<PAGE>   1





                                                                    EXHIBIT 10.7

                              EMPLOYMENT AGREEMENT


         This EMPLOYMENT AGREEMENT ("Agreement"), effective as of October 10,
1997, (the "Effective Date") by and between Merchants Bancshares, Inc., a Texas
corporation (the "Company"), and J. W. Lander, III (the "Executive"), evidences
that;

         WHEREAS, the Executive is a senior executive of the Company and/or one
or more of the Company's direct or indirect subsidiaries (hereinafter
individually referred to as a "Subsidiary" and collectively as the
"Subsidiaries") and has made and/or is expected to make or continue to make
significant contributions to the profitability, growth and financial strength
of the Company and/or the Subsidiaries;

         WHEREAS, the Company desires to assure itself and the Subsidiaries of
both present and future continuity of management in the event of a Change in
Control (as defined hereafter) and desires to establish certain minimum
compensation rights with respect to the key senior executives of the Company
and/or the Subsidiaries, including the Executive, applicable in the event of a
Change in Control;

         WHEREAS, the Company wishes to ensure that the senior executives of
the Company and/or the Subsidiaries are not practically disabled from
discharging their duties upon a Change in Control;

         WHEREAS, this Agreement is not intended to alter materially the
compensation and benefits which the Executive could reasonably expect to
receive from the Company and/or the Subsidiaries absent a Change in Control;
and

         WHEREAS, the Executive is willing to render services to the Company
and/or the Subsidiaries on the terms and subject to the conditions set forth in
this Agreement;

         NOW, THEREFORE, the Company and the Executive agree as follows:

         1.      Operation of Agreement:

                 (a)      Sections 1 and 8 through 21 of this Agreement shall
                          be effective and binding as of the Effective Date,
                          but, anything in this Agreement to the contrary
                          notwithstanding, Sections 2, 3, 4, 5, 6 and 7of this
                          Agreement shall not be effective and binding unless
                          and until there shall have occurred a Change in
                          Control.  For purposes of this Agreement, a "Change
                          in Control" will be deemed to have occurred if at any
                          time during the Term (as hereinafter defined) any of
                          the following events shall occur:

                          (i)     The Company is merged, consolidated or
                                  reorganized into or with another corporation
                                  or other legal entity, and as a result



J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 1
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                                  of such merger, consolidation or
                                  reorganization less than a majority of the
                                  combined voting power of the then outstanding
                                  securities of the Company or such corporation
                                  or other legal entity immediately after such
                                  transaction are held in the aggregate by the
                                  holders of Voting Stock (as hereinafter
                                  defined) of the Company immediately prior to
                                  such transaction and/or such voting power is
                                  not held by substantially all of such holders
                                  in substantially the same proportions
                                  relative to each other;

                          (ii)    The Company sells (directly or indirectly)
                                  all or substantially all of its assets
                                  (including, without limitation, by means of
                                  the sale of the capital stock or assets of
                                  one or more Subsidiaries) to any other
                                  corporation or other legal entity, of which
                                  less than a majority of the combined voting
                                  power of the then outstanding voting
                                  securities (entitled to vote generally in the
                                  election of directors or persons performing
                                  similar functions on behalf of such other
                                  corporation or legal entity) of such other
                                  corporation or legal entity are held in the
                                  aggregate by the holders of Voting Stock of
                                  the Company immediately prior to such sale
                                  and/or such voting power is not held by
                                  substantially all of such holders in
                                  substantially the same proportions relative
                                  to each other;

                          (iii)   Any person (as the term "person" is used in
                                  Section 13(d)(3) or Section 14(d)(2) of the
                                  Securities Exchange Act of 1934, as amended
                                  (the "Exchange Act") becomes (subsequent to
                                  the Effective Date) the beneficial owner (as
                                  the term "beneficial owner" is defined in
                                  Rule 13d-3 or any successor rule or
                                  regulation promulgated under the Exchange
                                  Act) of securities representing twenty
                                  percent (20%) or more of the combined voting
                                  power of the then-outstanding securities
                                  entitled to vote generally in the election of
                                  directors of the Company ("Voting Stock");

                          (iv)    The Company files a report or proxy statement
                                  with the Securities and Exchange Commission
                                  pursuant to the Exchange Act disclosing in
                                  response to Form 8-K, Schedule 14A or
                                  Schedule 14C (or any successor schedule, form
                                  or report or item therein) that a change in
                                  control of the Company has occurred;

                          (v)     If during any one (1) year period,
                                  individuals who at the beginning of any such
                                  period constitute the directors of the
                                  Company cease for any reason to constitute at
                                  least a majority thereof, unless the
                                  election, or the nomination for





J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 2
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                                  election by the Company's shareholders, of
                                  each director of the Company first elected
                                  during such period was approved by a vote of
                                  at least two-thirds of (i) the directors of
                                  the Company then still in office who were
                                  directors of the Company at the beginning of
                                  any such period or (ii) the directors of the
                                  Company whose nomination and/or election was
                                  approved by the directors referenced in
                                  clause (i) immediately preceding; or

                          (vi)    The shareholders of the Company approve a
                                  plan contemplating the liquidation or
                                  dissolution of the Company.

                          Notwithstanding the foregoing provisions of
                          Subsection 1(a)(iii) or 1(a)(iv) hereof, a "Change in
                          Control" shall not be deemed to have occurred for
                          purposes of this Agreement solely because (i) the
                          Company, (ii) a corporation or other legal entity in
                          which the Company directly or indirectly beneficially
                          owns 100% of the voting securities of such entity,
                          (iii) any employee stock ownership plan or any other
                          employee benefit plan of the Company or any
                          wholly-owned subsidiary of the Company or (iv) any
                          person (as the term "person" is used in Section
                          13(d)(3) or Section 14(d)(2) of the Exchange Act) who
                          is the beneficial owner (as the term "beneficial
                          owner" is defined in Rule 13d-3 or any successor rule
                          or regulation promulgated under the Exchange Act) of
                          securities representing twenty percent (20%) or more
                          of the Voting Stock of the Company as of the
                          Effective Date, either files or becomes obligated to
                          file a report or a proxy statement under or in
                          response to Schedule 13D, Schedule 14D-1, Form 8-K,
                          Schedule 14A or Schedule 14C (or any successor
                          schedule, form or report or item therein) under the
                          Exchange Act, disclosing beneficial ownership by it
                          of shares of Voting Stock, whether in excess of
                          twenty percent (20%) or otherwise, or because the
                          Company reports that a change in control of the
                          Company has occurred by reason of such beneficial
                          ownership.

                 (b)      Upon occurrence of a Change in Control at any time
                          during the Term, Sections 2, 3, 4, 5, 6 and 7 of this
                          Agreement shall become immediately binding and
                          effective.

                 (c)      The period during which this Agreement shall be in
                          effect (the "Term") shall commence as of the
                          Effective Date and shall expire as of the later of
                          (i) the close of business on October 9, 1999 or (ii)
                          the expiration of the Period of Employment (as
                          hereinafter defined); provided, however, that (A)
                          subject to Section 9 hereof, if, prior to a Change in
                          Control, the Executive ceases for any reason to be an
                          employee of the Company, thereupon the Term shall be
                          deemed to





J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 3
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                          have expired and this Agreement shall immediately
                          terminate and be of no further effect and (B)
                          commencing on December 31, 1997 and the last day of
                          each of the Company's fiscal years commencing
                          thereafter, the Term of this Agreement shall
                          automatically be extended for an additional year
                          unless, not later than the immediately preceding June
                          30, the Company or the Executive shall have given
                          notice that the Company or the Executive, as the case
                          may be, does not wish to have the Term of this
                          Agreement extended.

         2.      Employment; Period of Employment:

                 (a)      Subject to the terms and conditions of this
                          Agreement, upon the occurrence of a Change in
                          Control, the Company shall continue the Executive in
                          its employ and shall cause the Subsidiaries of which
                          the Executive is an employee as of the date of a
                          Change in Control to continue the Executive in their
                          employ and the Executive shall remain in the employ
                          of the Company and the applicable Subsidiaries (the
                          "Applicable Subsidiaries") for the period set forth
                          in Subsection 2(b) hereof (the "Period of
                          Employment"), in the positions and with substantially
                          the same duties and responsibilities that the
                          Executive had immediately prior to the Change in
                          Control, or to which the Company and the Executive
                          may hereafter mutually agree in writing.  Throughout
                          the Period of Employment, the Executive shall devote
                          substantially all of the Executive's time during
                          normal business hours (subject to vacations, sick
                          leave and other absences in accordance with the
                          policies of the Company and the Applicable
                          Subsidiaries as in effect for senior executives
                          immediately prior to the Change in Control) to the
                          business and affairs of the Company and the
                          Applicable Subsidiaries, but nothing in this
                          Agreement shall preclude the Executive from devoting
                          reasonable periods of time during normal business
                          hours to (i) serving as a director, trustee or member
                          of or participant in any organization or business so
                          long as such activity would not constitute
                          Competitive Activity (as hereinafter defined), (ii)
                          engaging in charitable and community activities, or
                          (iii) managing the Executive's personal investments
                          so long as such activity would not constitute
                          Competitive Activity.

                 (b)      The Period of Employment shall commence on the date
                          on which a Change in Control occurs and, subject only
                          to the provisions of Section 4 hereof, shall continue
                          until the earlier of (i) the expiration of the second
                          anniversary of the occurrence of the Change in
                          Control or (ii) the Executive's death; provided,
                          however, that commencing on each anniversary of the
                          Change of Control, the Period of Employment shall
                          automatically be extended for an additional one-year
                          period unless, not later than ninety (90) calendar
                          days prior





J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 4
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                          to such anniversary date, the Company or the
                          Executive shall have given notice that the Company or
                          the Executive, as the case may be, does not wish to
                          have the Term extended.

         3.      Compensation During Period of Employment:

                 (a)      During the Period of Employment, the Company
                          covenants that the Executive shall receive from the
                          Company and/or the Applicable Subsidiaries (i) annual
                          base salary at a rate not less than the Executive's
                          annual fixed or base compensation from the Company
                          and the Applicable Subsidiaries (including, without
                          limitation, director's fees and advisory director's
                          fees) prior to the Change of Control or such higher
                          rate as may be determined from time to time by the
                          Board of Directors of the Company (the "Board") or
                          the Compensation Committee thereof (the "Committee")
                          (which base salary at such rate is herein referred to
                          as "Base Pay") and (ii) an annual amount equal to not
                          less than the highest aggregate annual bonus,
                          incentive or other payments of cash compensation paid
                          to the Executive by the Company and the Applicable
                          Subsidiaries in addition to the amounts referred to
                          in clause (i) above made or to be made in or with
                          respect to any calendar year during the three
                          calendar years immediately preceding the year in
                          which the Change in Control occurred pursuant to any
                          bonus, incentive, profit-sharing, performance,
                          discretionary pay or similar policy, plan, program or
                          arrangement of the Company and the Applicable
                          Subsidiaries ("Incentive Pay") which contemplates
                          cash payments other than Employee Benefits (as
                          hereinafter defined); provided, however, that nothing
                          herein shall preclude a change in the mix between
                          Base Pay and Incentive Pay so long as the aggregate
                          cash compensation received by the Executive in any
                          one (1) calendar year is not reduced in connection
                          therewith or as a result thereof and, provided
                          further, however, that in no event shall any increase
                          in the Executive's aggregate cash compensation or any
                          portion thereof in any way diminish any other
                          obligation of the Company under this Agreement.  The
                          Executive's Base Pay shall be payable monthly.  The
                          Executive's Incentive Pay shall be paid annually as
                          soon as reasonably practicable following
                          determination of the amount payable but in no event
                          later than the date which is ninety (90) days
                          following the last day of the fiscal year during
                          which such Incentive Pay is deemed earned.

                 (b)      For the Executive's service pursuant to Subsection
                          2(a) hereof, during the Period of Employment the
                          Executive shall, if and on the same basis as the
                          Executive participated therein immediately prior to
                          the Change in Control, be a full participant in, and
                          shall be entitled to the perquisites, benefits and
                          service credit for benefits as provided





J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 5
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                          under any and all employee retirement income and
                          welfare benefit policies, plans, programs or
                          arrangements in which senior executives of the
                          Company and/or the Applicable Subsidiaries
                          participate generally, including without limitation
                          any stock option, stock purchase, stock appreciation,
                          savings, pension, supplemental executive retirement
                          or other retirement income or welfare benefit,
                          deferred compensation, incentive compensation, group
                          and/or executive life, accident, health, dental,
                          medical/hospital or other insurance (whether funded
                          by actual insurance or self-insured by the Company or
                          any Applicable Subsidiary), disability, salary
                          continuation, expense reimbursement and other
                          employee benefit policies, plans, programs or
                          arrangements that may exist immediately prior to the
                          Change in Control or any equivalent successor
                          policies, plans, programs or arrangements that may be
                          adopted thereafter by the Company or any Applicable
                          Subsidiary (collectively, "Employee Benefits");
                          provided, however, that the Executive's rights
                          thereunder shall be governed by the terms thereof and
                          shall not be enlarged hereunder or otherwise affected
                          hereby.  Subject to the proviso in the immediately
                          preceding sentence, if and to the extent such
                          perquisites, benefits or service credit for benefits
                          are not payable or provided under any such policy,
                          plan, program or arrangement as a result of the
                          amendment or termination thereof subsequent to a
                          Change in Control, then the Company shall itself pay
                          or provide such Employee Benefits.  Nothing in this
                          Agreement shall preclude improvement or enhancement
                          of any such Employee Benefits, provided that no such
                          improvement shall in any way diminish any other
                          obligation of the Company under this Agreement.

                 (c)      The Company has determined that the amounts payable
                          pursuant to this Section 3 constitute reasonable
                          compensation.  Accordingly, anything in this
                          Agreement to the contrary notwithstanding, in the
                          event it shall be determined that any payment or
                          distribution by the Company to the Executive (whether
                          paid or payable or distributed or distributable
                          pursuant to the terms of this Agreement or otherwise,
                          but determined without regard to any additional
                          payments required under Subsections 3(c), (d), (e)
                          and (f)) (a "Payment") is subject to the excise tax
                          imposed by Section 4999 of the Code, or any interest
                          or penalties are incurred by the Executive with
                          respect to such excise tax (such excise tax, together
                          with any such interest and penalties, are hereinafter
                          collectively referred to as the "Excise Tax"), then
                          the Company shall pay to the Executive an additional
                          payment (a "Gross-Up Payment") in an amount such that
                          after payment by the Executive of all taxes
                          (including any interest or penalties imposed with
                          respect to such taxes), including, without
                          limitation, any income taxes (and any interest and
                          penalties imposed with respect thereto)





J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 6
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                          and Excise Tax imposed upon the Gross-Up Payment, the
                          Executive retains an amount of the Gross-Up Payment
                          equal to the Excise Tax imposed upon the Payments.

                 (d)      Subject to the provisions of Subsection 3(e), all
                          determinations required to be made regarding whether
                          and when a Gross-Up Payment is required and the
                          amount of such Gross-Up Payment and the assumptions
                          to be utilized in arriving at such determination
                          shall be made by the Company's public accounting firm
                          (the "Accounting Firm") which shall provide detailed
                          supporting calculations both to the Company and the
                          Executive as soon as possible following a request
                          made by the Executive or the Company.  In the event
                          that the Accounting Firm is serving as accountant or
                          auditor for the individual, entity or group effecting
                          the Change in Control, the Company shall appoint
                          another nationally recognized public accounting firm
                          to make the determinations required hereunder (which
                          accounting firm shall then be referred to as the
                          Accounting Firm hereunder).  All fees and expenses of
                          the Accounting Firm shall be borne solely by the
                          Company. Any Gross-Up Payment shall be paid by the
                          Company to the Executive within five (5) days of the
                          receipt of the Accounting Firm's determination. If
                          the Accounting Firm determines that no Excise Tax is
                          payable by the Executive, it shall furnish the
                          Executive with a written opinion that failure to
                          report the Excise Tax on the Executive's applicable
                          federal income tax return would not result in the
                          imposition of a negligence or similar penalty.  Any
                          determination by the Accounting Firm shall be binding
                          upon the Company and the Executive.  As a result of
                          the uncertainty in the application of Section 4999 of
                          the Code at the time of the initial determination by
                          the Accounting Firm hereunder, it is possible that
                          Gross-Up Payments which will not have been made by
                          the Company should have been made ("Underpayment"),
                          consistent with the calculations required to be made
                          hereunder.  In the event that the Company exhausts
                          its remedies pursuant to Subsection 3(e) and the
                          Executive thereafter is required to make a payment of
                          any Excise Tax, the Accounting Firm shall determine
                          the amount of the Underpayment that has occurred and
                          any such Underpayment shall be promptly paid by the
                          Company to or for the benefit of the Executive.

                 (e)      The Executive shall notify the Company in writing of
                          any claim by the Internal Revenue Service that, if
                          successful, would require the payment by the Company
                          of the Gross-Up Payment.  Such notification shall be
                          given as soon as practicable but no later than ten
                          (10) business days after the Executive is informed in
                          writing of such claim and shall apprise the Company
                          of the nature of such claim and the date on which
                          such claim is requested to be paid.  The Executive
                          shall not pay such claim prior to the expiration of
                          the





J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 7
<PAGE>   8
                          30-day period following the date on which the
                          Executive gives such notice to the Company (or such
                          shorter period ending on the date that any payment of
                          taxes with respect to such claim is due).  If the
                          Company notifies the Executive in writing prior to
                          the expiration of such period that it desires to
                          contest such claim, the Executive shall:

                          (i)     give the Company any information reasonably
                                  requested by the Company relating to such
                                  claim,

                          (ii)    take such action in connection with
                                  contesting such claim as the Company shall
                                  reasonably request in writing from time to
                                  time, including, without limitation,
                                  accepting legal representation with respect
                                  to such claim by an attorney reasonably
                                  selected by the Company,

                         (iii)    cooperate with the Company in good faith to
                                  effectively contest such claim, and

                          (iv)    permit the Company to participate in any
                                  proceedings relating to such claim;

                          provided, however, that the Company shall bear and
                          pay directly all costs and expenses (including
                          additional interest and penalties) incurred in
                          connection with such contest and shall indemnify and
                          hold the Executive harmless, on an after-tax basis,
                          for any Excise Tax or income tax (including interest
                          and penalties with respect thereto) imposed as a
                          result of such representation and payment of costs
                          and expenses.  Without limitation on the foregoing
                          provisions of this Subsection 3(e), the Company shall
                          control all proceedings taken in connection with such
                          contest and, at its sole option, may pursue or forgo
                          any and all administrative appeals, proceedings,
                          hearings and conferences with the taxing authority in
                          respect of such claim and may, at its sole option,
                          either direct the Executive to pay the tax claimed
                          and sue for a refund or contest the claim in any
                          permissible manner, and the Executive agrees to
                          prosecute such contest to a determination before any
                          administrative tribunal, in a court of initial
                          jurisdiction and in one or more appellate courts, as
                          the Company shall determine; provided further, that
                          if the Company directs the Executive to pay such
                          claim and sue for a refund, the Company shall advance
                          the amount of such payment to the Executive on an
                          interest-free basis and shall indemnify and hold the
                          Executive harmless, on an after-tax basis, from any
                          Excise Tax or income tax (including interest or
                          penalties with respect thereto) imposed with respect
                          to such advance or with respect to any imputed income
                          with respect to such advance; and provided further,
                          that any extension of the statute of limitations
                          relating to payment of taxes for





J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 8
<PAGE>   9
                          the taxable year of the Executive with respect to
                          which such contested amount is claimed to be due is
                          limited solely to such contested amount.
                          Furthermore, the Company's control of the contest
                          shall be limited to issues with respect to which a
                          Gross-Up Payment would be payable hereunder and the
                          Executive shall be entitled to settle or contest, as
                          the case may be, any other issue raised by the
                          Internal Revenue Service or any other taxing
                          authority.

                 (f)      If, after the receipt by the Executive of an amount
                          advanced by the Company pursuant to Subsection 3(e),
                          the Executive becomes entitled to receive, and
                          receives, any refund with respect to such claim, the
                          Executive shall (subject to the Company's complying
                          with the requirements of Subsection 3(e)) promptly
                          pay to the Company the amount of such refund
                          (together with any interest paid or credited thereon
                          after taxes applicable thereto).  If, after the
                          receipt by the Executive of any amount advanced by
                          the Company pursuant to Subsection 3(e), a
                          determination is made that the Executive shall not be
                          entitled to any refund with respect to such claim and
                          the Company does not notify the Executive in writing
                          of its intent to contest such denial of refund prior
                          to the expiration of thirty (30) days after such
                          determination, then such advance shall be forgiven
                          and shall not be required to be repaid and the amount
                          of such advance shall offset, to the extent thereof,
                          the amount of Gross-Up Payment required to be paid.

                 (g)      The Executive shall be entitled throughout the Term
                          and thereafter to indemnification by the Company in
                          respect of any actions or omissions as an employee,
                          officer or director of the Company (or any successor
                          pursuant to Section 11) or of any Subsidiary or
                          affiliate of the Company in the manner set forth in
                          that certain Indemnification Agreement, of even date,
                          by and between the Company and the Executive.

                 (h)      In consideration for the Executive's commitments set
                          forth in Section 7, the Company agrees to pay to the
                          Executive, within five (5) days following the
                          occurrence of a Change in Control, the sum of
                          $400,000.

         4.      Termination Following a Change in Control:

                 (a)      In the event of the occurrence of a Change in
                          Control, this Agreement may be terminated by the
                          Company during the Period of Employment only upon the
                          occurrence of one or more of the following events:





J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 9
<PAGE>   10
                          (i)     If the Executive is unable to perform the
                                  essential functions of the Executive's job
                                  (with or without reasonable accommodation)
                                  because the Executive has become permanently
                                  disabled within the meaning of, and actually
                                  begins to receive disability benefits
                                  pursuant to, a long-term disability plan
                                  maintained by or on behalf of the Company or
                                  any Applicable Subsidiary for senior
                                  executives generally or, if applicable,
                                  employees of the Company or any Applicable
                                  Subsidiary immediately prior to the Change in
                                  Control; or

                          (ii)    For "Cause," which for purposes of this
                                  Agreement shall mean that, prior to any
                                  termination pursuant to Subsection 4(b)
                                  hereof, the Executive shall have committed:

                                  (A)      an intentional act of fraud,
                                           embezzlement or theft in connection
                                           with the Executive's duties or in
                                           the course of the Executive's
                                           employment with the Company or any
                                           Applicable Subsidiary;

                                  (B)      intentional wrongful damage to 
                                           property of the Company or any
                                           Subsidiary;

                                  (C)      intentional wrongful disclosure of
                                           secret processes or confidential
                                           information of the Company or any
                                           Subsidiary; or

                                  (D)      intentional wrongful engagement in 
                                           any Competitive Activity;

                 and any such act shall have been materially harmful to the
                 Company or any Subsidiary.  For purposes of this Agreement, no
                 act, or failure to act, on the part of the Executive shall be
                 deemed "intentional" if it was due primarily to an error in
                 judgment or negligence, but shall be deemed "intentional" only
                 if done, or omitted to be done, by the Executive not in good
                 faith and without reasonable belief that the Executive's
                 action or omission was in the best interest of the Company and
                 the Subsidiaries or not opposed to the best interest of the
                 Company and the Subsidiaries.  Notwithstanding the foregoing,
                 the Executive shall not be deemed to have been terminated for
                 "Cause" hereunder unless and until there shall have been
                 delivered to the Executive a copy of a resolution duly adopted
                 by the affirmative vote of not less than three-quarters of the
                 Board then in office at a meeting of the Board called and held
                 for such purpose (after reasonable notice to the Executive and
                 an opportunity for the Executive, together with the
                 Executive's counsel, to be heard before the Board), finding
                 that, in the good faith opinion of the Board, the Executive
                 has committed an act set forth above in this Subsection
                 4(a)(ii) and specifying the particulars thereof in





J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 10
<PAGE>   11
                 detail.  Nothing herein shall limit the right of the Executive
                 or the Executive's beneficiaries to contest the validity or
                 propriety of any such determination.

                 (b)      In the event of the occurrence of a Change in
                          Control, this Agreement may be terminated by the
                          Executive during the Period of Employment with the
                          right to benefits as provided in Section 5 hereof
                          upon the occurrence of one or more of the following
                          events:

                          (i)     Any termination of the employment of the
                                  Executive by the Company or any Applicable
                                  Subsidiary for any reason other than for
                                  Cause or as a result of the death of the
                                  Executive or by reason of the Executive's
                                  disability and the actual receipt of
                                  disability benefits in accordance with
                                  Subsection 4(a)(i) hereof; or

                          (ii)    Termination by the Executive of the
                                  Executive's employment by the Company or any
                                  Applicable Subsidiary during the Period of
                                  Employment upon the occurrence of any of the
                                  following events:

                                  (A)      Failure to elect or reelect the
                                           Executive to the office(s) of the
                                           Company or any Applicable Subsidiary
                                           which the Executive held immediately
                                           prior to the Change in Control, or
                                           failure to elect or reelect the
                                           Executive as a director of the
                                           Company or any Applicable Subsidiary
                                           or the removal of the Executive as a
                                           director of the Company or any
                                           Applicable Subsidiary (or any
                                           successor thereto), if the Executive
                                           shall have been a director of the
                                           Company or such Applicable
                                           Subsidiary immediately prior to the
                                           Change in Control;

                                  (B)      A significant adverse change in the
                                           nature or scope of the authorities,
                                           powers, functions, responsibilities
                                           or duties attached to the
                                           position(s) with the Company or any
                                           Applicable Subsidiary which the
                                           Executive held immediately prior to
                                           the Change in Control, a reduction
                                           in the aggregate of the Executive's
                                           Base Pay and Incentive Pay received
                                           from the Company and/or the
                                           Applicable Subsidiaries, or the
                                           termination of the Executive's
                                           rights to any Employee Benefits to
                                           which the Executive was entitled
                                           immediately prior to the Change in
                                           Control or a reduction in scope or
                                           value thereof without the prior
                                           written consent of the Executive,
                                           any of which is not remedied within
                                           ten (10)





J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 11
<PAGE>   12
                                           calendar days after receipt by the
                                           Company of written notice from the
                                           Executive of such change, reduction
                                           or termination, as the case may be;

                                  (C)      A determination by the Executive
                                           made in good faith that, following
                                           the Change in Control, as a result
                                           of a change in circumstances
                                           significantly affecting the
                                           Executive's position(s) held with
                                           the Company and/or the Applicable
                                           Subsidiaries, including, without
                                           limitation, a change in the scope of
                                           the business or other activities for
                                           which the Executive was responsible
                                           immediately prior to the Change in
                                           Control, that the Executive has been
                                           rendered substantially unable to
                                           carry out, has been substantially
                                           hindered in the performance of, or
                                           has suffered a substantial reduction
                                           in any of the authorities, powers,
                                           functions, responsibilities or
                                           duties attached to the position(s)
                                           held with the Company and/or the
                                           Applicable Subsidiaries by the
                                           Executive immediately prior to the
                                           Change in Control, which situation
                                           is not remedied within ten (10)
                                           calendar days after written notice
                                           to the Company from the Executive of
                                           such determination;

                                  (D)      The liquidation, dissolution,
                                           merger, consolidation or
                                           reorganization of the Company or any
                                           Applicable Subsidiary or transfer of
                                           all or a significant portion of its
                                           business and/or assets, unless the
                                           successor (by liquidation, merger,
                                           consolidation, reorganization or
                                           otherwise) to which all or a
                                           significant portion of its business
                                           and/or assets have been transferred
                                           (directly or by operation of law)
                                           shall have assumed all duties and
                                           obligations of the Company under
                                           this Agreement pursuant to Section
                                           11 hereof;

                                  (E)      The Company or any Applicable
                                           Subsidiary shall require that the
                                           principal place of work of the
                                           Executive be changed to any location
                                           which is in excess of twenty-five
                                           (25) miles from the location thereof
                                           immediately prior to the Change of
                                           Control or to travel away from the
                                           Executive's office in the course of
                                           discharging the Executive's
                                           responsibilities or duties hereunder
                                           significantly more (in terms of
                                           either consecutive days or aggregate
                                           days in any calendar year) than was
                                           required of the Executive prior to
                                           the Change of Control without, in
                                           either case, the Executive's prior
                                           consent; or





J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 12
<PAGE>   13
                                  (F)      Any material breach of this
                                           Agreement by the Company or any 
                                           successor thereto.

                 (c)      A termination by the Company pursuant to Subsection
                          4(a) hereof or by the Executive pursuant to
                          Subsection 4(b) hereof shall not affect any rights
                          which the Executive may have pursuant to any
                          agreement, policy, plan, program or arrangement of
                          the Company providing Employee Benefits, which rights
                          shall be governed by the terms thereof.  If this
                          Agreement or the employment of the Executive is
                          terminated under circumstances in which the Executive
                          is not entitled to any payments under Sections 3 or 5
                          hereof, the Executive shall have no further
                          obligation or liability to the Company hereunder with
                          respect to the Executive's prior or any future
                          employment by the Company or any Subsidiary.

         5.      Severance Compensation:

                 (a)      If, following the occurrence of a Change in Control,
                          the Company or any Subsidiary shall terminate the
                          Executive's employment during the Period of
                          Employment other than pursuant to Subsection 4(a)
                          hereof, or if the Executive shall terminate the
                          Executive's employment pursuant to Subsection 4(b)
                          hereof, the Company shall pay to the Executive the
                          amount specified in Subsection 5(a)(i) hereof within
                          five (5) business days after the date (the
                          "Termination Date") that the Executive's employment
                          is terminated (the effective date of which shall be
                          the date of termination, or such other date that may
                          be specified by the Executive if the termination is
                          pursuant to Subsection 4(b) hereof):

                          (i)     In lieu of any further payments to the
                                  Executive for periods subsequent to the
                                  Termination Date, but without affecting the
                                  rights of the Executive referred to in
                                  Subsection 5(b) hereof, a lump sum payment
                                  (the "Severance Payment") in an amount equal
                                  to the present value (using a discount rate
                                  required to be utilized for purposes of
                                  computations under Section 280G of the Code
                                  or any successor provision thereto, or if no
                                  such rate is so required to be used, a rate
                                  equal to the then-applicable interest rate
                                  prescribed by the Pension Benefit Guaranty
                                  Corporation for benefit valuations in
                                  connection with non-multiemployer pension
                                  plan terminations assuming the immediate
                                  commencement of benefit payments (the
                                  "Discount Rate")) of the sum of (A) the
                                  aggregate Base Pay (at the highest rate in
                                  effect during the Term prior to the
                                  Termination Date) for each remaining year or
                                  fraction of the Period of Employment which
                                  the Executive would have received had such
                                  termination not occurred, plus (B) the





J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 13
<PAGE>   14
                                  aggregate Incentive Pay (based upon the
                                  greatest amount of Incentive Pay paid or
                                  payable to the Executive for any year during
                                  the Term but prior to the year in which the
                                  Termination Date occurs), which the Executive
                                  would have received pursuant to this
                                  Agreement during the remainder of the Period
                                  of Employment had the Executive's employment
                                  continued for the remainder of the Period of
                                  Employment.

                          (ii)    The determination of whether any amount
                                  payable under Subsection 5(a)(i) and/or
                                  Section 3 is subject to the Excise Tax shall
                                  be governed by Subsections 3(c), (d), (e) and
                                  (f) of this Agreement.  The costs of
                                  obtaining such determination shall be borne
                                  by the Company.  Without limiting the
                                  generality of the foregoing, upon the
                                  Executive's termination of employment under
                                  the circumstances described in this Section
                                  5, the Company shall (upon request of the
                                  Executive) pay over to the Executive all
                                  vested benefits to which the Executive is
                                  entitled under and in accordance with the
                                  terms of the employee savings, stock
                                  ownership, supplemental executive retirement
                                  and similar plans of the Company and the
                                  Applicable Subsidiaries in the event such
                                  payments are not otherwise made in accordance
                                  with the terms of such plans.

                          (iii)   For the remainder of the Period of
                                  Employment, the Company shall arrange to
                                  provide the Executive with Employee Benefits
                                  substantially similar to those which the
                                  Executive was receiving or entitled to
                                  receive immediately prior to the Termination
                                  Date (and if and to the extent that such
                                  benefits shall not or cannot be paid or
                                  provided under any policy, plan, program or
                                  arrangement of the Company and the Applicable
                                  Subsidiaries solely due to the fact that the
                                  Executive is no longer an officer or employee
                                  of the Company and/or the Applicable
                                  Subsidiaries, then the Company shall itself
                                  pay to the Executive and/or the Executive's
                                  dependents and beneficiaries, such Employee
                                  Benefits).  Without limiting the generality
                                  of the foregoing, the remainder of the Period
                                  of Employment shall be considered service
                                  with the Company and the Applicable
                                  Subsidiaries for the purpose of service
                                  credits under the retirement income,
                                  supplemental executive retirement and other
                                  benefit plans of the Company and the
                                  Applicable Subsidiaries applicable to the
                                  Executive and/or the Executive's dependents
                                  and beneficiaries immediately prior to the
                                  Termination Date.  Without otherwise limiting
                                  the purposes or effect of Section 6 hereof,
                                  Employee Benefits payable to the Executive
                                  pursuant to this Subsection 5(a)(iii) by
                                  reason





J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 14
<PAGE>   15
                                  of any "welfare benefit plan" of the Company
                                  and the Applicable Subsidiaries (as the term
                                  "welfare benefit plan" is defined in Section
                                  3(1) of the Employee Retirement Income
                                  Security Act of 1974, as amended) shall be
                                  reduced to the extent comparable welfare
                                  benefits are actually received by the
                                  Executive from another employer during such
                                  period following the Executive's Termination
                                  Date until the expiration of the Period of
                                  Employment.

                 (b)      Upon written notice given by the Executive to the
                          Company prior to the receipt of any payment pursuant
                          to Subsection 5(a) hereof, the Executive, at the
                          Executive's sole option, without reduction to reflect
                          the present value of such amounts as aforesaid, may
                          elect to have all or any of the Severance Payment
                          payable pursuant to Subsection 5(a)(i) hereof paid to
                          the Executive on a quarterly or monthly basis during
                          the remainder of the Period of Employment.

                 (c)      There shall be no right of set-off or counterclaim in
                          respect of any claim, debt or obligation against any
                          payment to or benefit (including Employee Benefits)
                          of the Executive provided for in this Agreement.

                 (d)      Without limiting the rights of the Executive at law
                          or in equity, if the Company fails to make any
                          payment required to be made hereunder on a timely
                          basis, the Company shall pay interest on the amount
                          thereof at an annualized rate of interest equal to
                          the then-applicable Discount Rate or, if lesser, the
                          highest rate allowed by applicable usury laws.

         6.      No Mitigation Obligation:  The Company hereby acknowledges
that it will be difficult, and may be impossible, for the Executive to find
reasonably comparable employment following the Termination Date and that the
noncompetition covenant contained in Section 7 hereof will further limit the
employment opportunities for the Executive.  Accordingly, the parties hereto
expressly agree that the payment of the severance compensation by the Company
to the Executive in accordance with the terms of this Agreement will be
liquidated damages, and that the Executive shall not be required to mitigate
the amount of any payment provided for in this Agreement by seeking other
employment or otherwise, nor shall any profits, income, earnings or other
benefits from any source whatsoever create any mitigation, offset, reduction or
any other obligation on the part of the Executive hereunder or otherwise,
except as expressly provided in Subsection 5(a)(iii) hereof.

         7.      Competitive Activity:  During a period ending three (3) years
following the Termination Date, so long as the Company is in substantial
compliance with its obligations pursuant to this Agreement, the Executive shall
not, without the prior written consent by the Company, directly or indirectly
engage in a business that is competitive with the business of the Company or
any Applicable Subsidiary ("Competitive Activity") within the





J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 15
<PAGE>   16
State of Texas and any other geographical area served by the Company or such
Applicable Subsidiary during the twelve (12) month period immediately preceding
termination of the Executive's employment with the Company and such Applicable
Subsidiary. The Executive acknowledges that this limited prohibition is
reasonable as to time, geographical area and scope of activities to be
restrained and that such prohibition does not impose a greater restraint than
is necessary to protect the goodwill, proprietary information and other
business interests of the Company and such Applicable Subsidiary.  "Competitive
Activity" shall not include (i) the mere ownership of a de minimis amount of
securities in any such enterprise and exercise of rights appurtenant thereto or
(ii) participation in management of any such enterprise or business operation
thereof other than in connection with the competitive operation of such
enterprise.

         8.      Legal Fees and Expenses:

                 (a)      It is the intent of the Company that the Executive
                          not be required to incur the expenses associated with
                          the enforcement of the Executive's rights under this
                          Agreement by litigation or other legal action because
                          the cost and expense thereof would substantially
                          detract from the benefits intended to be extended to
                          the Executive hereunder.  Accordingly, if it should
                          appear to the Executive that the Company has failed
                          to comply with any of its obligations under this
                          Agreement or in the event that the Company or any
                          other person takes any action to declare this
                          Agreement void or unenforceable, or institutes any
                          litigation designed to deny, or to recover from, the
                          Executive the benefits intended to be provided to the
                          Executive hereunder, the Company irrevocably
                          authorizes the Executive from time to time to retain
                          counsel of the Executive's choice, at the expense of
                          the Company as hereafter provided, to represent the
                          Executive in connection with the litigation or
                          defense of any litigation or other legal action,
                          whether by or against the Company or any director,
                          officer, shareholder or other person affiliated with
                          the Company, in any jurisdiction.  Notwithstanding
                          any existing or prior attorney-client relationship
                          between the Company and such counsel, the Company
                          irrevocably consents to the Executive's entering into
                          an attorney-client relationship with such counsel
                          (other than Winstead Sechrest & Minick P.C.), and in
                          that connection the Company and the Executive agree
                          that a confidential relationship shall exist between
                          the Executive and such counsel.  The Company shall
                          pay or cause to be paid and shall be solely
                          responsible for any and all attorneys' and related
                          fees and expenses incurred by the Executive as a
                          result of the Company's failure to perform this
                          Agreement or any provision thereof or as a result of
                          the Company or any person contesting the validity or
                          enforceability of this Agreement or any provision
                          thereof as aforesaid.





J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 16
<PAGE>   17
                 (b)      To ensure the benefits intended to be provided to the
                          Executive under Subsection 8(a) hereof, the Company
                          has established an irrevocable standby Letter of
                          Credit in favor of the Executive and each other
                          person who is named an Executive under similar
                          agreements, drawn on Texas Commerce Bank (the "Letter
                          of Credit") which provides for a credit amount of
                          $250,000 being made available to the Executive
                          against presentation at any time and from time to
                          time of the Executive's clean sight drafts,
                          accompanied by statements of the Executive's counsel
                          for fees and expenses, in an aggregate amount not to
                          exceed $250,000, unless a larger amount is previously
                          authorized by two of the Chairman, President or Vice
                          President of the Company, provided that no such
                          person may act in two separate capacities or
                          authorize a larger amount for himself.

         9.      Employment Rights:  Nothing expressed or implied in this
Agreement shall create any right or duty on the part of the Company or any
Applicable Subsidiary (on the one hand) or the Executive (on the other hand) to
have the Executive remain in the employment of the Company or any Applicable
Subsidiary prior to any Change in Control; provided, however, that any
termination of employment of the Executive or removal of the Executive as an
Officer or director of the Company or any Applicable Subsidiary following the
commencement of any discussion with a third person that ultimately results in a
Change in Control shall be deemed to be a termination or removal of the
Executive after a Change in Control for purposes of this Agreement.

         10.     Withholding of Taxes:  The Company may withhold from any
amounts payable under this Agreement all federal, state, city or other taxes as
shall be required pursuant to any law or government regulation or ruling.

         11.     Successors and Binding Agreement:

                 (a)      The Company shall require any successor (whether
                          direct or indirect, by purchase, merger,
                          consolidation, reorganization, operation of law or
                          otherwise) to all or substantially all of the
                          business and/or assets of the Company, to expressly
                          assume and agree to perform this Agreement in the
                          same manner and to the same extent the Company would
                          be required to perform if no such succession had
                          taken place.  This Agreement shall be binding upon
                          and inure to the benefit of the Company and any
                          successor to the Company, including without
                          limitation any persons acquiring directly or
                          indirectly all or substantially all of the business
                          and/or assets of the Company whether by purchase,
                          merger, consolidation, reorganization, operation of
                          law or otherwise (and such successor shall thereafter
                          be deemed the "Company" for the purposes of this
                          Agreement).  This Agreement shall not otherwise be
                          assignable, transferable or delegable by the Company.





J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 17
<PAGE>   18
                 (b)      This Agreement shall inure to the benefit of and be
                          enforceable by the Executive's personal or legal
                          representatives, executors, administrators,
                          successors, heirs, distributees and/or legatees.

                 (c)      This Agreement is personal in nature and neither of
                          the parties hereto shall, without the consent of the
                          other, assign, transfer or delegate this Agreement or
                          any rights or obligations hereunder except as
                          expressly provided in Subsection 11(a) hereof.
                          Without limiting the generality of the foregoing, the
                          Executive's right to receive payments hereunder shall
                          not be assignable, transferable or delegable, whether
                          by pledge, creation of a security interest or
                          otherwise, other than by a transfer by the
                          Executive's will or by the laws of descent and
                          distribution and, in the event of any attempted
                          assignment or transfer contrary to this Subsection
                          11(c), the Company shall have no liability to pay any
                          amount so attempted to be assigned, transferred or
                          delegated.

                 (d)      The Company and the Executive recognize that each
                          Party will have no adequate remedy at law for breach
                          by the other of any of the agreements contained
                          herein and, in the event of any such breach, the
                          Company and the Executive hereby agree and consent
                          that the other shall be entitled to a decree of
                          specific performance, mandamus or other appropriate
                          remedy to enforce performance of this Agreement.

         12.     Applicable Law.   THIS AGREEMENT WILL BE GOVERNED BY AND
CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF TEXAS (EXCLUSIVE OF
CONFLICTS OF LAW PRINCIPLES) AND THE LAWS OF THE UNITED STATES OF AMERICA AND
WILL, TO THE MAXIMUM EXTENT PRACTICABLE, BE DEEMED TO CALL FOR PERFORMANCE IN
HARRIS COUNTY, TEXAS.  COURTS WITHIN THE STATE OF TEXAS WILL HAVE JURISDICTION
OVER ANY AND ALL DISPUTES BETWEEN THE PARTIES HERETO, WHETHER IN LAW OR EQUITY,
ARISING OUT OF OR RELATING TO THIS AGREEMENT.  THE PARTIES CONSENT TO AND AGREE
TO SUBMIT TO THE JURISDICTION OF SUCH COURTS.  VENUE IN ANY SUCH DISPUTE,
WHETHER IN FEDERAL OR STATE COURT, WILL BE LAID IN HARRIS COUNTY, TEXAS. EACH
OF THE PARTIES HEREBY WAIVES, AND AGREES NOT TO ASSERT IN ANY SUCH DISPUTE, TO
THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, ANY CLAIM THAT (I) SUCH PARTY
IS NOT PERSONALLY SUBJECT TO THE JURISDICTION OF SUCH COURTS, (II) SUCH PARTY
AND SUCH PARTY'S PROPERTY IS IMMUNE FROM ANY LEGAL PROCESS ISSUED BY SUCH
COURTS OR (III) ANY LITIGATION COMMENCED IN SUCH COURTS IS BROUGHT IN AN
INCONVENIENT FORUM.

         13.     Notices.  All notices, demands, requests or other
communications that may be or are required to be given, served or sent by
either party to the other party pursuant to this Agreement will be in writing
and will be mailed by first-class, registered or certified





J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 18
<PAGE>   19
mail, return receipt requested, postage prepaid, or transmitted by hand
delivery, telegram or facsimile transmission addressed as follows:

        (a)      If to the Company:          Merchants Bancshares, Inc.
                                             5005 Woodway, Suite 300
                                             Houston, Texas  77056
                                             Facsimile No.:  (713) 622-8922
                                            
                                            
                 with a copy (which will    
                 not constitute notice) to:  Winstead Sechrest & Minick P.C.
                                             5400 Renaissance Tower
                                             1201 Elm Street
                                             Dallas, Texas  75270
                                             Facsimile No.: (214) 745-5390
                                             Attn: Robert E. Crawford, Jr., Esq.
                                            
        (b)      If to the Executive:        J. W. Lander, III
                                             5311 Willers Way
                                             Houston, Texas  77056
                                             Facsimile No.:  (713) 622-8922
                                            

Either party may designate by written notice a new address to which any notice,
demand, request or communication may thereafter be given, served or sent.  Each
notice, demand, request or communication that is mailed, delivered or
transmitted in the manner described above will be deemed sufficiently given,
served, sent and received for all purposes at such time as it is delivered to
the addressee with the return receipt, the delivery receipt, the affidavit of
messenger or (with respect to a facsimile transmission) the answer back being
deemed conclusive evidence of such delivery or at such time as delivery is
refused by the addressee upon presentation.

         14.     Gender.   Words of any gender used in this Agreement will be
held and construed to include any other gender, and words in the singular
number will be held to include the plural, unless the context otherwise
requires.

         15.     Amendment.  This Agreement may not be amended or supplemented
except pursuant to a written instrument signed by the party against whom such
amendment or supplement is to be enforced.  Nothing contained in this Agreement
will be deemed to create any agency, joint venture, partnership or similar
relationship between the parties to this Agreement.  Nothing contained in this
Agreement will be deemed to authorize either party to this Agreement to bind or
obligate the other party.

         16.     Counterparts.   This Agreement may be executed in multiple
counterparts, each of which will be deemed to be an original and all of which
will be deemed to be a single agreement.  This Agreement will be considered
fully executed when all  parties have executed an identical counterpart,
notwithstanding that all signatures may not appear on the same counterpart.





J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 19
<PAGE>   20
         17.     Severability.  If any of the provisions of this Agreement are
determined to be invalid or unenforceable, such invalidity or unenforceability
will not invalidate or render unenforceable the remainder of this Agreement,
but rather the entire Agreement will be construed as if not containing the
particular invalid or unenforceable provision or provisions, and the rights and
obligations of the parties will be construed and enforced accordingly.  The
parties acknowledge that if any provision of this Agreement is determined to be
invalid or unenforceable, it is their desire and intention that such provision
be reformed and construed in such manner that it will, to the maximum extent
practicable, be deemed to be valid and enforceable.

         18.     Third Parties.  Except as expressly set forth or referred to
in this Agreement, nothing in this Agreement is intended or will be construed
to confer upon or give to any party other than the parties to this Agreement
and their successors and permitted assigns, if any, any rights or remedies
under or by reason of this Agreement.

         19.     Waiver.  No failure or delay in exercising any right hereunder
will operate as a waiver thereof, nor will any single or partial exercise
thereof preclude any other or further exercise or the exercise of any other
right.

         20.     Prior Agreement.  This Agreement is voluntarily entered into
and upon the occurrence of a Change in Control will supersede and take the
place of any prior change in control, severance or employment agreements
between the parties hereto.  The parties hereto expressly agree and hereby
declare that any and all prior change in control, severance or employment
agreements between the parties are terminated and of no force or effect.

         21.     Indemnity. UNDER CERTAIN CIRCUMSTANCES, THIS AGREEMENT IMPOSES
INDEMNIFICATION OBLIGATIONS ON THE PARTIES HERETO.



             [THE REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK.]





J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 20
<PAGE>   21
         IN WITNESS WHEREOF, the parties have caused this Agreement to be duly
executed and delivered as of the date first above written.


                           COMPANY:

                           MERCHANTS BANCSHARES, INC.



                           By:    
                                ----------------------------------------------

                                Name:  Norman H. Bird
                                Title:  Vice President


                           EXECUTIVE:



                           ---------------------------------------------------
                           J. W. Lander, III





J. W. LANDER, III
EMPLOYMENT AGREEMENT - PAGE 21