Preauditing Employment-Related Agreements
Published: 01/31/24
Author Name: Kara Millonzi
After an approximately four-year tenure, the town manager files a confidential report claiming a hostile work environment. The town manager’s attorney negotiates a settlement agreement in which the town manager agrees to resign and not bring future legal claims against the town in exchange for a financial payment from the town. The manager signs the settlement agreement. The agreement is subsequently approved by a majority of the town council. Immediately after the council vote, though, three council members who voted for the settlement agreement resign. The town attorney also resigns. The newly constituted town council does not make the necessary budget ordinance amendment to fund the settlement agreement. Without that amendment, the finance officer cannot legally disburse the settlement payment to the now former town manager. The former manager sues for enforcement of the settlement agreement. The town asserts that the settlement agreement is void because it lacks a preaudit certificate. These are the facts arising out of a recent employment dispute in Rural Hall, North Carolina.
So how did it end? The trial court agreed with the town and ordered the settlement agreement void as a matter of law for failing to follow the preaudit provisions in G.S. 159-28. And the court of appeals also agreed, leaving the former town manager with no recourse to recover payment from the settlement agreement. Town of Rural Hall v. Garner, No. COA23-185 (Sept. 5, 2023). This holding is not surprising. It is consistent with long case law precedent involving the preaudit requirement.
The case, however, has prompted questions about the applicability of the preaudit to other contracts arising out of employment relationships, including employment agreements and termination packages. This post first reviews when the preaudit requirements are triggered and how the preaudit process is performed. It then summarizes the applicability of the preaudit requirements to employee settlement agreements and employment agreements more broadly.
Triggering the Preaudit
The preaudit statute, G.S. 159-28(a), requires a finance officer, or a deputy finance officer who is specifically appointed by the board, to take certain steps before a unit may incur an obligation. An obligation is incurred when:
- a unit executes a legal contract that is budgeted for in the annual budget ordinance or a capital or grant project ordinance (A legal contract can take a variety of forms, including purchase orders, MOUs, MOAs, service agreements, employment agreements, interlocal agreements, and other arrangements representing a binding commitment of the parties.); AND
- the unit is obligated to pay money to another party by the terms of the contract; AND
- if the obligation is budgeted in the annual budget ordinance, the unit anticipates paying at least some of the money in the fiscal year in which the contract is entered into. (If the obligation is budgeted in a grant project ordinance or capital project ordinance this third criteria does not apply.)
All applicable criteria must be met to trigger the preaudit, but there is no dollar threshold. (The requirement applies equally to an obligation for $1 as an obligation for $1,000,000.) As detailed in previous posts, any legal contract requiring a local government or public authority (collectively local unit) to pay money to another party (including employment agreements) is subject to the statutory preaudit.
Preaudit Process
If the preaudit applies, G.S. 159-28(a) requires that before a unit may incur the obligation, the unit’s finance officer or a deputy finance officer specifically appointed by the board must:
- Check to see if there is an appropriation in the annual budget ordinance, or a project ordinance, for the amount that is expected to be paid during the current budget period (The budget period for the annual budget ordinance is the current fiscal year. The budget period for a grant or project ordinance, is the life of the grant or project.);
- Check to see if sufficient funds remain in the appropriation to cover the amount that is expected to be paid during the budget period;
- Affix and sign a preaudit certificate to any “writing” that evidences the legal contract, unless an exception applies. The “writing” can be hardcopy or digital. The preaudit certificate must state that “[t]his instrument has been preaudited in the manner required by the Local Government Budget and Fiscal Control Act.” (Although not legally required, it is smart practice to also date the certificate.)
There are a few exceptions to the third step (the signed preaudit certificate). First, no preaudit certificate is required if there is no “writing” evidencing the contract. It does not apply to oral contracts. Second, if the local unit maintains an accounting system that automatically performs the first two steps of the preaudit process, G.S. 159-28(a3)-(a4), and is certified by the Local Government Commission (LGC), then it does not need to affix a signed preaudit certificate on any legal contract. It is exempt from this third step completely. Third, the preaudit certificate requirement does not apply to any legal contract approved by the LGC. Fourth, no preaudit certificate is required on payroll expenditures. Finally, a preaudit certificate is not required for obligations incurred as an electronic transaction (via p-card, credit card, fuel card, etc.), as long as the local unit adopts a policy related to electronic transactions that complies with LGC regulations.
Consequences for Failure to Properly Preaudit
If the preaudit is not completed properly before the execution of the legal contract, the contract is void and, thus, unenforceable by either party. Whoever within the local unit executed the legal contract, or caused it to be executed, in violation of the preaudit requirement may be held personally liable by the governing board for the amounts committed, see G.S. 159-28(e), and may be criminally liable, pursuant to G.S. 159-181. So the consequences can be significant for failing to follow the statute.
Applicability of Preaudit Requirements to Employee Settlement Agreements
An employee settlement agreement is a legally binding contract that details an agreement between an employer and their employee that usually terminates the working relationship under the terms laid out. A settlement agreement will typically include a financial severance package for the employee, which is offered in return for ending the employment contract on a set date and the employee agreeing not to bring future legal claims against the employer.
The former Rural Hall town manager argued in the court of appeals that the preaudit statute did not apply to settlement agreements. She cited Lee v. Wake County, 165 NC App 154 (2004), as favorable precedent. In Lee, the court held that the preaudit statute did not apply to a preliminary settlement agreement in which both parties committed to draw up a final settlement agreement. According to the Lee court, the preliminary settlement agreement was a contract for specific performance, not a contract “requiring the payment of money or a purchase order,” therefore it did not trigger the preaudit requirement. The court rejected the former Rural Hall manager’s comparison to Lee because in this case the settlement agreement included a monetary payment to the former manager. And the payment was expected to be paid out during the current budget period. As such, it was clearly subject to the preaudit requirement because it met all the criteria. See also Cabarrus County v. Systel Business Equipment Co., Inc., 171 N.C. App. 423 (2005) (holding a settlement agreement invalid for lack of a signed preaudit certificate, where the agreement, on its face, mandated that the county pay a specified sum to the defendant). The court also rejected the former Rural Hall manager’s argument that she was entitled to equitable relief because the town acted in bad faith. Citing Data General Corp. v. County of Durham, 143 NC App 97 (2001), the court reaffirmed that “a party may not recover under contractual claims nor claims in equity concerning the same matter where the county has not entered a valid contract.”
Applicability of Preaudit Requirement to Employment Contracts and Termination Payments
The Rural Hall case involved the applicability of a preaudit in the context of an employment relationship, but it did not involve an employment contract. The preaudit requirement also applies to employment agreements, even at-will employment agreements, that commit the local unit to pay money (salary/wages) to the employee. And the requirement is triggered even if the total salary amount is not certain at the time the employee is hired. For example, in Transportation Services of North Carolina, Inc. v. Wake County Bd. of Educ., 198 N.C.App. 590, 680 S.E.2d 223 (2009), the court held that an employment agreement in which school board agreed to compensate a transportation services provider for services on a per-student-assigned basis was subject to preaudit requirement under analogous provision to G.S. 159-28. The preaudit will be done based on a reasonable estimate of the amount that will be expended during the budget period.
Most employment agreements span for more than one fiscal year. At-will employees continue to be employed until they resign, pass away, or are terminated. A preaudit is required when the employee is initially hired and the preaudit will encompass the amount expected to be paid during the remainder of the budget period in which the employee is hired. For example, if a town manager is hired on August 1 and the manager’s salary will be budgeted in the annual budget ordinance, the preaudit will be done based on the amount expected to be paid to the manger under the terms of the employment agreement from August through June, the budget period. But a new preaudit is not required in subsequent budget periods unless there is change in salary or other monetary terms to the agreement during the new budget period. (Note that a new preaudit is not necessary because G.S. 159-13 requires the governing board to appropriate funds in subsequent budget years to cover any amounts due under continuing employment agreements.)
How does the preaudit requirement apply to “golden parachutes” – termination clauses included (or added to) an existing employment agreement that trigger payments to the employee but only if/when the employee is terminated by the local unit under certain circumstances? The answer to this question is more complicated and depends on several factors. Let’s look at the two most likely scenarios.
In the first scenario, the town manager negotiates for a severance package when he is first employed. A provision is included in his initial employment agreement that sets out the amount of severance and the terms under which it will be triggered. The employment agreement includes the regular compensation amount and an additional amount that will be paid if and only if a termination occurs under specified circumstances. Assume that the manager’s salary is budgeted for in the annual budget ordinance. At the time the manager is hired, there is an expectation that the local unit will pay his regular compensation during the budget period, but there is likely no expectation that the town will pay the severance amount during that budget period. Because of that, a preaudit would be required for the regular compensation amount but not the severance amount.
In Myers v. Town of Plymouth, 135 N.C.App. 707, 522 S.E.2d 122 (1999), the town entered into an employment contract with the town manager in March 1997 (fiscal year 1996-97), whereby the manager agreed to work for the town for four years. Both the town and the manager reserved the right to terminate the employment relationship with thirty days’ notice. The contract provided the manager with a severance package if he was terminated by the town for any reason except felonious criminal conduct or a failure of performance which the manager failed to cure after appropriate notice. The following December (fiscal year 1997-98) a new town council was seated and within a few months the new council terminated the manager and refused to pay the severance package. The manager sued. Among other defenses, the town argued that the employment contract was void because it lacked a preaudit certificate in violation of G.S. 159-28. The court disagreed, holding that no preaudit was needed because it was highly improbable that the town would have been required to pay the severance package in the fiscal year in which the contract was signed.
Contrast that with a second scenario. When a town manager is hired, there is no severance package included as part of her employment agreement. The local unit preaudits the agreement based on the amount of salary expected to be paid to the manager during the budget year in which she is hired. A few years later, after a primary election reveals that the governing board’s composition is likely to change in December, the current board majority votes to modify the manager’s employment agreement to add a severance package. The board believes it is likely that the new board majority will terminate the manager shortly after they are sworn in. The board amends the employment agreement in July. The new board members will take office in December. In this scenario a preaudit likely is required on the amount of the severance package because there is a reasonable expectation that it will be paid during the budget year. That also means that the applicable budget appropriation must include sufficient funds to cover the amount of the severance package at the time the agreement is amended.
Thus, the key to determining whether an employment agreement (or amendment to an employment agreement) requires a preaudit boils down to whether there is a reasonable expectation of making the financial payments during the current budget period.
1
Coates’ Canons NC Local Government Law
Preauditing Employment-Related Agreements
Published: 01/31/24
Author Name: Kara Millonzi
After an approximately four-year tenure, the town manager files a confidential report claiming a hostile work environment. The town manager’s attorney negotiates a settlement agreement in which the town manager agrees to resign and not bring future legal claims against the town in exchange for a financial payment from the town. The manager signs the settlement agreement. The agreement is subsequently approved by a majority of the town council. Immediately after the council vote, though, three council members who voted for the settlement agreement resign. The town attorney also resigns. The newly constituted town council does not make the necessary budget ordinance amendment to fund the settlement agreement. Without that amendment, the finance officer cannot legally disburse the settlement payment to the now former town manager. The former manager sues for enforcement of the settlement agreement. The town asserts that the settlement agreement is void because it lacks a preaudit certificate. These are the facts arising out of a recent employment dispute in Rural Hall, North Carolina.
So how did it end? The trial court agreed with the town and ordered the settlement agreement void as a matter of law for failing to follow the preaudit provisions in G.S. 159-28. And the court of appeals also agreed, leaving the former town manager with no recourse to recover payment from the settlement agreement. Town of Rural Hall v. Garner, No. COA23-185 (Sept. 5, 2023). This holding is not surprising. It is consistent with long case law precedent involving the preaudit requirement.
The case, however, has prompted questions about the applicability of the preaudit to other contracts arising out of employment relationships, including employment agreements and termination packages. This post first reviews when the preaudit requirements are triggered and how the preaudit process is performed. It then summarizes the applicability of the preaudit requirements to employee settlement agreements and employment agreements more broadly.
Triggering the Preaudit
The preaudit statute, G.S. 159-28(a), requires a finance officer, or a deputy finance officer who is specifically appointed by the board, to take certain steps before a unit may incur an obligation. An obligation is incurred when:
- a unit executes a legal contract that is budgeted for in the annual budget ordinance or a capital or grant project ordinance (A legal contract can take a variety of forms, including purchase orders, MOUs, MOAs, service agreements, employment agreements, interlocal agreements, and other arrangements representing a binding commitment of the parties.); AND
- the unit is obligated to pay money to another party by the terms of the contract; AND
- if the obligation is budgeted in the annual budget ordinance, the unit anticipates paying at least some of the money in the fiscal year in which the contract is entered into. (If the obligation is budgeted in a grant project ordinance or capital project ordinance this third criteria does not apply.)
All applicable criteria must be met to trigger the preaudit, but there is no dollar threshold. (The requirement applies equally to an obligation for $1 as an obligation for $1,000,000.) As detailed in previous posts, any legal contract requiring a local government or public authority (collectively local unit) to pay money to another party (including employment agreements) is subject to the statutory preaudit.
Preaudit Process
If the preaudit applies, G.S. 159-28(a) requires that before a unit may incur the obligation, the unit’s finance officer or a deputy finance officer specifically appointed by the board must:
- Check to see if there is an appropriation in the annual budget ordinance, or a project ordinance, for the amount that is expected to be paid during the current budget period (The budget period for the annual budget ordinance is the current fiscal year. The budget period for a grant or project ordinance, is the life of the grant or project.);
- Check to see if sufficient funds remain in the appropriation to cover the amount that is expected to be paid during the budget period;
- Affix and sign a preaudit certificate to any “writing” that evidences the legal contract, unless an exception applies. The “writing” can be hardcopy or digital. The preaudit certificate must state that “[t]his instrument has been preaudited in the manner required by the Local Government Budget and Fiscal Control Act.” (Although not legally required, it is smart practice to also date the certificate.)
There are a few exceptions to the third step (the signed preaudit certificate). First, no preaudit certificate is required if there is no “writing” evidencing the contract. It does not apply to oral contracts. Second, if the local unit maintains an accounting system that automatically performs the first two steps of the preaudit process, G.S. 159-28(a3)-(a4), and is certified by the Local Government Commission (LGC), then it does not need to affix a signed preaudit certificate on any legal contract. It is exempt from this third step completely. Third, the preaudit certificate requirement does not apply to any legal contract approved by the LGC. Fourth, no preaudit certificate is required on payroll expenditures. Finally, a preaudit certificate is not required for obligations incurred as an electronic transaction (via p-card, credit card, fuel card, etc.), as long as the local unit adopts a policy related to electronic transactions that complies with LGC regulations.
Consequences for Failure to Properly Preaudit
If the preaudit is not completed properly before the execution of the legal contract, the contract is void and, thus, unenforceable by either party. Whoever within the local unit executed the legal contract, or caused it to be executed, in violation of the preaudit requirement may be held personally liable by the governing board for the amounts committed, see G.S. 159-28(e), and may be criminally liable, pursuant to G.S. 159-181. So the consequences can be significant for failing to follow the statute.
Applicability of Preaudit Requirements to Employee Settlement Agreements
An employee settlement agreement is a legally binding contract that details an agreement between an employer and their employee that usually terminates the working relationship under the terms laid out. A settlement agreement will typically include a financial severance package for the employee, which is offered in return for ending the employment contract on a set date and the employee agreeing not to bring future legal claims against the employer.
The former Rural Hall town manager argued in the court of appeals that the preaudit statute did not apply to settlement agreements. She cited Lee v. Wake County, 165 NC App 154 (2004), as favorable precedent. In Lee, the court held that the preaudit statute did not apply to a preliminary settlement agreement in which both parties committed to draw up a final settlement agreement. According to the Lee court, the preliminary settlement agreement was a contract for specific performance, not a contract “requiring the payment of money or a purchase order,” therefore it did not trigger the preaudit requirement. The court rejected the former Rural Hall manager’s comparison to Lee because in this case the settlement agreement included a monetary payment to the former manager. And the payment was expected to be paid out during the current budget period. As such, it was clearly subject to the preaudit requirement because it met all the criteria. See also Cabarrus County v. Systel Business Equipment Co., Inc., 171 N.C. App. 423 (2005) (holding a settlement agreement invalid for lack of a signed preaudit certificate, where the agreement, on its face, mandated that the county pay a specified sum to the defendant). The court also rejected the former Rural Hall manager’s argument that she was entitled to equitable relief because the town acted in bad faith. Citing Data General Corp. v. County of Durham, 143 NC App 97 (2001), the court reaffirmed that “a party may not recover under contractual claims nor claims in equity concerning the same matter where the county has not entered a valid contract.”
Applicability of Preaudit Requirement to Employment Contracts and Termination Payments
The Rural Hall case involved the applicability of a preaudit in the context of an employment relationship, but it did not involve an employment contract. The preaudit requirement also applies to employment agreements, even at-will employment agreements, that commit the local unit to pay money (salary/wages) to the employee. And the requirement is triggered even if the total salary amount is not certain at the time the employee is hired. For example, in Transportation Services of North Carolina, Inc. v. Wake County Bd. of Educ., 198 N.C.App. 590, 680 S.E.2d 223 (2009), the court held that an employment agreement in which school board agreed to compensate a transportation services provider for services on a per-student-assigned basis was subject to preaudit requirement under analogous provision to G.S. 159-28. The preaudit will be done based on a reasonable estimate of the amount that will be expended during the budget period.
Most employment agreements span for more than one fiscal year. At-will employees continue to be employed until they resign, pass away, or are terminated. A preaudit is required when the employee is initially hired and the preaudit will encompass the amount expected to be paid during the remainder of the budget period in which the employee is hired. For example, if a town manager is hired on August 1 and the manager’s salary will be budgeted in the annual budget ordinance, the preaudit will be done based on the amount expected to be paid to the manger under the terms of the employment agreement from August through June, the budget period. But a new preaudit is not required in subsequent budget periods unless there is change in salary or other monetary terms to the agreement during the new budget period. (Note that a new preaudit is not necessary because G.S. 159-13 requires the governing board to appropriate funds in subsequent budget years to cover any amounts due under continuing employment agreements.)
How does the preaudit requirement apply to “golden parachutes” – termination clauses included (or added to) an existing employment agreement that trigger payments to the employee but only if/when the employee is terminated by the local unit under certain circumstances? The answer to this question is more complicated and depends on several factors. Let’s look at the two most likely scenarios.
In the first scenario, the town manager negotiates for a severance package when he is first employed. A provision is included in his initial employment agreement that sets out the amount of severance and the terms under which it will be triggered. The employment agreement includes the regular compensation amount and an additional amount that will be paid if and only if a termination occurs under specified circumstances. Assume that the manager’s salary is budgeted for in the annual budget ordinance. At the time the manager is hired, there is an expectation that the local unit will pay his regular compensation during the budget period, but there is likely no expectation that the town will pay the severance amount during that budget period. Because of that, a preaudit would be required for the regular compensation amount but not the severance amount.
In Myers v. Town of Plymouth, 135 N.C.App. 707, 522 S.E.2d 122 (1999), the town entered into an employment contract with the town manager in March 1997 (fiscal year 1996-97), whereby the manager agreed to work for the town for four years. Both the town and the manager reserved the right to terminate the employment relationship with thirty days’ notice. The contract provided the manager with a severance package if he was terminated by the town for any reason except felonious criminal conduct or a failure of performance which the manager failed to cure after appropriate notice. The following December (fiscal year 1997-98) a new town council was seated and within a few months the new council terminated the manager and refused to pay the severance package. The manager sued. Among other defenses, the town argued that the employment contract was void because it lacked a preaudit certificate in violation of G.S. 159-28. The court disagreed, holding that no preaudit was needed because it was highly improbable that the town would have been required to pay the severance package in the fiscal year in which the contract was signed.
Contrast that with a second scenario. When a town manager is hired, there is no severance package included as part of her employment agreement. The local unit preaudits the agreement based on the amount of salary expected to be paid to the manager during the budget year in which she is hired. A few years later, after a primary election reveals that the governing board’s composition is likely to change in December, the current board majority votes to modify the manager’s employment agreement to add a severance package. The board believes it is likely that the new board majority will terminate the manager shortly after they are sworn in. The board amends the employment agreement in July. The new board members will take office in December. In this scenario a preaudit likely is required on the amount of the severance package because there is a reasonable expectation that it will be paid during the budget year. That also means that the applicable budget appropriation must include sufficient funds to cover the amount of the severance package at the time the agreement is amended.
Thus, the key to determining whether an employment agreement (or amendment to an employment agreement) requires a preaudit boils down to whether there is a reasonable expectation of making the financial payments during the current budget period.