PUBLISHED ARTICLES

No-Fault Divorce: Employment pre-nups save a lot of heartache when your best workers bat their eyes at other suitors.

Leader's Edge, October 2007

Fast Focus

• Employment contracts are critical to protecting your agency's most important assets.
• Courts won't uphold agreements that overreach the bounds of reason, so be specific about what you want to protect and how you plan to do it.

Is it time to tie the knot with a new employee? If you think all that's necessary is reading between the lines of the resume and assessing the person's handshake, you might be missing an essential part of the process. And what you don't do may come back to bite you as surely as a spider who's taken up residence in a seldom-used pair of shoes.

Contracts over critical employment matters-such as employment agreements, non-competes and non-solicitation agreements-are becoming as common as the tycoon's lawyers drafting a prenuptial before he walks his fourth wife down the aisle. In the world of mergers and acquisitions, these documents have become the reality of business relationships. And yet, like the bachelor who never learned how to boil water, many agency owners are clueless about these critical employee matters.

In more than two decades of consulting with agencies on business strategies and M&A work, I have found more and more need to counsel clients on the use of these contracts. While negotiating these matters is often very difficult, most sellers today understand it is a necessary part of the overall transaction. When money is on the table, people tend to take these things seriously. However, outside of the M&A world, it still shocks me that many agency owners either do not use such agreements, or worse, they use them but they have no idea what the agreements really say and whether they really protect the agency.

Do We Have To?

The first question to ask yourself is whether you need an employment agreement for that new hire. Although the contracts have been part of the standard producer package for quite a while, very few agencies used them for general business purposes even five years ago. Now the trend is to push these agreements into the employment discussion with people much farther down the ladder, to cover not only management and producers, but also key client-centric employees, such as account executives, account managers and sometimes customer service representatives.

From the 30,000-foot overview, it is obvious that business has shifted as the country has moved from a manufacturing to a service economy. In our brave new world of information, our customer lists, industry knowledge and business know-how have become our most valuable assets. We can't afford to let our people scurry over to a competitor with an open set of our company's tangible and intangible assets.

So how do you make sure your information assets remain protected? Let's start with the basics of an employment agreement and why you should utilize it at various levels within your agency. The benefits include:

• A defense against claims of wrongful termination, by clearly stating at-will employment;
• Protection of the agency's confidential information, by including a confidentiality agreement;
• Protection of the agency against competition from its clients and employees, by including a non-compete and/or non-solicitation provision; and
• An arbitration clause, which lowers the risk of expensive litigation.

Define Your Terms

I am often amazed by the lack of understanding agency owners exhibit regarding an agreement's legal definitions and ramifications. I know. We don't even read the cereal box, much less the language of a serious legal contract. But this business pre-nup really will lay each party's future fortunes on the line, so it is important to pay attention. Let's keep it simple and define some basic terms.

Employment agreement. This typically outlines the agreement between the agency and employee regarding salary, commissions, incentive arrangements, vacations, benefits and termination provisions. An EA can have many parts, and it might also include a confidentiality agreement, a non-compete agreement and a non-solicitation agreement. Most agency owners believe that an employment agreement stipulates a length of time and guaranteed salary. This may be correct, but again, the true power of it is in the details. A good agreement will also clearly state that employment is at-will. That means, generally, that an employee can be fired at any time for no reason or for any reason, with two exceptions: discrimination and contract.

Confidentiality agreement. This typically stipulates that an employee cannot disclose any proprietary agency information, such as customer lists or trade secrets, to any party during employment or after termination.

Non-compete agreement. Sometimes called a restrictive covenant, this prevents employees from competing with their employer after employment for a limited time period and limited geographic area.

Non-solicitation agreement. Generally this will include two provisions: non-solicitation of clients and prospective clients for a time period after the employee leaves and non-solicitation of employees, which serves to prevent a former employee, or the new employer, from attempting to hire away other employees of your firm.

Structuring Good Agreements

By now, most of you are thinking this is old hat. Everybody has these agreements. The bad news: Many of you do not. Even worse news: Many of you really do not know what is in your agreement if you have one. Either you asked your buddy for a copy of his and did some minor tweaks, found some simplistic downloadable agreements from a basic online search, or took some other ill-advised shortcut to draft the documents. I repeat: The odds are that you are not adequately protected. I see it every week, year after year. Poorly written documents are the norm.

To create a truly good agreement, start from the basics. It is worth the money to have an attorney involved in the drafting. But that is just the beginning. More important is that you, as the agency owner or manager, must guide the attorney to include the specific contractual elements you need.

The agreement should start by describing the employee's position at the firm, and the salary, commission and all other compensation or employee benefits. It should specify the time-period of the agreement. It also should state whether termination can be done by either party at will, or whether the employee may only be terminated for cause. If your contract stipulates the latter, that means you cannot fire the employee during the time-period of the contract unless there is a specific cause, such as dishonesty, conviction of a felony, loss of the insurance license, etc.

A confidentiality agreement should include some particulars regarding your agency. Make sure your agreement lists the items that the agency wants to protect. Examples include trade secrets, client and prospect lists, proprietary technology, proposals and other information-both tangible and intangible-that you would not want your competitor to have.

State that by signing the agreement, the person agrees not to disclose this information at any time. Also state the legal ramifications of violating the agreement.

Your non-compete agreement must comply with applicable laws, which differ from state to state. In places such as California, non-competes are not enforceable unless the person signing is a shareholder of the agency. Many state courts will not even uphold a non-compete for a professional employee. If you are considering a non-compete agreement, and it is not for a shareholder of your agency, discuss it with your attorney first. However, while I am not an attorney, some states allow the language of a non-compete to stand as long as it is reasonable and is drafted to protect the interests of the business. Let's assume a non-compete is enforceable in your state and continue here.

Non-competes need to include a time limit. Generally, if it's being drafted as part of an M&A agreement, that period will be five years. If it's just drafted for a going concern as part of the day-to-day business, the time period is generally one to two years.

Non-competes also must include a geographic scope, which needs to be tied to where your agency conducts business. One word of caution: Even if your agency provides services on a national basis, your non-compete probably cannot specify the entire U.S. as its scope without some carve-outs. Some agency owners argue for making the provisions as sweeping as possible, then seeing what happens if the contract ever gets tested. But I counsel people to be cautious and not to get greedy, as courts generally try to look at matters from the employee's standpoint.

The non-compete needs to spell out specifically what activities will be restricted, and this also needs to be a reasonable list. If a producer wants to leave and go to work for another firm in a position that doesn't deal directly with clients (e.g., marketing), the agreement should probably not restrict that. Most courts would not allow a non-compete to be enforced under those conditions.

Finally, the non-compete must indicate that the breach of the contract could cause irreparable harm to the agency and that, if a court finds the contract unreasonable, the agency has the right to rectify the agreement in order to make it reasonable and enforceable.

Many of the same key points about a non-compete are also true for a non-solicitation agreement. For instance, this must stipulate a reasonable time period, which typically is one to two years post-employment.

As with the non-compete, the non-solicitation agreement notes that a breach could cause irreparable harm to your business. However, a trend just developing is that the non-solicitation spells out specific monetary rewards for a breach, as well as giving the employer the right to go to court to obtain enforcement. For example, the non-solicitation may state that, in a case where there is a breach of the provision related to clients, the penalty would be 200% to 300% of the annual commission revenue generated by that client. This provision would be in addition to whatever the court may reward the employer. Such a clause generally makes future employers very cautious about allowing their new producer to solicit former clients.

Will It Hold Up?

I'm often asked whether these agreements are enforceable. The answer varies by state, and there is no template that will make a non-compete or these other agreements bulletproof. However, there are some basic legal points that, if followed, will enhance the likelihood that a judge will smile upon your petition and view the contract as valid.

Because courts view the facts of each agreement on a case-by-case basis, it is imperative that yours be reasonable and precise. The first test is often the length of the restriction for such things as the non-compete, then the judge will look at the geographic coverage and what business elements are restricted by the covenants.

Furthermore, the court wants to see what you're restricting the employee from doing. In this regard, I often advise clients that "less is more." When drafting an agreement, don't go overboard in your zeal to prove dominance over your peons. Simply identify, very specifically, what company assets you are trying to protect, and then base the language of the contract on reasonable steps that would provide that protection.

Since a major concern is loss of clients due to one of your producers leaving and wooing the clients away, write your non-compete to specifically prohibit this possibility. Courts generally rule the contract enforceable in such situations because there is an obvious connection between the producer and your client. In essence, the goodwill associated with the relationship belongs to the agency, even if it was the producer who maintained the relationship and, in fact, even may have initiated it. The agency should be allowed sufficient time to bring in a new producer to maintain that relationship. This is where the time period of the non-solicitation agreement is critical, and courts will evaluate whether your contract's time restrictions are reasonable to protect the business assets.

Part of being reasonable in creating, signing and trying to enforce employee agreements is to understand the old adage that "you don't get anything for free." Certainly that is applicable here. Any employment, non-compete or non-solicitation agreement must be supported by sufficient consideration. In this arena also there is no standard, guaranteed-to-succeed answer to what is deemed sufficient consideration. The laws vary from state to state. There is one overriding rule: You must inform potential employees that they will be subject to a non-compete or non-solicitation before they become employed. You must make it clear that signing those agreements is a condition of employment. Then, your offer of employment is deemed adequate consideration. This does not mean that you cannot require an employee to sign an agreement after employment, but if you do, you should expect to pay them consideration.

The employee agreement, like a pre-nup, is essentially good, old-fashioned anti-golddigger insurance. When you bring someone into the fold, you want to be able to trust them. But it's wise to have that signed piece of paper safely tucked away, just in case the marriage ever hits the skids.