A recurring issue employers must address is the enforceability of restrictive covenants entered into with an employee. These restrictive covenants are typically non-disclosure (confidentiality), non-solicitation, and/or non-competition agreements. The timing, form, and substance of these agreements will determine whether a court will find them valid. From a former employee’s perspective, the issue is basically the same but reversed: can the employee disregard a previously signed restrictive covenant without being liable for monetary damages to his former employer (and if newly employed at another company, keeping the second company out of litigation)?
Two cases recently decided by the Pennsylvania Superior Court provide guidance for employers and employees:
Fleisher v. Bergman, concerned an employee who was hired as a full-time employee. At the time of his hire, employee signed a restrictive covenant which was a confidentiality and non-competition agreement. The restrictive covenant provided that employee would not divulge any “Confidential Information” (e.g., customer lists, pricing policies, names of vendors) to other parties without the consent of employer; the Agreement further mandated that for a period of five years after termination of his employment, employee would not “. . . solicit or do business with any . . . entity . . . that was, within the three year period preceding the Employee’s termination, a Client or Prospect of Employer... ”
Reprinted by permission of Catalyst Center for Nonprofit Management. Further duplication without permission is prohibited.
Childhood victimization and other abuses of our most vulnerable citizens unfortunately remain a much too prevalent and tragic issue of our times. Particularly offensive is the possibility of physical or emotional abuse of those susceptible because of age, disability or circumstance while receiving services of a nonprofit. Safety efforts to protect the very people being served by a nonprofit, regardless of size, must be constantly monitored.
Even the smallest nonprofit should adopt safety-related policies based on nationally recommended guidelines developed by experts. Such policies and guidelines help protect both the recipients of the nonprofit’s services and the integrity of the nonprofit’s programs. Every nonprofit that serves children and youth has the obligation to exercise “reasonable due diligence” with regards to screening as part of its hiring and vetting programs for members of the nonprofit’s Board, staff and volunteers. Without such screening or gate-keeping vigilance, the very people the nonprofit is trying to serve are more likely to be unprotected and the reputation of the nonprofit (not to mention its fiscal health) are at unnecessary risk.
Business divorce, just like traditional matrimonial divorce, can occur for many reasons. Many times, business divorce is occasioned by underperformance and the need to separate an underperforming owner. However, the opposite circumstance, a business that has done well, can also spur desire for change in structure. Just like matrimonial divorce, business divorce can be a long, painful and expensive proposition. Consideration of trigger events for dissolution and setting an exit strategy before commencing the business venture can manage the expectations of the parties and facilitate transition when it becomes necessary. And it almost always does.
One of the primary considerations is trust. Consider the level of trust you place in a business partner on so many levels. Trust ranges from the basics of whether you can trust your partner not to have a hand in the cookie jar, to more esoteric questions of whether you can trust your partner to share your long term vision. All too often clients come to us with stories of unexplained payments for personal expenses which are only discovered by accident. What are the rights and obligations of the company and the business partners in such event? These rights should be spelled out in the agreement between the parties, otherwise the company, and the innocent shareholders, are left to argue common law claims and may be without a way to specifically extract the untrustworthy owner.
Trust goes deeper than the simple situation of defalcation (misuse of funds). Can you trust your business partner to have the same desire to grow your business and increase sales and performance metrics over an extended time? Business entities generally have perpetual existence. Can you trust that your partner will continue to make the requisite investments of time, energy and money that are necessary to bring the success you work so hard to achieve? If the agreements between the parties do not provide for a mechanism to remove that partner, or at least monetarily induce that partner to voluntarily separate, what strategy is available to accomplish the necessary change?
If extraction of a non performing owner is one side of the coin, the terms of voluntary separation are the other. Even in the absence of material differences between owners and managers, time and circumstance often require parties to go their separate ways. The terms of voluntary separation can be every bit as complex as forcible removal. Often, the most problematic inquiry is the right to be compensated in consideration of separation. Such terms of separation can vary based on valuation methodologies such as “market” or “book” values, timing of payments, reductions or additions to value based on subsequent conduct. In the absence of advance planning, the parties are almost certain to find dispute.
Post-employment obligations and fiduciary duties are also fertile ground for dispute. Corporate officers and directors have fiduciary obligations to the business. Partners, shareholders and members may have fiduciary obligations to each other. A departing shareholder may or may not be permitted to directly compete either during or after termination of the business relationship. Certainly, issues arise with respect to client/customer relationships and confidential information. More substantial issues may arise when the business develops a new technology or intellectual property which one party seeks to exploit in a different way. Agreements between the parties can address such possibilities and preserve rights by contract which might otherwise be ambiguous.
What if it all goes wrong? Again, business entities are generally established to have a perpetual existence, so termination must be accomplished by agreement or statutory procedure. What kind of consent is necessary to effectuate dissolution? Must all of the shareholders or members agree? Agreements can specify events and effect of dissolution including specific assignments in distribution of assets according to differing methodologies or factual circumstances. In circumstances where one party is opposed to liquidation or dissolution, the situation can become even more complex. Occasionally, only the appointment of a receiver can effectuate liquidation or dissolution; a generally unappealing circumstance as such an appointment necessitates the loss of control.
The questions posed and circumstances described above underline the importance of careful consideration prior to establishment of business entities. Such considerations during the business “engagement” and before business matrimony are necessary to prevent significant hardship when expectations are not managed. Advance planning though counsel can address many of the issues potentially faced by business owners and help the parties realize their expectations when circumstances change.
The U.S. Supreme Court finally rendered its decision in U.S. v. Quality Stores, Inc., 572 U.S. ____ (2014), on March 25, 2014, in a closely watched tax case. The Supreme Court reversed the Sixth Circuit Court of Appeals, and found that severance pay is to be considered wages, and therefore subject to Federal Insurance Contribution Act (“FICA”) taxes.
This holding dashed the expectations created by the Sixth Circuit’s holding that severance pay was not subject to FICA taxes. Many businesses had already filed refund claims based on the Sixth Circuit decision, and many more were in the process. Those refund claims are now most likely going to be denied.
The taxpayer, Quality Stores, Inc., paid severance to hundreds of employees while undergoing Chapter 11 bankruptcy reorganization. In its originally filed payroll tax returns, the taxpayer paid roughly $1 million of FICA tax on those severance payments. It later sought a refund of those payments while in bankruptcy, which then placed jurisdiction with the U.S Bankruptcy Court, rather than the U.S. Tax Court. That jurisdictional position seemed to work in the taxpayer’s favor, as the Bankruptcy Court found in favor of the taxpayer, as did the Michigan District Court on review of the decision.
Commercial lenders were left shuddering in the wake of a September 6, 2013 Pennsylvania Superior Court decision that affirmed a $3.6 million Bucks County jury verdict in favor of a local developer against an area bank. In County Line/New Britain Realty, LP v. Harleysville National Bank and Trust Company, the developer successfully argued that the term sheet provided to it by Harleysville was in fact a binding contract notwithstanding evidence of the parties’ intent to execute subsequent, more detailed agreements. The court also upheld the lower court ruling that Harleysville’s decision not to fund the loan described in the term sheet constituted a breach of contract. The court dismissed Harleysville’s claim that the term sheet did not contain the essential terms of a loan agreement (such as the closing date, how interest would be calculated, a repayment schedule, representations and warranties, and defaults and remedies) and therefore was not enforceable. The court held that the term sheet contained sufficient terms to create a binding contract, such as the identities of the borrower and lender, the principal amount of the loan, interest rates, the term, the manner of repayment, the names of the guarantors, and an identification of the collateral. The court acknowledged that the evidence showed that the parties intended to execute subsequent agreements but nevertheless held the term sheet to be binding.
Harleysville also argued that the developer did not meet all the loan conditions specified in the term sheet, so Harleysville was not required to fund the loan. Specifically, Harleysville asserted that two conditions were not met: (i) a satisfactory review by the lender of an “environmental assessment” of the parcels, and (ii) a satisfactory review by the lender of all specifications, engineer reports and government approvals. It argued that the trial court impermissibly allowed the jury to consider evidence regarding industry custom and practice, the course of dealing between the parties, and evidence of Harleysville’s motives in evaluating whether these loan conditions had been met. The Superior Court found that the term sheet did not articulate these conditions in sufficient detail and that it was appropriate for the jury to consider additional evidence in order to interpret the parties’ intent. This extrinsic evidence was particularly damning to Harleysville because it showed that Harleysville lost interest in making the loan shortly after the term sheet was issued, due in part to its desire to reduce the amount of commercial real estate loans in its portfolio and its precarious position as a result of the recent bankruptcy filing of its largest customer.
By William T. MacMinn, Esquire Reprinted with permission from August 13, 2013 issue of The Legal Intelligencer. (c)
2013 ALM Media Properties. Further duplication without permission is prohibited.
But He Asked Me First!
Is that a good defense to an alleged breach of a non-solicitation agreement? In a recent decision a Pennsylvania trial court said that it was.
In Marino, Robinson & Associates, Inc. v. Robinson, 2013 Pa. Dist. & Cnty. Dec LEXIS 18 (Jan 2013) Judge Wettick of the Allegheny County Court of Common Pleas entered summary judgment dismissing the case against Defendant who allegedly violated a non-solicitation clause. Plaintiff acquired Defendant’s accounting practice. The contract signed by the parties included clauses prohibiting Defendant from competing with the Plaintiff or soliciting any of her former clients. The non-compete was not implicated in the case because, while the Defendant provided competing accounting services, she did so outside of the geographic limits imposed by the covenant. However, she provided those services to several of her former clients, each of whom unilaterally approached her and asked her to continue on as their accountant. Plaintiff alleged that by providing services to these former clients, the Defendant violated the non-solicitation clause of the contract which prohibited Defendant from “Solicit(ing) in any manner any past clients … for a period of ten (10) years from closing”. The Court, following cases decided in other states, agreed with the Defendant that she was not required to turn away former clients who, unsolicited, approached her to request that she provide services. The Court held that solicitation required conduct on the part of the Defendant designed to awaken or incite the desired action in the former client. Where, as in this case, the former client approached the Defendant unilaterally, the Defendant did not violate the non-solicitation clause.
A similar result obtained in Meyer-Chatfield v. Century Bus. Servicing, Inc., 732 F. Supp. 2d 514, 517-518 (E.D. Pa. 2010) where the Court decided that the meaning of the word “solicit” was not ambiguous and applied the parole evidence rule to bar evidence regarding the meaning of the term. In Meyer-Chatfield, Plaintiff’s Vice-President of Sales and Marketing left his employment with Plaintiff and accepted a similar position with Defendant. An agreement, which included non-solicitation provisions, was negotiated between the parties. Shortly thereafter the parties engaged in negotiations for the acquisition of Plaintiff by Defendant. Those negotiations failed. Subsequently (and after he was terminated by Plaintiff) one of Plaintiff’s sales persons accepted employment with Defendant and took with him other employees (who were part of his sales team) with the result that several significant customers of the Plaintiff eventually began doing business with Defendant. Plaintiff brought suit alleging violation of the non-solicit provisions in the solicitation of both the employees and the customers.
The language at issue prohibited the direct or indirect “…solicit(ation) of any of Plaintiff's employees, agents, representatives, strategic partnerships, [or] affiliations.” The contract did not define the word “solicit.” The Court looked to the common meaning of the term, citing the Black's Law Dictionary definition:
"To appeal for something; to apply to for obtaining something; to ask earnestly; to ask for the purpose of receiving; to endeavor to obtain by asking or pleading; to entreat, implore, or importune; to make petition to; to plead for; to try to obtain; and though the word implies a serious request, it requires no particular degree of importunity, entreaty, imploration, or supplication. To awake or incite to action by acts or conduct intended to and calculated to incite the act of giving. The term implies personal petition and importunity addressed to a particular individual to do some particular thing."
The Court also cited the Webster’s definition of the word: “to entreat, importune . . . to endeavor to obtain by asking or pleading . . . to urge.”
The issue before the Court was whether the word “solicit” was ambiguous permitting parole evidence of its meaning. In holding that it was not, the Court reviewed Akron Pest Control v. Radar Exterminating Co., Inc. 216 Ga. App. 495, 455 S.E.2d 601 (Ga. App. 1995), in which the Court held that an agreement “not to solicit, either directly or indirectly, any current or past customers” requires more than “[m]erely accepting business [to] constitute a solicitation of that business.” A party is not required to turn away uninvited contacts of former customers. The Court also cited Maintenance Co. v. West, 39 Cal. 2d 198, 246 P.2d 11 (Cal. 1952) in which it was held that neither the act of informing former customers of one’s change of employment, nor the discussion of business upon the invitation of the former customer constitutes solicitation. Finding no ambiguity, the Court prohibited testimony regarding the parties’ understanding of the term.
It seems clear that the Court will apply the ordinary meaning of the word “solicit” which has been repeatedly found to require some overt act of entreaty on the part of the former employee designed to induce the former customer to action. Responding to an uninvited inquiry from a former customer, even where that inquiry is for the purpose of discussing business, and where that inquiry ultimately results in doing business with that former customer, will not be sufficient to support a finding of a breach of a non-solicitation agreement. Of course, doing business with a former customer may well violate the provisions of a non-compete clause and, in such cases, the Courts have not been reluctant to enforce such provisions. Although research has found no cases directly on point, the reasoning of the cases suggests that advertisements or social media posts informing the general public or one’s social media circle of new employment circumstances would also not constitute the type of targeted action required to support a finding that a non-solicitation agreement has been breached.
Those of us routinely asked to draft or review letters of intent (LOI), memorandum of understanding (MOU) and initial term sheets have a new challenge. The use of conventional text clearly stating “this is non-binding” to be sure a preliminary document memorializing negotiations does not give rise to the risk of unintended enforcement apparently is no longer sufficient. As a result of the Delaware Supreme Court’s decision in SIGA Technologies v. PharmAthene, Inc., No 314, 2012 2013 Del. LEXIS 265, 1-2 (Del. May 24, 2013), it is now suggested that counsel negotiating LOIs, MOUs and even term sheets designated as final include a specific negation of good faith. Text specifically stating the parties agree that neither party shall have a duty to negotiate in good faith is now considered appropriate. Getting both sides to agree to include such a forbidding sentence, however, is a significant challenge.
In SIGA Technologies, the court held that expectation or “benefit of the bargain” damages (and not just out of pocket, reliance damages) were appropriate where (1) the parties had a term sheet; (2) the parties expressly agreed to negotiate in good faith in a final transaction in accordance with those terms; and (3) but for the breaching party’s bad faith in trying to improve the terms, the parties would have consummated a definitive agreement with the terms set forth in the term sheet.
The SIGA Technologies decision might have been appropriate in light of the specific facts before the court but it leaves transactional lawyers at a loss. Business lawyers have been advising clients since the beginning of time that there is, and should be, a great difference between incomplete and preliminary letters, drafts and other communications clearly understood as non-binding (with the exception of specifically identified provisions, such as those relating to confidentiality and exclusivity) and final, mutually executed contracts with an integration clause. The former should have no legal effect other than as a basis to start the hard drafting process for definitive agreements. LOIs, MOUs and term sheets referring to the parties’ intent to finalize binding documents later are to be used as support for financing efforts and strategic planning and not evidence of a final oral or implied agreement between the parties. Exceptions to this rule were, until recently, very narrowly applied and usually only if the parties made an effort to carve out the intended exceptions with clear language (non-disclosure, exclusivity or no-shop provisions). Efforts by counsel for either party to impose a written duty of good faith and fair dealing on the other party are normally met with resistance with the better practice perceived to be silence on this point and text that allows either party to halt negotiations at any time for any reason as long as there is no breach of the binding confidentiality and/or exclusivity provisions. Termination fees are sometimes added to encourage good faith negotiations and cover out of pocket costs incurred as a cost of freedom to abandon those negotiations.
To avoid imposition of a SIGA Technologies penalty, many corporate advisors are now insisting the only safe course is to explicitly refute the presence of good faith. And yet, most clients do not want to suggest that they would ever negotiate in bad faith. Worse, most clients do not want to agree to allow the other party to the proposed transaction to abandon all pretenses of good faith and fair dealing. Who wants to go to the dance with a partner who asks for permission to humiliate you while there and tells you of his or her plan to possibly leave you without a ride home?
Bad faith in the midst of negotiations has historically been perceived as bad form but not an exception to the “non-binding” rule and certainly not the basis for expectation (lost profits) damages. To make this area even more challenging, a judicial determination of one company’s bad faith (e.g., trying to improve terms if the circumstances have become more favorable for the company) can easily be deemed by the shareholders/members of the same company to be the exercise of management’s fiduciary duty to maximize equity holders’ return. Failure to push for the best possible terms in the face of a non-binding term sheet could be found by another court to be a breach of that duty.
Whether bad faith should support an exception to the “non-binding” rule as a matter of law is an interesting question but the philosophy of law is rarely a topic businessmen and women wish to explore. Any number of things can make a deal that seemed attractive at a given point unacceptable some time later. Negotiations with respect to terms not included in the preliminary documents can be filled with real dispute; due diligence may reveal greater risks than anticipated; the industry-wide market may shift; or business may suddenly improve supporting more favorable terms for one party and less favorable terms for the other. Where the risk of the business enterprise does not begin to shift until after the execution of a definitive document, why should either party get the benefit of a preliminary bargain when the facts and circumstances supporting the transaction have changed?
While no one should be conducting negotiations in bad faith, the imposition of an implied duty of good faith and fair dealing in preliminary “non-binding” documents unless the parties specifically negate that obligation seems problematic. In contrast, once agreements are fully negotiated and signed, the covenant to act in good faith and engage in fair dealings is appropriate between business partners of all kinds. As found in other Delaware decisions, even where the contracting parties appear to have agreed to limit the scope of their common law and statutory fiduciary duties in a final document, good faith and fair dealing have an important role that should be implied and enforced by the courts. But, only after a final document is signed and sealed, however, should we be insisting a party trying to maximize their position “Did a bad, bad thing.”
From time to time, a client asks about when and why a corporate seal is necessary. Even some attorneys (particularly from out of state) question during contract negotiations whether the phrase “executed under seal” should be removed from a contract as an archaic concept. Historically, seals were affixed to a document as a formality to attest to the parties’ intention to be legally bound by the promises contained in the document. In several states, however, the execution of an agreement under seal continues to have specific legal significance that is not always understood or intended by the parties.
As a general rule, the Pennsylvania Judicial Code provides that the statute of limitations for actions based on a contract is four years. For instruments that are executed under seal, however, the statute of limitations is twenty years. The guarantor of a commercial loan recently learned the hard way that his guaranty was subject to the extended statute of limitations. In Osprey Portfolio, LLC v. Izett, the lender confessed judgment under Mr. Izett’s guaranty nearly five years after the loan went into default. Mr. Izett argued that the action was precluded because it was filed after the four-year limitation period. While acknowledging that the document was executed “under seal”, Mr. Izett maintained that the twenty-year limitation period did not apply because the guaranty agreement was not an “instrument”, which he defined as instruments under Article 3 of the Uniform Commercial Code. Article 3 defines “instrument” as a “negotiable instrument”, namely “an unconditional promise to pay a fixed amount of money.” Because his guaranty related to a line of credit (not a loan for a fixed sum) and was conditional upon the default of the borrower under the note, he reasoned that it did not meet this definition of “instrument.” The Pennsylvania Supreme Court disagreed and affirmed the lower courts’ rulings. It held that the term “instrument”, as used in the Judicial Code, should be interpreted using its ordinary meaning: a written document that defines the rights and obligations of the parties, such as a contract, will, promissory note, etc. Using this broader definition, the guaranty in question clearly qualifies as an instrument. Since the instrument was executed under seal, the twenty-year statute of limitations applied and the action was allowed to go forward.
It should be noted that the Judicial Code section providing for the twenty-year statute of limitations is due to expire on June 27, 2018. Of course, the sunset date for this provision has been extended in the past, so only time will tell whether the execution of contracts and other writings “under seal” will continue to have special legal significance in Pennsylvania.
Four years ago, the Home Improvement Consumer Protection Act (HICPA) went into effect, forcing home improvement contractors to register with the Commonwealth and to comply with various contracting requirements (for more information, see our Client Alerts on the subject https://www.ammlaw.com/general/articles.html). We have found that unfortunately many contractors remain unaware of this law. Failure to comply with HICPA could result in civil and criminal penalties. But does non-compliance also mean that a contractor is prevented from receiving payment from its customer for completed work? Not necessarily, held the Pennsylvania Superior Court, which recently gave hope to contractors when it concluded that a contractor who does not comply with HICPA may nevertheless recover the value of its services from the customer.
In Shafer Electric & Construction v. Mantia, an out-of-state contractor entered into a written contract with a Pennsylvania homeowner (who also happened to be a contractor) to build an addition to the homeowner’s garage and provided services valued at over $37,000. The contractor did not register with the Commonwealth under HICPA. After the homeowner failed to pay the amount due, the contractor sued to recover its fees. The homeowner asserted that the complaint was legally insufficient because the underlying contract was not enforceable under HICPA. The contractor countered that even if the contract were unenforceable, the contractor should be able to recover its fees under the equitable doctrine of quantum meruit, a theory which allows a party to recover the reasonable value of its services so as to avoid unjust enrichment of the other party. Unfortunately, although HICPA preserves a contractor’s right to recover its fees under a quantum meruit theory, the language of the statute appears to require compliance with HICPA as a prerequisite to recovery. The lower court, strictly interpreting the statute’s plain language, ruled in favor of the homeowner. The Superior Court reversed, holding that the plain language of the statute impermissibly limits the purpose of the provision allowing recovery under quantum meruit. It reasoned that to require the contractor to comply with HICPA before recovering under a quantum meruit theory made no sense because a compliant contractor can recover its fees under a breach of contract theory and does not need an equitable remedy such as quantum meruit.
While Shafer Electric provides reassurance for home improvement contractors doing work in Pennsylvania, the prudent contractor will not rely on it to ensure collection of its fees. Because of the hefty fines and possible criminal penalties that may be imposed for violations, we strongly encourage contractors to register and comply with the other requirements set forth in HICPA.
Employers frequently want to attract new, super-talented management to an existing Company, or potentially worse, have already promised to give one or more trusted and loyal current employees equity as part of their compensation package as soon as the time is right. Unfortunately, this is easier said than safely done.
Clearly, equity can be a powerful, seemingly low-cost form of compensation and motivation. Having your most valued employees vested in something beyond their pay check certainly seems like a fine idea. If the Company does well, the employee shares in that growth in the form of annual distributions or a buy-out upon death, disability, retirement or other termination of employment. So, what do I have against such an idea?