One of the trickiest issues we deal with in business control disputes relates to the impact and management of personal guaranties on the part of the individual shareholders/members.  A personal guaranty can be an impediment to a transaction among the shareholders consolidating ownership, an impediment to the withdrawal of a shareholder/member, or even a trigger of default under the terms of financing agreements in place between a business and its bank.  Managing the impact and expectations of business owners as to a personal guaranty should be considered in the early stages of any potential transaction.

In nearly every small business banking relationship, the bank requires personal guaranties on the part of business owners.  Personal guaranties, often even the more overbearing “spousal” personal guaranties, are the norm.  Of course, the purpose from the bank’s perspective is to increase the level of security against repayment.  The individual terms of the personal guaranty are governed by the language of the agreements. 

The net effect of a personal guaranty is to, in effect, pierce the corporate veil and render the guarantor liable for the debt to the bank (or other creditor party to the guaranty agreement).  In this way, not only does the bank obtain another source from which it can recover, but also dramatically impacts its practical bargaining power.     Often we see shareholder agreements including and incorporating indemnification provisions which reference those situations in which a shareholder/member has guarantied an obligation to a lender.  The value of such indemnification provisions is suspect given that the bank is always going to look to the path of least resistance to recover the extent of its obligation.  In a guaranty the company is the primary obligor to the creditor.  It is the primary obligor’s default which leads to exposure under a personal guaranty.  In that instance, the company is not likely in a position to indemnify as its assets are likely devoted to the repayment of the primary guarantied obligation.

The best and most frequent approach to a personal guaranty in a business control dispute is to secure the release of the guaranty by the bank or other creditor as part of the transaction.  Certainly, if the debt is retired in a third party sale, accounts are closed and the issue is moot.   Not necessarily so in an ownership consolidation transaction involving a transfer among existing owners or members, or where one or more shareholders/members leaves the business.  In that case, the business may continue and banking relationships may remain unmodified.  The bank is not required to release the guaranty.  Even further, under certain circumstances and agreements, a transaction may constitute an event of default of the credit arrangement.  Management of the personal guaranty becomes an important part of the deal.

It is obviously always better to secure a release of a guaranty contemporaneous with a transaction.  If that course of action is unavailable, indemnity is the only other option.  In such cases, indemnification should flow from both the company and individuals as, if the guaranty is ever an issue, it is likely the Company’s ability to pay in the first place, which gives rise to creditor’s pursuit of the guarantor.    

Elaine Yandrisevits, an associate in Antheil Maslow & MacMinn’s Estates and Trusts practice group, will participate as faculty on March 28th at a Pennsylvania Bar Institute continuing education program in Philadelphia, with simulcast at various locations. This basic to intermediate level program will teach the essential procedures for closing an Pennsylvania estate including: the advantages and disadvantages of the methods used to close an estate, steps involved in a Formal Court Accounting and Audit, Family Settlement Agreements and Receipts and Releases.  To register visit www.pbi.org/meetings

Course Content

Examine Each Step of a Formal Court Accounting and the Audit Process

•  Learn the statutory requirements for filing an account
• Understand the nuances involved in providing proper notice to an accounting
• Know what forms to use and when
• Understand how to handle objections to the accounting and walk through the audit process

Family Settlement Agreements and Receipts and Releases

• Understand what elements are required in a family settlement agreement
• Avoid common mistakes when drafting a family settlement agreement
• Review sample agreements and discuss enforceable issues

A recent case from the United States Court of Appeals for the Sixth Circuit demonstrates the ongoing struggle to apply the Fair Labor Standards Act (“FLSA”) to the “side gigs” that have come to signify the modern employment market.  In Acosta v. Off Duty Police Services, Inc., United States Court of Appeals for the Sixth Circuit, Nos. 17-5995/6071 (February 12, 2019), the Sixth Circuit held that security offers working for Off Duty Police Services (“ODPS”) as a side job were employees entitled to overtime pay under the FLSA.  

ODPS workers were either sworn law enforcement officers who worked for law enforcement entities during the day, or unsworn workers with no background in law enforcement.  All workers had the same duties, but sworn officers earned a higher hourly rate.  Duties included “sitting in a car with the lights flashing or directing traffic around a construction zone.”  They were free to accept or reject assignments, but would be punished by withholding future assignments if they did so.  When they accepted an assignment, ODPS instructed the workers where to report, when to show up, and who to report to upon arrival.  ODPS provided some equipment, but workers did have to use some of their own equipment.  Workers followed customer instructions while on assignment, and only occasionally received supervision from ODPS.  ODPS paid workers for their hours upon submission of an invoice.  Workers did not have specialized skills, as sworn officers and unsworn workers had the same duties.   

ODPS treated the workers as “independent contractors.” As the facts set forth in the Sixth Circuit opinion demonstrate, the factors relevant to determining whether a worker is an independent contractor or employee do not provide a clear answer.  The United States District Court for the Western District of Kentucky broke the tie this way:  the court held that “nonsworn workers” were employees, but that the sworn officers were independent contractors because they “were not economically dependent on ODPS and instead used ODPS to supplement their incomes.”   

The Sixth Circuit disagreed, noting that the FLSA is a broadly remedial and humanitarian statute, designed to improve labor conditions.  The Sixth Circuit applied the “economic reality” test to determine that the sworn offers were also employees and not independent contractors, and to uphold the finding that unsworn workers were employees.  Specifically, the Court noted that the officers provided services that represented an integral part of the business, and that the work required no specialized skills, that the officers made only limited investment in equipment, and that the workers had little opportunity for profit or loss.  The Court noted that the facts did not “break cleanly in favor of employee or independent contractor status” regarding the right to control the work for the sworn officers. 

In the last segment of this series, we focused on concerns for employers in drafting and enforcing restrictive covenants.  The choices for employees are fewer, and none of them are good.   Employees are generally asked to sign restrictive covenants at two points:  either at the beginning of their career or upon a promotion or other significant improvement in employment status.  Such agreements diminish employees’ choices should they want to move on from their current employment, whether or not the restrictions are actually enforceable.

Some employers require employees to sign a restrictive covenant at the outset of their employment.  If the employee was recruited and has other employment choices, the employee has some bargaining power to reduce the duration or scope of the restrictions.  But this is seldom the case, and the law recognizes that employees generally have limited (or no) bargaining power in these situations.  The law disfavors restrictive covenants for precisely this reason:  the agreement imposes a post-employment restriction that may hinder the employee’s ability to earn a living at a time when the employee has little or no bargaining power to negotiate the restriction.

This calculus changes a little when the employee is required to sign a restrictive covenant in conjunction with a promotion or other benefit, such as participation in a stock option or bonus program.  Then the employee has to decide whether the value of the promotion or other benefit is enough to justify agreeing to the post-employment restriction.  Where it is not, the employee can refuse to sign, forcing the employer to decide how valuable this employee is to the employer.  However, the employee should factor into this decision that the employer is free to terminate the employee for refusing to sign.  And, this might be a good thing, as the employee will be leaving the employer without a noncompete. 

Frequently, employees breach the restriction without consulting an attorney first based on the widely held, mistaken, belief that courts do not enforce noncompetes.  Let’s be clear:  courts will enforce noncompetes where the law permits them to do so.  More importantly, the old employer will sue the employee and the employee’s new employer for breach of the agreement.  The new employer may terminate the new employment to avoid the costs of litigation.  Litigation regarding these matters is expensive, time-consuming and stressful.  Practically speaking, most employers will refuse to hire an employee with a restrictive covenant even if it is unenforceable for any number of technical reasons we have discussed in this series. 

At the very least, employees should consult an attorney prior to signing, even if they have limited bargaining power, to understand the restrictions in place.  We can help employees with that review, and we can help employees navigate the minefield of finding new employment when they have a noncompete in place.