EXHIBIT 10.31 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT ("Agreement") is made as of January 4, 2005 and shall be deemed effective as of November 29, 2004 between TEMECULA VALLEY BANK, N.A., a national banking association ("Bank") and WILLIAM H. McGAUGHEY ("Executive"). R E C I T A L Bank desires that Executive be employed as Executive Vice President/Chief Operating Officer of Bank and Executive desires to be so employed subject to the terms and conditions herein stated. NOW, THEREFORE, in consideration of the mutual covenants and agreements contained herein, and other good and valuable consideration, the parties agree as follows: 1. TERM OF EMPLOYMENT. 1.1. Term. Bank hereby agrees to employ Executive, and Executive hereby accepts employment with Bank, for the period ("Term") commencing November 29, 2004 ("Commencement Date"), and terminating on such date and upon such terms as provided for in Section 4 hereof. 2. DUTIES OF EXECUTIVE. 2.1. Duties. Executive shall perform the duties of Executive Vice President/Chief Operating Officer of Bank, as assigned by Bank's Chief Executive Officer, subject to the powers by law vested in the Board of Directors of Bank and in Bank's Shareholder. During the Term, Executive shall perform the services herein contemplated to be performed by Executive with due care faithfully, diligently, to the best of Executive's ability and in compliance with all applicable laws and Bank's Articles of Association and Bylaws. 2.2. Exclusivity. Executive shall devote substantially all of Executive's productive time, ability and attention to the business of Bank during the Term. Executive shall not directly or indirectly render any services of a business, commercial or professional nature to any other person, firm or corporation for compensation without prior consent evidenced by a resolution duly adopted by the Board of Directors of Bank, or the Executive Committee thereof. Notwithstanding the foregoing, Executive may (i) make investments of a passive nature in any business or venture; and (ii) serve in any capacity in civic, charitable or social organizations, provided, however, that such investments or services shall not be in competition, directly or indirectly, in any manner with Bank. 1 3. COMPENSATION AND BENEFITS. 3.1. Salary. For Executive's services hereunder, Bank shall pay, or cause to be paid, as annual gross base salary, to Executive $200,000 during the Term ("Base Salary"), beginning with the Commencement Date, payable in equal installments in accordance with Bank's normal payroll periods as in effect from time to time. The Board of Directors shall also, from time to time, and at least once each calendar year grant such additional "merit" increases, if any, in, the Base Salary as are determined after review to be appropriate in the discretion of the Board of Directors. 3.2. Bonus. (a) For each year within the Term, Executive shall be entitled to an annual Incentive Bonus, determined in accordance with this Section, if the Threshold Test is met. The Threshold Test shall be deemed to have been met if: (i) Bank's regular outside independent loan reviewer gives a favorable review of the overall SBA loan quality of the Bank; and (ii) the latest report of supervisory activity relative to Bank issued by the Bank's principal bank regulator rates Bank operations no less than satisfactory. The annual Incentive Bonus shall be the greater of: $100,000, or one and one-half percent (1.5%) of the pre-tax profits of Bank. The Incentive Bonus shall be payable in January of the year following completion of the year on which its is based, or as soon thereafter as is practical after Bank's certified public accountants have delivered their report on Bank's condition and results of operations for the year. (b) As a signing bonus, Executive shall receive $15,000 per month, for five months ($75,000 in the aggregate), payable for the first time on January 1, 2005 and on the first of each of the next four successive calendar months. 3.3. Vacation. Executive shall be entitled to 20 days of vacation leave each year of the Term accruing in accordance with Bank policy, of which eight consecutive working days must be taken in each calendar year ("Mandatory Vacation"). Any vacation not used in excess of the Mandatory Vacation shall not accumulate but at the end of each year of the Term, Executive shall be entitled to vacation pay in lieu of vacation. 3.4. Equipment. Bank shall provide for Executive's use an automobile, the selection of which shall be within the discretion of the Chief Executive Officer. Bank shall pay all the expenses (including, but not limited to, maintenance, fuel, insurance, registration) related to such automobile during the Term. Bank shall also provide Executive with a cellular phone for Executive's reasonable use in the performance of his duties hereunder. Bank shall pay all reasonable expenses in connection with the business use of such cellular phone. 2 3.5. Group Medical and Other Benefits. Bank shall provide for Executive, at Bank's expense, participation in the medical and other benefit plans offered to other similarly titled employees of Bank, commencing on the first day of the month following Executive's start date. Bank will reimburse Executive for any COBRA costs incurred in maintaining insurance coverage between the Commencement Date and the effective date of coverage under the Bank's medical and other benefit plans. Executive will become eligible to participate in Bank's 401(k) Plan on the first day of the month following the 90th day after the Commencement Date. Executive will also be eligible to participate in an Executive deferred compensation plan and a salary continuation program, on terms agreeable to Bank and Executive. 3.6. Sick Leave. Executive shall be entitled to sick leave in accordance with Bank's personnel policy. Accrued sick leave may not be carried over from prior periods and Executive shall not be entitled to be paid in lieu thereof. 3.7. Stock Options. As soon as practicable after the Commencement Date, Executive shall receive an incentive stock option under the Temecula Valley Bancorp Inc. ("Company") 2004 Stock Incentive Plan which will entitle Executive, upon vesting, to purchase up to an aggregate of 20,000 shares of the Company's common stock. 3.8. Relocation Expenses. Bank shall pay for all of Executive's reasonable relocation expenses from Truckee, California to the Temecula, California area. 3.9. Interim Living Expenses. Bank shall pay for all of Executive's temporary, reasonable, housing expenses in the Temecula, California area until the first to occur of: (i) June 1, 2005, or (ii) the date Executive permanently moves his residence to the Temecula, California area. 3.10. Salary Continuation Plan. Subject to Executive's successful passing of a required physical examination and insurability, as determined by Bank and Bank's insurance provider, Executive shall receive a salary continuation plan that provides, during the Term, an annual $100,000 benefit when Executive reaches the age of 65 for up to 15 years. 4. TERMINATION. 4.1. Termination With Cause. Except as otherwise provided herein, this Agreement may be terminated by Bank, at Bank's option with notice to Executive, upon the occurrence of any of the following events: (a) A material breach by Executive of any of the express terms or provisions of this Agreement; (b) Executive is charged with illegal activity or pleads guilty to or nolo contendere to, illegal activity; 3 (c) Executive has committed any illegal or dishonest act which would cause termination of coverage under Bank's Bankers Blanket Bond as to Executive or termination of coverage as to Bank as a whole; (d) Executive fails to perform or neglects Executive's duties or commits an act of malfeasance or misfeasance in connection therewith; (e) Executive becomes permanently disabled, as determined in good faith by the Board of Directors; (f) The Comptroller of the Currency, or any other regulatory agency having jurisdiction, requests Executive's dismissal or removal, issues a notice of suspension or removal, finally removes, or suspends Executive from office; (g) The Comptroller of the Currency or other supervisory or regulatory authority having jurisdiction takes possession of the property and business of Bank; or (h) The death of the Executive. 4.2. Termination Without Cause. During the Term, subject to provisions specifically intended to survive termination, this Agreement may be terminated by either party without cause upon written notice to the other. 4.3. Compensation Upon Termination. If Executive's employment is terminated by Bank pursuant to Section 4.1 above, or by Executive pursuant to Section 4.2, Executive shall then only be entitled to receive his Base Salary through the effective date of such termination. If Executive's employment is terminated by Bank pursuant to Section 4.2 or within six months before or after a Change of Control, as defined in Section 4.4, subject to any limitations on payments under applicable federal or state law, Executive shall be entitled to the same amount as if the termination had been pursuant to Section 4.1, plus a Severance Payment in an amount equal to Executive's Base Salary (as in effect immediately prior to termination) for the severance period, which shall, for this purpose, be twelve months from the effective date of termination, payable over twelve months, in equal installments, in accordance with the Bank's normal payroll practices. 4.4. Vesting of Options Upon Change of Control. Executive's option agreements covering Company stock options to be issued to him, from time to time, shall provide that in the event of a Change of Control (as defined below), all options shall vest immediately prior to any Change of Control. "Change of Control" means: (a) more than 50% of the Company's voting stock is transferred to a person or entity that is not, prior to the transaction, a Bank "Affiliate," as that term is defined in 12 U.S.C. Section 371c or (b) a merger, consolidation or other transaction or series of transactions pursuant to which Company's shareholders prior to such transaction or series of transactions own less than 50% of the voting control of the resulting entity after such transaction. 4 4.5. Other Employment. In the event of termination of Executive under Section 4.2 and payment by Bank of the Severance Payment under Section 4.3, Executive agrees not to seek or accept employment in the banking industry for performance of services within a 25 mile radius of every location Bank maintains an office for a period of six months from the effective date of termination. If Executive chooses to accept such employment, he shall not be entitled to the Severance Payment and to the extent paid, shall be repaid immediately to Bank. 5. GENERAL PROVISIONS. 5.1. Ownership of Books and Records; Confidentiality. (a) All records or copies thereof of the accounts of customers, and any other records and books relating in any manner whatsoever to Bank customers, and all other files, books and records and other materials owned by Bank or used by it in connection with the conduct of its business, whether prepared by Executive or otherwise coming into his possession, shall be the exclusive property of Bank regardless of who actually prepared the original material, book or record. All such books and records and other materials, together with all copies thereof, shall be immediately returned to Bank by Executive on any termination of his employment; and (b) During the Term, Executive will have access to and become acquainted with what Executive and Bank acknowledge are trade secrets, to wit, knowledge or data concerning Bank, including its operations and business, and the identity of Bank customers, including knowledge of their financial condition, their financial needs, as well as their methods of doing business. Executive shall not disclose any of the aforesaid trade secrets, directly or indirectly, or use them in any way, either during the Term or thereafter, except as required in the course of Executive's employment with Bank. Executive shall not solicit any Bank employee or Bank customer to become an employee or customer of another institution until six months following his termination of employment. 5.2. Assignment and Modification. This Agreement, and the rights and duties hereunder, may not be assigned by Executive. 5.3. Notices. All notices required or permitted hereunder shall be in writing and shall be delivered in person, sent by courier, by facsimile or certified or registered mail, return receipt requested, postage prepaid as follows: To Bank: Temecula Valley Bank, N.A. 27710 Jefferson Drive, Suite A100 Temecula, California 92590 Attn: Stephen H. Wacknitz, President / Chief Executive Officer Facsimile: (909) 694-9194 5 With a copy to: Stephanie E. Allen, Esq. McAndrews, Allen & Matson 2040 Main Street, 14th Floor Irvine, CA 92614 Facsimile: (949) 955-3723 or to such other party or address as either of the parties may designate in a written notice served upon the other party in the manner provided herein. All notices required or permitted hereunder shall be deemed duly given and received on the date received if delivered in person, by courier or by facsimile, or on the third day next succeeding the date of mailing if sent by certified or registered mail, postage prepaid. 5.4. Successors. This Agreement shall be binding upon, and shall inure to the benefit of, the successors and assigns of the parties. 5.5. Entire Agreement. Except as provided herein, this Agreement constitutes the entire agreement between the parties, and all prior negotiations, representations, or agreements between the parties, whether oral or written, are merged into this Agreement. This Agreement may only be modified by an agreement in writing executed by both of the parties hereto. 5.6. Governing Law. This Agreement shall be construed in accordance with the laws of the State of California. 5.7. Executed Counterparts. This Agreement may be executed in one or more counterparts, all of which together shall constitute a single agreement and each of which shall be an original for all purposes. 5.8. Section Headings. The various section headings are inserted for convenience of reference only and shall not affect the meaning or interpretation of this Agreement or any section hereof. 5.9. Calendar Days/Close of Business. Unless the context so requires, all periods terminating on a given day, period of days or date shall terminate on the close of business on that day or date and references to "days" shall refer to calendar days. 5.10. Severability. In the event that any of the provisions, or portions thereof, of this Agreement are held to be unenforceable or invalid by any court of competent jurisdiction, the validity and enforceability of the remaining provisions or portions hereof, shall not be affected thereby. 6 5.11. Attorneys' Fees. In the event that any party shall bring an action or arbitration in connection with the performance, breach or interpretation hereof, then the prevailing party in such action as determined by the court or other body having jurisdiction shall be entitled to recover from the losing party in such action, as determined by the court or other body having jurisdiction, all reasonable costs and expenses of litigation or arbitration, including reasonable attorneys' fees, court costs, costs of investigation and other costs reasonably related to such proceeding, in such amounts as may be determined in the discretion of the court or other body having jurisdiction. 5.12. Rules of Construction. The parties hereby agree that the normal rule of construction, which requires the court to resolve any ambiguities against the drafting party, shall not apply in interpreting this Agreement. This Agreement has been reviewed by each party and counsel for each party and shall be construed and interpreted according to the ordinary meaning of the words used so as to fairly accomplish the purposes and intentions of all parties hereto. Each provision of this Agreement shall be interpreted in a manner to be effective and valid under applicable law, but if any provision shall be prohibited or ruled invalid under applicable law, the validity, legality and enforceability of the remaining provisions shall not, except as otherwise required by law, be affected or impaired as a result of such prohibition or ruling. IN WITNESS WHEREOF, this Agreement is executed as of the date first above written. Bank: TEMECULA VALLEY BANK, N.A. By: /s/ Stephen H. Wacknitz President and Chief Executive Officer Executive: /s/ William H. McGaughey 7