over $1 Million USD in annual compensation to an executive. ** IRC § 4960. **Compensation includes not just the annual salary, but also bonuses, severance and deferred compensation. **26 U.S. Code § 3401. ** The excess compensation is taxed at a 21% tax rate, and is imposed on the organization, not the recipient.

Given the compensation proposed, the excise tax will be imposed in the second year of the contract and beyond (the first year is a partial year). In the second year, the Company could face a liability of 21% of $1,250,000 (based on a bonus award of $250,000 for the first (partial) year).

3\. Non-Compete:

The law of Virginia is typical, in that it requires a non-compete agreement to be reasonable for it to be enforceable. See, for example, Assurance Data, Inc. v. Malyevac , 286 Va. 137, 144 (2013) and Home Paramount Pest Control Cos. v. Shaffer, No. 101837, 2011 Va. LEXIS 222 (Nov. 4, 2011).

Importantly, Virginia is a 'no-blue-pencil' state, which means that an overbroad covenant cannot be saved by a judge; it will be struck down in its entirety. _Lasership, Inc. v. Watson_ (No. CL-2009-1219).

In Virginia, non-compete agreements are enforceable if an employer can show (i) the restrictions imposed on the former employee are no greater than necessary to protect the employer's legitimate business interests, (ii) the non-compete is not unduly severe in limiting the former employee's ability to obtain other employment, and (iii) the non-compete does not otherwise violate Virginia public policy.

Here, the geographic scope is excessively broad (U.S., Canada and Mexico), the term is long (5 years), and the scope is excessive in terms of the limitations it places on the CEO's future employment.

4\. Direction Needed on Deal Terms:

The primary clarifications needed include: (i) the severance payable if the CEO is terminated without cause (is it a full year's base salary? More? Less?); (ii) similarly, the severance payable if a successor by merger fails to assume the CEO's contract and the CEO elects to leave; (iii) the recoupment provision (e.g., what types of CEO misconduct would allow the Board to recoup the compensation paid?); (iv) does the Board want to specify in the contract the metrics to be used in calculating the annual bonus, or leave that calculation to "Board discretion;" (v) how much vacation will the CEO be granted each year; and (vi) does the Board want to be more specific in the contract as to the duties of the CEO, or leave it as "as assigned from time to time"? See also other notations in the body of the agreement; e.g., as to notice terms.

**D. Assumptions: **

1\. ** **Company is based in Virginia, and I have assumed that the CEO will operate there. If the CEO will perform services in other jurisdiction, additional review of the non-compete clause will be required. Other jurisdictions, e.g., California, take a much stricter approach to non-compete covenants. California generally does not allow non-competes (see _Edwards v. Arthur Andersen LLP_ 44 Cal. 4th 937 (2008) holding that non-competes are generally void under California Business and Professions Code Section 16600**.** California will also override a contract's choice of law provision to apply this California law (_Lifestyle Improvement Centers, LLC v. East Bay Health, LLC _2013 WL 5564144 (S.D. Ohio Oct. 7, 2013).

2\. I have assumed that the IRC Section 4960 excise tax on excess parachute payments" will not apply. This tax is triggered if e.g., a severance is paid that is greater than three (3) times the base salary of an employee. While direction is needed from the Board as to severance, I have assumed the severance will be below this threshold. if not, the "Change of Control" clause may need to be revised.

3\. I have assumed that Company, based on its merger discussions to date, envisions that a successor company will likely retain the CEO. If not, further discussion and drafting of the "Change of Control" clause is required.

**E.** **Conclusion and Recommendations:**

1\. As to the intermediate sanctions issue, the Board should engage a compensation expert to provide an opinion as to the reasonableness of the compensation proposed. If the compensation is not deemed reasonable by the expert, the compensation should be re-negotiated, or both the new CEO and the approving directors could face potential risk. Once a reasonable compensation is agreed-upon, the Board should follow the other steps set forth in the IRS regulations to properly and timely document their decision.

2\. As to the non-compete, it should be significantly narrowed, to a time period of perhaps 1 year, and to a much smaller geographic area (i.e., the area where the company currently operates), and to allow the CEO to obtain other employment that is not specifically related to the types of services he provided at Acme, so long as it does not draw upon the confidential information he obtained at Acme.

3\. As to severance and recoupment, the agreement should be modified to reflect the direction to be provided by the Board.

**Attachment**: Draft Employment Agreement






**EMPLOYMENT AGREEMENT**

_ _THIS AGREEMENT (“Agreement”) is entered into effective as of July 1, 2026 by and between ACME CORPORATION (the “Company”) and \_\_\_\_\_\_\_\_\_\_\_\_ (“Employee”).

WHEREAS, the Company desires to employ Employee as one of its full time executives, on the terms and conditions set forth herein; and

WHEREAS, Employee is willing to accept such employment.

NOW, THEREFORE, in consideration of the foregoing and of the mutual covenants and agreements hereinafter set forth, the parties hereby agree as follows:

1\. Employment and Duties. Upon the terms and conditions set forth herein, the Company agrees to employ Employee as the Company’s Chief Executive Officer, and Employee agrees to accept such employment as set forth herein. Employee shall operate out of the Company’s \_\_\_\_\_\_\_\_\_, Virginia office or such other office as the Board of Directors of the Company (the "Board") shall direct. Employee shall report to the Board, and shall have the duties, obligations, and responsibilities as shall be assigned to him from time to time by the Board, consistent with the Charter and Bylaws of the Company. [FOR DISCUSSION: DO WE WANT TO ADD MORE DETAIL AS TO DUTIES, WITH THE PROVISO THAT THIS LIST IS ILLUSTRATIVE AND NOT EXHAUSTIVE? OR LEAVE AS "AS ASSIGNED TO HIM FROM TIME TO TIME?]

2\. Term. Unless sooner terminated in accordance with the provisions hereof, the term of employment under this Agreement shall commence on the date hereof and shall end three (3) years thereafter (“Employment Term”), provided the Employment Term may be renewed for additional periods, each not to exceed three (3) years, under such terms as both parties may mutually agree and as documented in an amendment hereto signed by both parties.

3\. Extent of Services. Employee shall devote Employee's best efforts and substantially all of Employee's time during normal business hours to the business of the Company and such other time as may be reasonably necessary to accomplish Employee's responsibilities, subject to vacations, sick leave, and other approved absences, and shall perform no acts contrary to the best interests of the Company. Any other employment, other than covered under this Agreement, must have prior written approval of the Chairman of the Board.

4\. Compensation.

(a) For all services rendered by Employee, the Company shall pay to Employee the following compensation: [SEE NOTE IN MEMO REGARDING NEED TO CONFIRM THE REASONABLENESS OF THE PROPOSED COMPENSATION.]

(i) A base salary at the rate no less than ONE MILLION DOLLARS ($1,000,000.00) per year, less all applicable deductions, payable in equal installments corresponding to the Company’s normal payroll periods. This base salary may be increased from time to time upon the approval of the Board.

(ii) An annual bonus of up to a maximum of FIFTY PERCENT (50%) of Employee’s base salary may be awarded for successful completion of Board-determined objectives [DISCUSSION: DO WE WANT TO SPECIFY HERE, OR PROVIDE TO CEO IN SEPARATE DOCUMENTATION, PERHAPS AT THE BEGINNING OF EACH YEAR?], as determined in the sole discretion of the Board. Bonus awards for any partial calendar year shall be prorated. Annual bonuses shall be payable in a single lump sum payment no later than March 15 of the calendar year following the calendar year with respect to which such annual bonus relates.

(b) Employee shall be entitled to participate fully in all fringe benefit programs, if any, established by the Board in accordance with the terms and conditions applicable to employees of the Company generally, including retirement plans, vacation and sick leave, medical or insurance plans, or any other benefit policy, plan or any other practice that under applicable law constitutes a benefit of employment to which employees of the Company generally are entitled.

(c) Employee shall be entitled to \_\_\_\_\_ (\_) weeks of vacation per calendar year during the term of this Agreement [NEED DIRECTION FROM BOARD]. Vacation for partial years shall be prorated. Employee shall be entitled to use his vacation days as business conditions permit.

(d) Deferred compensation: It is intended that the Agreement shall conform to all applicable requirements of Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”). Accordingly, in interpreting, construing or applying any of the terms, conditions or provisions of the Agreement, including without limitation the bonus and severance terms, the same shall be construed in such manner as shall meet and comply with Code Section 409A, to the extent applicable.

5\. Termination of Employment.

(a) Employee's employment hereunder shall terminate upon Employee's death.

(b) The Company may terminate Employee's employment under the following circumstances:

(i) If, as a result of Employee's incapacity due to physical or mental illness or other similar incapacity, Employee shall have been unable to perform the essential functions of Employee's position hereunder, which inability continues for more than \_\_\_\_\_ (\_\_) consecutive months;

(ii) For "Cause," which is defined for purposes of this Agreement as (A) a refusal or repeated failure by Employee to carry out any reasonable order of the Board; (B) the gross misconduct, or gross negligence in the performance of duties, by Employee resulting in demonstrably material injury to the Company or willful breach of fiduciary duty; (C) the conviction of or plea of guilty or nolo contendre of Employee to a misdemeanor or felony; (D) abuse of alcohol or illegal or prescription drugs, or a violation of the Company’s policies regarding drugs and/or alcohol; (E) a material breach of this Agreement; (F) the habitual or repeated neglect of Employee’s duties; or (G) any act of dishonesty or moral turpitude injurious to the interest, property, operations, business or reputation of the Company, all as determined in the sole discretion of the Board .

(iii) Without Cause, by giving not less than \_\_\_\_\_ (\_\_) days’ written notice to Employee of the Company’s intention to terminate.

(c) Employee may terminate his employment hereunder under the following circumstances:

(i) Employee may terminate his employment hereunder at any time by giving not less than \_\_\_\_\_ (\_\_) days’ written notice to the Company of his intention to terminate.

(ii) Employee may terminate his employment hereunder upon the failure of the Company to perform or observe any of the material terms or provisions of this Agreement, if such failure is not cured within \_\_\_\_\_\_ (\_\_) days following receipt by the Company of written notice from Employee of such failure and demand for performance, which notice and demand shall describe specifically the nature of such alleged failure; provided, however, that if cure is impossible within such \_\_\_\_\_ (\_\_) day period, it shall be sufficient for the Company to commence such cure within said \_\_\_\_\_ (\_\_) day period and pursue such cure diligently to completion.

(d) The termination of employment by the Company or by Employee shall be communicated by written notice to the other party (a "Notice of Termination"), delivered in accordance with the provisions of Section \_\_, Notice. The Notice of Termination shall indicate the specific termination provision in this Agreement relied upon.

(e) For purposes of this Agreement, the "Date of Termination" shall mean: (i) the date of Employee's death; (ii) \_\_\_\_\_ (\_\_) days after Notice of Termination if Employee's employment is terminated due to the incapacity of Employee pursuant to Section 5(b)(i), provided that Employee shall not have returned to the performance of Employee's duties on a full-time basis during such \_\_\_\_\_\_ (\_\_) day period; (iii) the date specified in the Notice of Termination subject to the minimum notice requirements (if any) under Sections 5(b) or 5(c), but not later than \_\_\_\_\_\_ (\_\_) days after the date of the Notice of Termination if Employee's employment is terminated pursuant to Sections 5(b)(ii), 5(b)(iii), 5(c)(i) or 5(c)(ii); or (iv) the last day of the Employment Term.

(f) In the event of termination by the Company pursuant to Sections 5(b)(ii) for incapacity or 5(b)(iii) for Cause, or termination by Employee pursuant to Section 5(c), the Company shall have the right to remove Employee, effective as of the date specified in written notice by the Company to Employee, from performance of any or all duties or responsibilities on behalf of the Company.

(g) Notwithstanding anything herein to the contrary, termination of employment shall mean a “separation from service” within the meaning of Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”). In general, this applies to a termination of employment, where it is reasonably anticipated that no further services would be performed after termination, or that the services performed after that date (whether as an employee or independent contractor) would permanently decrease to less than fifty percent (50%) of the average level of bona fide services performed previously.

6\. Recoupment. If Employee is terminated for Cause, and the Employee's conduct involved [DEFINE] the Company shall be entitled to [DEFINE, AFTER DISCUSSION WITH BOARD]

7\. Severance.

(a) If the Company terminates Employee’s employment without Cause under Section 5(b)(iii), or Employee terminates his employment under Section 5(c)(ii) for failure of the Company to perform, Employee shall be entitled to receive, as a lump sum severance cash payment, an amount equal to one (1) year's base salary, less all applicable deductions. [NEED TO DISCUSS WITH BOARD IF THEY WANT TO MODIFY THIS AMOUNT]. In consideration of and as a precondition to the Company’s obligation to pay such severance payment, Employee shall execute and deliver to the Company a "Release and Waiver of Claims" in form attached hereto as Exhibit A. Payment of the aforementioned lump sum severance shall be made as soon as practicable following Employee’s termination of employment and, in all events, no later than March 15th of the calendar year following the calendar year in which such termination of employment occurs.

(b) Employee shall not be required to mitigate amounts payable pursuant to this Section 7 by seeking other employment or in any other manner.

8\. Covenant Not to Compete. [SEE NOTE IN MEMO REGARDING NARROWING SCOPE OF NON-COMPETE.]

(a) Employee hereby covenants and agrees that until the later to occur of: (a) five (5) years after the Date of Termination; (b) five (5) years after expiration of the Employment Term; or (c) five (5) years from the last day on which Employee receives compensation from the Company hereunder, Employee will not, directly or indirectly, within the United States, Canada or Mexico (the “Restricted Area”), engage in "Competing Activities" (as defined below) as an owner, employee, officer, director, partner, investor, consultant, agent or otherwise.

(b) The covenants contained in this Section 8 shall be construed as a series of separate and severable covenants. Employee and the Company agree that, if in any proceeding, the court or tribunal shall refuse to enforce fully any covenants contained herein because such covenants cover too extensive a geographic area or too long a period of time or for any other reason whatsoever, any such covenant shall be deemed amended to the extent (but only to the extent) required by law. Each party acknowledges and agrees that the services to be rendered by Employee to the Company hereunder are of a special and unique character. Each party shall have the right to injunctive relief, in addition to all of its other rights and remedies at law or in equity, to enforce the provisions of this Agreement.

(c) The obligations of Employee under this Section 8 shall survive the termination or expiration of the Employment Term.

(d) In this Agreement:

(i) “Competing Activities” means to: (a) provide, supervise or manage services for a "Competing Business" (as defined immediately below) within the Restricted Area; (b) assist a Competing Business with business activities involving a "Conflicting Product or Service" (as defined immediately below); or (c) otherwise undertake any position or duties with a Competing Business that would be likely to result in the use or disclosure of "Confidential Information" (as defined in Section 8 below).

(ii) “Competing Business” means any person or entity that provides goods or services that compete with Company’s business that Employee.

(iii) “Conflicting Product or Service” means a product or service that would compete with a product or service that is, was, or was planned to be, part of the Company’s business.

9\. Confidentiality.

(a) In the course of Employee’s employment by the Company, Employee will have access to or obtain from Company confidential or proprietary information of a technical or non-technical nature. As used herein, the term "Confidential Information" shall mean any and all information, including, but not limited to, all data, compilations, programs, devices, strategies, concepts, ideas or methods concerning or related to:

(i) Financial information that has not yet been released publicly;

(ii) The Company's financial condition, and results of operations;

(iii) Marketing and sales programs and business plans of the Company (including research and analysis) and the terms and conditions (including non-public pricing and underlying pricing-related variables such as costs) of sales and offers of sales of products and/or services by the Company, and the technical capabilities of the equipment and/or services offered by the Company;

(iv) Private bids, proposals, quotes, requests for proposal, and related analyses;

(v) The non-public terms, conditions and current status of the Company's agreements and relationships with any customers, suppliers, contractors or other entities;

(vi) The non-public identities and business preferences of the Company's actual and prospective customers, contractors and suppliers or any employee or agent thereof with whom the Company communicates;

(vii) The know-how, compositions, methods, techniques, research and development, data, specifications, drawings, blueprints, models, test results, manufacturing processes and techniques, regulatory approval strategies, computer programs, formulae, compositions, service techniques and protocols, new product designs and other skills, ideas, and strategic and business plans;

(ix) Research and development plans and process know-how; and

(x) Any other matter or thing, whether or not recorded on any medium, that is a trade secret (A) by which the Company derives actual or potential economic value from such matter or thing being not generally known or readily ascertainable to other persons or entities who might obtain economic value from its disclosure or use, or (B) which gives the Company an opportunity to obtain an advantage over its competitors who do not know or use the same.

All such Confidential information disclosed to Employee by the Company shall remain the sole and exclusive property and proprietary information of the Company and is disclosed in confidence by the Company in reliance on Employee's agreement to maintain such information in confidence and not to use or disclose it to any other person except as required of Employee in the course of Employee’s employment or as specifically authorized by the Company.

Due to its special value and utility as a compilation, a confidential compilation of information will remain protected even if individual items of information in it are public or otherwise readily available. Authorized disclosure of Confidential Information to parties the Company is doing business with for business purposes shall not cause the information to lose its protected status under this Agreement. Employee acknowledges that items of Confidential Information are the Company’s valuable assets and they are not generally known by the public. To the extent Employee retains any rights of ownership and/or control in Confidential Information, Employee assigns all such rights to the Company to the fullest extent allowed by law.

(b) Restriction On Disclosure of Confidential Information. In furtherance of such obligation of confidentiality, Employee agrees:

(i) Not to use such information, except as authorized in this Agreement;

(ii) Not to disclose the information to third parties without the prior written consent of the Board of Directors; and

(iii) To observe such non-use and nondisclosure of Confidential Information beyond the term of this Agreement until the information has been disclosed by Company, by publication or otherwise, to the public generally or until Company grants Employee specific approval for use or disclosure; provided, however, that if a time limitation is required on the post-employment restrictions, then such restrictions shall be limited to a period of five (5) years for Confidential Information that does not qualify as a trade secret, with restrictions for trade secret information to extend for so long as the information continues to qualify as a trade secret.

(c) Return Of Property Upon Termination. Employee agrees that upon the termination of Employee’s employment for any reason, or earlier as otherwise requested, Employee will immediately return to the Company:

(i) All originals and copies (including electronic copies) of all or any part of any and all things, equipment and written materials obtained by Employee from the Company, including Confidential Information;

(ii) All property of the Company, including, without limitation, keys, computer software, laptop or other computers, Company-issued credit cards, and all other Company-owned property and equipment, including proprietary information used by Employee in performing duties for the Company.

10\. Assignment. This Agreement shall not be assignable by either party hereto without the prior written consent of the other party hereto, except that without securing such consent, the Company may assign its rights and obligations hereunder to any successor entity to the Company, subject to Section 11(a) below.

11\. Change of Control.

(a) The Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business or assets of the Company, by an assumption agreement in form and substance reasonably satisfactory to Employee, to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place.

(b) Failure of the Company to obtain such assumption agreement shall constitute a termination of this Agreement by the Company without Cause, if Employee provides a Notice of Termination tp Company within thirty (30) days of the effective date of the change of control. If Employee chooses to terminate his employment, he shall be entitled to severance in the amount of one (1) year's base salary, less all applicable deductions. In consideration of and as a precondition to the Company’s obligation to pay such severance payment, Employee shall execute and deliver to the Company a "Release and Waiver of Claims" in form attached hereto as Exhibit A. Payment of the aforementioned lump sum severance shall be made as soon as practicable following Employee’s termination of employment and, in all events, no later than March 15th of the calendar year following the calendar year in which such termination of employment occurs. [FOR DISCUSSION WITH BOARD - DOES CEO GET ONE YEAR, OR SOME OTHER AMOUNT, IF A SUCCESSOR COMPANY WILL NOT AGREE TO ASSUME THIS EMPLOYMENT AGREEMENT? NOTE COMMENT IN MEMO RE: EXCESS PARACHUTE PAYMENTS]

12\. Arbitration.

(a) Any controversy or claim arising out of or relating to this Agreement or the breach thereof shall be settled by arbitration in \_\_\_\_\_\_\_\_\_\_, Virginia in accordance with the commercial rules of the American Arbitration Association, and any judgment upon the award rendered may be entered in any court having jurisdiction thereof. Provided, however, that nothing in this Section 11 shall be construed to prevent the Company from applying to a court for injunctive relief from a breach by Employee of the provisions of Sections 8 or 9 hereof.

(b) All fees and expenses, including reasonable attorney's and consultant's fees and the like, incurred by the parties hereto related to any controversy or claim arising out of or relating to this Agreement or the breach thereof shall be borne by the party who does not prevail or substantially prevail in the arbitration or litigation.

13\. Non-Disparagement. Employee agrees and covenants that he will not at any time, directly or indirectly, make, publish, or communicate to any third party or in any public forum any defamatory or disparaging remarks, comments, or statements concerning the Company or any of its employees, officers, directors, members, or advisors. The Company agrees and covenants that it shall cause its officers and directors to refrain from making any defamatory or disparaging remarks, comments, or statements concerning Employee to any third parties or in any public forum. This section does not in any way restrict or impede either party from exercising protected rights to the extent such rights cannot be waived by agreement or from complying with any applicable law or regulation or a valid order of a court of competent jurisdiction or an authorized government agency, provided that such compliance does not exceed that required by the law, regulation, or order.

14\. Agreement Limitations. Nothing in this Agreement: (a) prohibits Employee from reporting an event that Employee reasonably and in good faith believes is a violation of law to the relevant law-enforcement agency (such as the Equal Employment Opportunity Commission or Securities and Exchange Commission); or (b) prohibits Employee from cooperating or participating in an investigation conducted by such a government agency. Employee acknowledges that the 2016 Defend Trade Secrets Act (“DTSA”) creates immunity for employees from criminal and civil liability under federal and state law for the specific types of disclosures set out in 18 U.S.C. 1833. This may include a disclosure of trade secret information provided that it complies with the DTSA, which provides that (1) no individual will be held criminally or civilly liable under federal or state trade secret law for the disclosure of a trade secret (as defined in the Economic Espionage Act) that: (i) is made in confidence to a federal, state, or local government official, either directly or indirectly, or to an attorney, and is made solely for the purpose of reporting or investigating a suspected violation of law; or (ii) is made in a complaint or other document filed in a lawsuit or other proceeding, if such filing is made under seal so that it is not made public; and (2) an individual who pursues a lawsuit for retaliation by an employer for reporting a suspected violation of the law may disclose the trade secret to the attorney of the individual and use the trade secret information in the court proceeding, if the individual files any document containing the trade secret under seal, and does not disclose the trade secret, except as permitted by court order. The foregoing shall not be deemed to authorize or limit liability for an act by Employee that would otherwise be illegal absent this Agreement, such as unlawful access of material by unauthorized means or theft of Company property.

15\. Governing Law. This Agreement shall be subject to and governed by the laws of the Commonwealth of Virginia (but not including the choice of law rules thereof). [NOTE DISCUSSION IN MEMO UNDER "ASSUMPTIONS"]

16\. Voluntary Agreement.** **Employee and the Company represent and agree that each has reviewed all aspects of this Agreement, has carefully read and fully understands all provisions of this Agreement, and is voluntarily entering into this Agreement. Each party represents and agrees that such party has had the opportunity to review any and all aspects of this Agreement with the legal, tax or other advisor or advisors of such party's choice before executing this Agreement.

[ADD BOILERPLATE PROVISIONS IN NEXT DRAFT, PER BOARD DIRECTION -- INCLUDING PROVISIONS ON NOTICE, SEVERABILITY, SUCCESSORS, SURVIVAL, WAIVER, ENTIRE AGREEMENT, GOVERNING LAW, HEADINGS, ETC.]

IN WITNESS WHEREOF, the undersigned have duly executed this Agreement, or have caused this Agreement to be duly executed on their behalf, effective as of the day and year set forth above.



ACME CORPORATION



By: \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_
Name: \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_
Title: \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_



EMPLOYEE:


\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_
[Name]


[PAGE BREAK]


EXHIBIT A
RELEASE AND WAIVER OF CLAIMS

Author's notes on the task:
I tried to create a prompt that would test the model's ability to identify and address legal issues that were not obvious from the prompt; here, that issue is the IRS restriction on excessive compensation for the executives of tax exempt organizations. I wanted to see if the model would identify that issue, including the personal liability the individual directors could face, and inform the Board about the steps it could take to mitigate that risk. I also wanted to test whether the model would identify other legal issues such as (i) the limitations on non-compete agreements, (ii) the IRS rules on deferred compensation, and (iii) the need to obtain a release when paying severance.

Why this scenario is realistic: I would say a 4, as it is a very real issue facing tax exempt organizations, with serious consequences for the directors that approve compensation deemed excessive.

What makes it difficult: It's a 4, not so much for the drafting itself, but because of the issues that must be identified and incorporated into that drafting.

Reference materials: The primary source is IRC § 4958, and the "safe harbor" provisions of the IRS regulations promulgated thereunder.

Scoring rubric:
rubric_category: Structure & Style Rubric
criterion: Does the memo to the Board include identification of key issues, analysis of those issues, citation of sources, and assumptions made?
rubric_category: Structure & Style Rubric
criterion: Does the memo to the Board follow the direction provided by the Board as to compensation and non-compete?
justification: IRC § 4958
rubric_category: Structure & Style Rubric
criterion: Does the draft employment agreement provide placeholders for boilerplate issues?
justification: Important that model is able to follow the direction in the prompt.
rubric_category: Substance Rubric - Explicit requirements
criterion: Does the memo highlight the issue of excessive compensation under IRC 4958?
justification: The most important issue to be identified here, given the potential personal liability of directors.
rubric_category: Substance Rubric - Implicit requirements
criterion: Does the memo inform the Board about the potential personal liability of directors for approving excessive compensation under IRC 4958?
justification: It is critical that the model not just identify the issue, but alert the directors as to the significant personal liability they could face.
rubric_category: Substance Rubric - Legal correctness
criterion: Does the memo inform the Board that there are "safe harbors" from 4958 liability?
justification: The model, just like a real attorney, has to provide not just problems, but also solutions.
rubric_category: Substance Rubric - Legal correctness
criterion: Does the memo detail the steps the Board can take to obtain this rebuttable presumption?
justification: Again, the model must provide solutions. Here, it should detail (or at least summarize) the steps needed for the Board to protect itself.
rubric_category: Substance Rubric - Legal correctness
criterion: Does the agreement have provisions about the timing of deferred compensation under 409A and state a march 15 payment deadline?
justification: Tests the model's ability to spot legal issues, and the depth of the model's research and analysis.
rubric_category: Substance Rubric - Legal correctness
criterion: Does the agreement have a change of control provision?
justification: Tests whether the model extrapolated from the prompt's mention of a possible change in control and saw the need for a corresponding provision in the employment agreement.
rubric_category: Substance Rubric - Reasoning quality
criterion: Does the memo inform the Board of concerns about the non-compete?
justification: Tests the depth of the model's research and analyis. The prompt should trigger the model to look into this issue in detail, and conduct relevant research.
rubric_category: Substance Rubric - Legal correctness
criterion: Does the memo suggest how the non-compete could be narrowed?
justification: Tests if the model identified the issue, determined the relevant jurisdiction, researched applicable case law, and applied it to the situation at hand, enabling it to provide the needed legal advice.
rubric_category: Substance Rubric - Reasoning quality
criterion: Does the agreement have a severance provision?
justification: Tests if the model includes an important provision in any employment agreement for a senior executive.
rubric_category: Substance Rubric - Reasoning quality
criterion: Does the severance provision state what severance is paid if there is a change of control and the successor entity does not assume the contract of the CEO (or at least have a placeholder for this information)?
justification: This tests whether the model not only identified a standard provision (i.e., severance) but then realized that, given the prompt's reference to a possible merger/consolidation, the clause should specify how severance would be handled in the event of a change in control.
rubric_category: Substance Rubric - Legal correctness
criterion: Does the severance provision condition payment of the severance upon the employee signing a release?
justification: Tests the depth of the model's understanding of legal issues.
rubric_category: Substance Rubric - Reasoning quality
criterion: Does the agreement have a "limitations" clause that allows the employee to make disclosures when required by law, e.g., as a protected whistleblower?
justification: Tests the currency of the model's legal knowledge, as lawyers started including such a provision in recent years.
rubric_category: Substance Rubric - Explicit requirements
criterion: Does the agreement state the governing law is the Commonwealth of Virginia?
justification: Tests if the model included a standard contract clause (governing law), and then incorporated the information provided in the prompt (which stated that the company is based in Virginia).
rubric_category: Negative Rubric
criterion: Did the memo fail to cite relevant Virginia case law on non-competes?
justification: Tests if the model not only identified Virginia as the relevant jurisdiction, but then identified relevant Virginia case law.
rubric_category: Negative Rubric
criterion: Did the memo fail to recommend that the Board retain a compensation expert?
justification: Again, important for the model to not just identify problems, but also to be able to offer solutions and risk mitigation steps.
rubric_category: Negative Rubric
criterion: Did the agreement fail to mention March 15 as the deadline for paying deferred compensation?
justification: Tests if model can identify an issue (IRS limitations on the payment of deferred income) and provide specific guidance.
rubric_category: Sources and References Rubric
criterion: Did the memo reference the IRS statute on excessive compensation?
justification: The key statute here, in terms of risk to the company and personal financial risk for directors.
rubric_category: Sources and References Rubric
criterion: Did the memo reference the IRS regulations that detail the steps in obtaining the rebuttable presumption?
justification: The key regulations in this scenario, as they provide the risk mitigation measures the Board should take to reduce the risk of personal liability to the directors.
rubric_category: Sources and References Rubric
criterion: Did the memo reference the IRS regulations imposing personal liability on directors for approving excessive compensation?
justification: Also key regulations here, as the directors need to understand the gravity of the situation, so they will see the need to act.
rubric_category: Sources and References Rubric
criterion: Did the agreement cite the IRC requirements as to the payment of deferred compensation?
justification: Tests if the model spotted this issue and correctly identified the relevant law.
rubric_category: Substance Rubric - Explicit requirements
criterion: Does the memo mention the financial risk of an excise tax under IRC 4960?
justification: Tests model's ability to follow the direction provided in the prompt, identify key legal issues, and analyze them with support for that analysis.
rubric_category: Substance Rubric - Explicit requirements
criterion: Does the memo include an assumption about governing law, and indicate that if the CEO's work will be in other jurisdictions then further analysis is need on choice of law?
justification: Tests model's ability to follow the direction provided in the prompt, identify key legal issues, and analyze them with support for that analysis.
rubric_category: Substance Rubric - Explicit requirements
criterion: Do the memo and the draft agreement suggest a "Recoupment" clause for CEO misconduct?
justification: Tests model's ability to follow the direction provided in the prompt, identify key legal issues, and analyze them with support for that analysis.
rubric_category: Substance Rubric - Explicit requirements
criterion: Does the memo detail how an excise tax under IRC 4960 would be calculated?
justification: Tests model's ability to follow the direction provided in the prompt, identify key legal issues, and analyze them with support for that analysis.
rubric_category: Sources and References Rubric
criterion: Does the memo mention excise taxes for excess compensation under IRC 4960?
justification: Tests model's ability to follow the direction provided in the prompt, identify key legal issues, and analyze them with support for that analysis.
rubric_category: Sources and References Rubric
criterion: Does the memo mention the rules under IRC 4960 for parachute payments of over 3 times base salary?
justification: Tests model's ability to follow the direction provided in the prompt, identify key legal issues, and analyze them with support for that analysis.

Peer review 1:
Overall quality: 4 - Above Standards
This is a competent, thoughtful first-draft work that a Board could act on with clarifications, but falls short of elite GC standards due to client-accessibility tweaks, deeper explanations/proposals on open terms, stronger risk wording, and minor factual/drafting cleanups.
Representativeness: 4 - Typical
Difficulty: 3 - Moderate
The task requires integrating specialized knowledge across three distinct areas—nonprofit tax compliance, Virginia employment/non-compete law, and executive contract drafting.
Task specification: Well-Specified

Peer review 2:
Overall quality: 5 - Exemplary
It succeeds by forcing the model to solve a "Double Trap" involving federal tax law and state employment rules. The prompt places the writer in a high-stakes role as General Counsel. The respondent must warn the Board of personal financial risks under IRS Section 4958.
The Gold Answer provides a clear summary of these risks. It correctly notes that a salary taking up 20% of total revenue is an "excess benefit transaction." By pairing a legal memo with a draft contract, the task creates a tough test. It checks if an AI can act as a strategic advisor instead of just a text tool.
Representativeness: 5 - Core Activity
Difficulty: 5 - Very Hard
It requires deep knowledge in two separate areas of law. A writer must navigate the IRS "safe harbor" rules while also applying Virginia’s strict three-part test for non-compete clauses.
The task is hard because it sets a trap. The Board wants a five-year, three-country ban. In Virginia, this is legally void. To pass, the AI must have the skill to tell the "client" no. It must explain the "No Blue Pencil" rule, which means a bad clause is killed entirely, not fixed by a judge. This requires the kind of complex thinking that tests the limits of the best AI models.
Task specification: Well-Specified