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Going Out of Business Checklist

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									                           THE EMPLOYEE
                             PARADOX
                            Thursday, May 21, 2009

                          Presented by:
                          David C. Burton
                          Sean M. Gibbons
                          Michael C. Lord
 Williams Mullen 2009.
                          The Employee Paradox
                  • These are troubling economic times. As
                    businesses struggle to keep their heads above
                    water, they have to rely more and more on their
                    most successful and profitable employees.
                  • Unfortunately, these are the employees that can
                    do the most damage to an employer if they
                    become a competitor.
                  • Let’s look at an example.




 Williams Mullen 2009.                                               2
                          The Employee Paradox
            • Company A is a computer software design company
              that last year won a big contract with a fortune 100
              company. The contract was obtained by the Vice-
              President of Sales John Smith. Smith is the biggest
              rain maker at the Company and he is highly respected
              by many of the employees. Smith has no employment
              contract and has threatened many times, usually when
              his yearly raise is discussed, to leave the company
              and take all of his friends with him. This year the
              company has asked Smith to sign an employment
              contract that contains numerous restrictive covenants.
              Negotiations have not gone well and a week ago
              Smith resigned his employment.
 Williams Mullen 2009.                                                3
                           The Employee Paradox
                      The day after Smith left, the president of the
                      company, Jim Milktoast, arrives at work to find
                      that Smith has cleaned out his office, including the
                      files on which he was negotiating potential sales
                      to several braches of the federal government and
                      the military, and has made a copy of his computer
                      hard drive, because “it contained his personal
                      photo library, iTunes library, and checking
                      account information.” Of course the computer also
                      contained all of the company’s confidential
                      financial information and pricing guidelines.


 Williams Mullen 2009.                                                      4
                          The Employee Paradox
                      Three days later Milktoast learns that Smith has
                      started up a branch office for a competitor right
                      down the street in an office space Company A
                      had been negotiating to take over. Suddenly,
                      many of the employees that Smith brought to
                      Company A resign to take jobs with Smith’s new
                      company. Two days ago Smith’s clients start
                      calling Milktoast stating they are moving their
                      business to Smith because “Company A no longer
                      has the ability to service them and the rumor on
                      the street is that the company is going out of
                      business.”

 Williams Mullen 2009.                                                   5
                          The Employee Paradox

                      Milktoast thinks to himself, “Too bad I never got
                      the employment agreement with Smith.” Despite
                      not having an employment agreement with
                      restrictive covenants, the company still has many
                      protections. First we will focus on the law of
                      fiduciary duty/duty of loyalty.




 Williams Mullen 2009.                                                   6
                                Duty of Loyalty

                      Every employee owes his/her employer a
                      duty of loyalty. This duty requires that
                      while employed an employee:
                  • Owes his/her employer an undivided duty of
                    loyalty.
                  • Should be careful to avoid taking any actions that
                    are not in the best interests of his/her employer.




 Williams Mullen 2009.                                                  7
                               Duty of Loyalty (cont’d)

                  • Does this mean that employees cannot moonlight.
                          – State law immunizing employees from discipline
                            while engaged in lawful activities “off the clock.”
                  • Officers and directors of a company owe an even
                    greater duty of loyalty.




 Williams Mullen 2009.                                                           8
                          Duty of Loyalty (cont’d)
                  • The second component of loyalty is that an
                    employee is prohibited from engaging in self-
                    dealing and diverting or usurping opportunities
                    that belong to his/her employer. Employees may
                    not solicit clients of their employer while still
                    employed by their employer.
                     – This duty ends with employment unless the
                       employee has violated his duty while employed
                       or entered into an enforceable contract
                       prohibiting post-employment competition.



 Williams Mullen 2009.                                                 9
                                       Exceptions
              • Virginia does permit employees to prepare to
                compete while still employed as long as the following
                criteria are met:
                 – The preparation occurs during non-working hours.
                 – The employee does not solicit co-workers to take
                    actions to leave the company through a process of
                    mass resignations.
                 – No proprietary or confidential information is taken or
                    used to benefit the employee or the new employer.
                          • The fiduciary duty continues to be owed after an
                            employee starts a new business or joins a new
                            company.

 Williams Mullen 2009.                                                        10
                                         Exceptions
                  • En masse hiring recognized in North Carolina as
                    an unfair trade practice in unique circumstances.
                  • In North Carolina, general rule is that employee’s
                    breach of loyalty does not entitle the employer to
                    sue. Instead, the misconduct provides the
                    employer with justification to end the employment
                    relationship and a defense against a claim of
                    wrongful discharge.
                          – A breach-of-loyalty claim, however, will lie against
                            those few employees who can literally control the
                            company.


 Williams Mullen 2009.                                                            11
                                  Documents
                  • Documents are deemed confidential if they
                    contain:
                     – Information designated in some way as
                       confidential by the employer; or
                     – Information that a reasonable employee should
                       know that his/her employer does not want
                       disclosed.




 Williams Mullen 2009.                                                12
                              Restrictive Covenants
                  Can protect the employer from:
                          • Direct competition from former employees.
                          • Former employees’ solicitation of clients and
                            employees.
                          • Former employees’ use of confidential
                            information.




 Williams Mullen 2009.                                                     13
                                 Non-Competes
                  • One size does not fit all.
                  • There is no “form” non-compete or non-solicitation.
                  • Don’t “copy” old agreements because facts are
                    always different.
                  • Need to balance terms, no magic duration or
                    geographic scope.
                  • Don’t be greedy.
                  • No “perfect” non-compete or non-solicitation.



 Williams Mullen 2009.                                                   14
                            Standard of Review
                             for Non-Competes
                  Three-part Balancing Test:
                  • Is the restraint, from the standpoint of the
                    employer, reasonable in the sense that it is not
                    greater than necessary to protect the employer in
                    some legitimate business interest?
                  • Is the restraint, from the standpoint of the
                    employee, reasonable in the sense that it is not
                    unduly harsh in curtailing individual’s legitimate
                    efforts to earn a livelihood?
                  • Is the restraint reasonable from a public policy
                    standpoint?
 Williams Mullen 2009.                                                  15
                             Standard of Review
                              for Non-Competes
                   Five-part Test in North Carolina. Covenant must be:
                   • In writing.
                   • Made part of the employment contract.
                   • Based on valuable consideration.
                   • Reasonable as to time, territory and post-
                     employment activities in light of the legitimate
                     business interests to be protected.
                   • Consistent with public policy.



 Williams Mullen 2009.                                                  16
                          Time, Geography, Activities
                  • Generally, courts will examine three factors.
                  • Time: the duration of the restraint.
                  • Geography: the geographic scope of the restraint.
                  • Scope: the activity being restricted.
                  • It is important to note that these elements are
                    always balanced and weighed against each other
                    in light of the facts of each case.




 Williams Mullen 2009.                                                 17
                          Time, Geography, Activities
         • What is reasonable amount of time to restrict an
           employee from competing with his former employer?
                –     There is no magic number.
         • What is a reasonable geographic scope of a restricted
           covenant?
                – Several factors impact the analysis of a geographic
                  limitation, including the:
                       Area or scope of the restriction.
                       Area assigned to the employee prior to termination.
                       Area the employee actually worked.

 Williams Mullen 2009.                                                       18
                          Time, Geography, Activities
                       Area in which the employer operated.
                       Nature of the employer’s business.
                       Nature of the employee’s duty and his knowledge of the
                        employer’s business operations.
                – Thus, It is important for you to have a good
                  understanding of your actual marketplace when
                  considering a reasonable geographic scope.
                  Practically, this is the easiest place for a court to
                  shoot down the restrictive covenant.




 Williams Mullen 2009.                                                      19
                          Time, Geography, Activities
                  • What activities are reasonably restricted?
                          – Companies must narrowly tailor the activities
                            that they are attempting to prohibit. The
                            restricted activities prong has become a very
                            popular prong to attack, not only based on the
                            duties of the employee, but also based on the
                            specific services provided by the company.
                          – “Janitor defense.”




 Williams Mullen 2009.                                                      20
                          Non-Solicitation Agreements
                  • Judges more inclined to enforce.
                  • Still, you must make sure they are narrowly
                    tailored.
                  • Defining who a “client” is helps.
                          – Someone who paid you, etc.
                          – Provide some temporal scope, i.e. be careful to
                            include someone that last paid you for services in
                            2003 in the definition of “client.”
                  • Don’t overreach and include “prospective clients.”
                  • Like non-competes, need a duration.
                  • Also consider geographic scope issues.

 Williams Mullen 2009.                                                          21
                             Drafting Considerations
                  • Strictly construed against employers.
                          – Virginia courts have been unwilling to modify terms
                            of an overly broad non-compete to make it
                            enforceable.
                          – North Carolina judges wield a limited blue pencil.
                  • Agreements must be carefully drafted to
                    accurately reflect the balance between the
                    employer’s right to restrict competition and the
                    employee’s right to earn a livelihood. It is
                    important to ask what legitimate interests the
                    agreement is designed to protect, and if none,
                    perhaps consider not entering into the agreement.
 Williams Mullen 2009.                                                           22
                          Drafting Considerations
                  • Non-compete agreements should specifically
                    restrict competition by an employee only in the
                    branches or lines of the employer’s business in
                    which the employee has performed work.
                  • Non-solicitation agreements should define “client”
                    and “employees.”
                  • Choice of Law provisions. Don’t automatically
                    choose Virginia or North Carolina.




 Williams Mullen 2009.                                                  23
                          Drafting Considerations
                  • Check for state statues on restrictive covenants
                    (California, Colorado, Florida) that may make
                    them unenforceable.
                  • Check state law on “blue-penciling.”
                  • You may want to include a “forum selection”
                    clause.
                  • Be careful about consideration. Continued
                    employment provides adequate consideration in
                    Virginia but not North Carolina.
                  • If you use “continued employment” you better
                    mean it.

 Williams Mullen 2009.                                                24
                          Drafting Considerations
                  • Consider using non-solicitation, anti-raiding, and
                    confidentiality provisions without the need for non-
                    competes.
                  • If possible, include language that the non-
                    compete clause is not intended to restrict the
                    employee from performing work in some role that
                    does not compete with the business of the
                    employer.




 Williams Mullen 2009.                                                    25
                          New Employer Checklist
         Things to consider when you are hiring someone:

                  • Ask candidate if they have any agreements with
                    current employer. If they do, have agreements
                    reviewed by counsel.
                  • Be sure that the departing employee has not
                    made plans with other employees to bring them
                    along.
                  • If possible, avoid communicating with candidate
                    via e-mail. In light of electronic discovery
                    obligations, nearly all e-mails will be reviewed by
                    the other side.


 Williams Mullen 2009.                                                   26
                          New Employer Checklist
                  • Do not ask candidate for confidential salaries
                    and/or pricing information of current employer.
                  • Confirm that candidate has not disclosed any
                    confidential information of current employer and
                    inform candidate that you have no interest in such
                    information.
                  • Do not ask candidate to copy or take anything
                    from current employer.
                  • Avoid discussions about which clients and/or
                    employees would leave current employer.



 Williams Mullen 2009.                                                  27
                          New Employer Checklist
                  • You should not discuss when or how they should
                    resign. But, you can discuss when you would like
                    them to start.
                  • Do not have candidate perform any services for
                    you until actual employment begins.
                  • Do not encourage candidate to solicit any
                    customers or other employees prior to leaving
                    their current employer.




 Williams Mullen 2009.                                                28
                          New Employer Checklist
                  • Send out announcements after employee begins
                    working.
                  • Do not suggest or encourage that candidate
                    should divert any work to us until after start date.
                  • Obtain acknowledgement that the new employees
                    have not disclosed any confidential information
                    from their former employer to us and that new
                    employee will not violate enforceable terms of any
                    contract.




 Williams Mullen 2009.                                                    29
                          Questions & Answers
                  David C. Burton
                     757.473.5354
                     dburton@williamsmullen.com

                  Sean M. Gibbons
                     804.783.6499
                     sgibbons@williamsmullen.com

                  Michael C. Lord
                     919.981.4093
                     mlord@williamsmullen.com



 Williams Mullen 2009.                            30

								
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