THE EMPLOYEE PARADOX

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THE EMPLOYEE PARADOX

• Thursday, May 21, 2009
• Presented by
• David C. Burton
• Sean M. Gibbons
• Michael C. Lord

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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.
• Lets look at an example.

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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.

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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 companys
  confidential financial information and pricing
  guidelines.

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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 Smiths new company.
  Two days ago Smiths 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.

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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.

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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.

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Duty of Loyalty (contd)

• 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.

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Duty of Loyalty (contd)

• 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.

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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.

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Exceptions

• En masse hiring recognized in North Carolina as
  an unfair trade practice in unique circumstances.
  
• In North Carolina, general rule is that
  employees 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.

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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.

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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.

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Non-Competes

• One size does not fit all.
• There is no form non-compete or
  non-solicitation.
• Dont copy old agreements because facts are
  always different.
• Need to balance terms, no magic duration or
  geographic scope.
• Dont be greedy.
• No perfect non-compete or non-solicitation.

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Standard of Reviewfor 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 individuals
  legitimate efforts to earn a livelihood?
• Is the restraint reasonable from a public policy
  standpoint?

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Standard of Reviewfor 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.

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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.

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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.

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Time, Geography, Activities

• Area in which the employer operated.
• Nature of the employers business.
• Nature of the employees duty and his knowledge
  of the employers 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.

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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.

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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.
• Dont overreach and include prospective
  clients.
• Like non-competes, need a duration.
• Also consider geographic scope issues.

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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
  employers right to restrict competition and the
  employees 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.

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Drafting Considerations

• Non-compete agreements should specifically
  restrict competition by an employee only in the
  branches or lines of the employers business in
  which the employee has performed work.
• Non-solicitation agreements should define
  client and employees.
• Choice of Law provisions. Dont automatically
  choose Virginia or North Carolina.

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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.

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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.

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New Employer ChecklistThings 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.

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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.

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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.

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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.

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Questions Answers

• David C. Burton
• 757.473.5354
• dburton_at_williamsmullen.com
• Sean M. Gibbons
• 804.783.6499
• sgibbons_at_williamsmullen.com
• Michael C. Lord
• 919.981.4093
• mlord_at_williamsmullen.com