Small business owners understandably may be reluctant to use non-compete agreements for many reasons.  The desire to divert precious resources to paying an attorney to prepare a contract is hardly appealing.  Similarly, businesses may feel that such agreements are unnecessary because they have few employees.  But as Ben Franklin once wisely advised, an ounce of prevention is worth a pound of cure. 

The term “non-compete agreement” technically refers to a contract that preclude a person from engaging in certain acts of competition for a prescribed period of time within a prescribed geographic area.  In common usage, however, the term often is used more broadly to refer to any contract by which someone has any type of competitive restrictions, including non-solicit, non-recruit, non-disclosure and confidentiality agreements.  Simply put, non-competes come in all shapes and sizes, but the reasons small business owners should use one or more of these covenants are equally diverse.

1. Enhance the value of your company if you think you may sell someday – If you think someday you may wish to sell your business, it is important to protect the value of your company by requiring employees to sign restrictive covenants.  When someone purchases a business, they want to know that they will get what they pay for.  If they believe key employees with access to customers and relationships may not stay on board after a merger or acquisition, they may balk at the price or even walk away.  You may think that you can always sign employees up to a non-compete later, but such afterthought covenants present their own challenges.  You can protect the value of your company and its assets by using appropriately tailored non-compete agreements.

2. Qualify for trade secret protection – Generally speaking, any valuable business information that you try to keep secret from competitors is subject to trade secret protection.  But to state the obvious, to be a trade secret, the information must in fact be secret.  When determining whether information should be entitled to trade secret protection, courts look at many factors including the extent to which the owner of the secret took reasonable steps to preserve its secrecy.  A widely recognized precaution includes requiring employees to agree not to use or disclose confidential information.  In addition, if customer information is a trade secret, a covenant not to solicit customers (i.e., a non-solicitation agreement) may well be appropriate.

3. Protect your customer relationships –Small businesses tend to place client relationships in the hands of fewer employees.  Consequently, when an employee resigns, the client relationship may walk out the door with the employee.  Just as importantly, you may need time to rebuild your clients’ confidence and to show that your other employees are equally capable of serving their interests.  Clients are the lifeblood of any business; but this is particularly true for small businesses.  A small business simply cannot afford to lose its clients. 

4. Enhance client confidence – Would you do business with a company if you felt your personal financial information was at risk?  Of course not.  Your clients feel the same way.  If your clients entrust their personal or business information to you, they want to know that your employees are not going to take it when they leave.  Requiring employees to sign restrictions on their use and disclosure of confidential information is a good way to make your clients confident that their data is safe in your hands.

5. Protect your investment in training – Training employees is a worthwhile expense, and the training resources you provide may even help you to attract talented employees.  But steps should be taken to prevent your competitors from swooping in to hire your employees after you invest the time and expense to train them.  For this reason, courts commonly recognize that employers have a legitimate interest in protecting their investments in specialized training.

6. Clarify expectations with employees – Do your employees realize that you expect them to leave behind the information you entrusted to them if they decide to move on to a new job?  Do they understand that the relationships you paid them to cultivate and maintain belong to you?  The best time to clarify expectations with your employees is before a dispute arises.  Doing so may influence a departing employee’s conduct and provide you with the leverage you need to protect your company.

7. Shape ground rules for potential litigation – Litigation against departing employees can be expensive, but when your business is on the line, you may have little choice but to protect your interests through legal action.  Although no contract can eliminate the expense associated with litigation, careful forethought can help to minimize your costs.  Restrictive covenants are a perfect opportunity to reach agreement with employees about some of the ground rules that will apply if litigation becomes necessary, such as whether you are entitled to recover attorneys’ fees and costs if you prevail, whether lawsuits should be filed in a local forum, and whether you are entitled to certain remedies such as an injunction or liquidated damages.

8. Deter competitors from hiring your employees –  Deterring competitors from hiring your employees is not a sufficient fact in and of itself to warrant the imposition of a restrictive covenant.  In fact, courts will not enforce restrictive covenants if they serve no purpose other than to restrict competition.  But assuming you have a legitimate purpose for requiring employees to sign such agreements – such as a need to protect confidential information or customer relationships – sending a message to your competitors that you are prepared to protect these interests is a nice side effect.

In short, there are advantages to using non-compete agreements that may not be apparent until it is too late.  Small business owners should think about protecting their business in advance.  Please let me know your thoughts in the comment section below.

A recent survey by Manpower suggests that employers across the country are planning to increase their hiring during the second quarter of 2011. Are your employees poachable?  Consider the following:

1)  Is employee morale down?
If so, it may not be long before the word is out.  With the use of social media growing exponentially, there are more ways than ever before for recruiters to learn if employees are fed up with their companies and ready to tip toe out the door. You want to know if your employees are unhappy before your competitors do. Don’t wait until they are broadcasting their discontent on social networks. If you are unclear about how your employees feel, conduct an internal survey to measure morale before it’s too late.

2)  Is upheaval shaking up your industry?
Employees working in industries that are facing increased regulation, an onslaught of mergers or uncertainty about tomorrow’s profitability are more apt to want to leave to find a more stable environment. If your industry is in transition, don’t leave your employees guessing about what’s going on. Be open and honest. Employees who feel like they are being kept in the know feel more loyalty to their companies and are less likely to bolt for the door when turbulence is afoot.

3)  Are you experiencing turnover at the top?
CEO turnover is higher than it’s ever been. Unfortunately, unrest in the upper levels of management can cause a chain reaction of defections. Employees may either want to follow their boss out the door or may feel that a new manager is chasing them away. Before making changes at the top, consider how managers closest to the CEO will respond. Will they likely be relieved or more willing to leave? Conversely, involve top managers in the decision-making process to replace their leader.

4)  Are your employees well trained and/or specialized?  
Having the best of the best employees is a blessing and a curse. A popular exchange rounding the internet these days between a fictitious CFO and CEO reads as follows:  “CFO to CEO: What if we train our employees and they leave us?  CEO to CFO: What if we don’t and they stay?” The fact is, employees with highly specialized expertise are probably the most poachable of all.  Your competitors will be pleased to find talent with fine-tuned skills and low-learning curves, and they may believe such employees are well worth the risk of litigation. If you’re investing heavily in training, invest equally in retention by rewarding employees. But, don’t focus solely on money as a motivator. Provide personalized options. Some employees might choose a flexible work schedule over a plump paycheck and these employees are worth being catered to.
 
5)  Is your competition moving in?
If your competitor has opened a new office in one of your territories, they are probably making a beeline for your back door. It’s cheaper to poach your talent than to fly in candidates from across the country. Now is an optimal time to let your employees know that you care.

6)  Are you in the professional services industry?
Employees who embody the product are prime candidates for poaching because they often have clients that are willing to come along for the ride, exponentially boosting their value.  Remember that your client list may qualify for trade secret protection, and of course, you should protect your company with suitable restrictive covenants.  But the best prevention is to keep your employees happy.

7)  Are you sharing the bounty?
During the recent economic downturn, many employers were forced to tighten their belts.  In turn, employees were asked to make sacrifices.  Many employees responded favorably because they were grateful to have a job, and putting in a few extra hours or foregoing an annual raise was viewed as a reasonable sacrifice to remain employed in a difficult economy.  But as the economy rebounds, employees are taking notice.  As your profits increase, are you sharing the bounty with employees?  As noted above, this does not always mean paying employees a bonus or giving them a raise.  Consider offering employees special training opportunities. Ambitious employees are always looking to improve themselves.  Are you providing them with training opportunities to expand and sharpen their existing skillsets?

In this environment where many employees are looking for a change and recruiters are happy to oblige their wishes, noncompetes are not optional. When used in conjunction with competitive intelligence and retention techniques, you can have a comprehensive strategy to fend-off intruders from absconding with your valuable talent, trade secrets and clients during these precarious times.Let your employees know you care, and cater to their interests.  But of course, some employees may choose to join a competitor.  For these departures, it is important to be prepared with a plan of action.

Michael R. Greco and Christopher P. Stief are partners in the Employee Defection & Trade Secrets Practice Group at Fisher & Phillips LLP.  To receive notice of future blog posts by Mr. Greco, Mr. Stief or other members of the Practice Group, you may subscribe to this blog's RSS feed or follow Mr. Greco on Twitter on on LinkedIn or follow Mr. Stief on Twitter or LinkedIn.  As always, please feel free to share your thoughts or pose your questions in the comment field below.

Protecting a company's non-compete and trade secret interests can be a daunting task.  There are so many things to consider.  Here's a list of ten things to keep in mind and some resources to help you take action. 

1. Implementing a Trade Secrets Protection Program – Protecting your trade secrets cannot be left to afterthought.  Companies are well advised to implement a trade secrets protection program.  If you don’t know where to start, consider conducting an audit of your company’s confidential information.

2. Drafting Non-Competition Agreements --  Many employers with offices or employees located in multiple states use the same non-compete/confidentiality agreement in each state in which they do business. Typically, the form of the non-compete/confidentiality agreement originated in the employer’s home state, and the employer went on to use this same agreement wherever the employer does business. However, these employers may find out too late that a non-compete/confidentiality agreement enforceable in their home state may not be enforceable in another state.

3. Online Social Networking Policies -- Chances are that one-quarter to perhaps as much as one-half of your workforce (or more if your workforce is younger) are regular users of social networking websites.  Any business that does not have a social networking policy or does not train its employees on the do’s and don’ts of social networking may have a critical security gap in the protection of its trade secrets.  A recent case suggests that LinkedIn can present a threat to your trade secrets.  If you have expectations concerning the manner in which your employees may or may not use LinkedIn, it is wise to address these concerns upfront through contracts and written policies.

4. Can Your Lawyer Keep a (Trade) Secret? -- Ensuring that your trade secrets are kept secret is not a new requirement.  Internal controls on use and dissemination of confidential information may not be entirely sufficient.  Businesses need to recognize that risks sometimes involve the handling of their data by third parties specifically entrusted for that purpose, such as their attorneys.  Remote storage of client data presents several concerns including unauthorized access to confidential client information by a vendor’s employees or by hackers, a failure to adequately back up data, or insufficient data encryption. 

5. Can Litigation Place Trade Secrets at Risk? --  The last place you might expect your trade secrets to be at risk of disclosure is in a court action intended to protect them, but courts around the country have held that plaintiffs alleging trade secret misappropriation must identify the secrets at issue with specificity. So what is a plaintiff to do if it wishes to minimize disclosure of its trade secrets during litigation while maximizing its ability to discover what information may have been taken by the defendants?  Click here.

6. Open Source – Hidden Exposure --  Open source code is computer code that is publicly available on the internet for use by anyone.  Typically, in order to copy open source code from the internet, a party must agree to the terms of a “click” or similar pop-up license.  Although there are hundreds of different open source code licenses, many require that the user of the code must make publicly available any subsequent use of the code.  In other words, if your software programs are built using open source code, it may be more difficult to claim trade secrecy for such programs.

7. Taking Control of Litigation Budgets in Non-Compete Cases -- Litigation budgets can be difficult to prepare under the best of circumstances.  Budgeting for non-compete litigation, with its unpredictable nature and often front-loaded cost structure, is even more difficult.  Although many factors are outside the control of parties and their counsel when it comes to litigation costs, the litigation strategy you choose can have a particularly significant impact on your budget in a non-compete case.  Moreover, given the fast pace of non-compete litigation, there is an increased need to continually reassess your budget early on as developments unfold.

8. Handling Employee Defections -- When employees leave to join a competitor, you can often be taken by surprise.  In order to secure your confidential information and customer relationships, rapid action may be required.  Consider these ten tips for responding to employee defections.

9. Advising Recruits -- Just as employers must be prepared to respond to employee defections, they must be prepared to advise their incoming recruits on what not to do when resigning from a former employer.  Here are ten things to keep in mind.

10. Mergers and Acquisitions -- Good mergers can turn bad without attention to employee retention -- be sure to carefully analyze the existence and enforceability of non-competes signed by key employees early in the process.

Michael R. Greco is a partner in the Employee Defection & Trade Secrets Practice Group at Fisher & Phillips LLP.  To receive notice of future blog posts either follow Michael R. Greco on Twitter or on LinkedIn or subscribe to this blog's RSS feed.

A merger that looks good on paper can lose value when too many employees in the target company get nervous about what life will be like after the deal closes -- Will the culture be different?  Is the acquiring firm too big?  Too rigid?  Will they understand how we do business?  These risks have had enormously negative impacts on many mergers.  Employee attrition following mergers and acquisitions is so common that it has been the subject of psychological studies, has been written about in Human Resources publications, and even has spawned its own name -- “Merger Syndrome.”  Back in 1986, Psychology Today published an article called, “The Merger Syndrome: When Companies Combine A Clash Of Cultures Can Turn Potentially Good Business Alliances Into Financial Disaster.”  What can an acquirer’s Legal Department do to manage this risk? 

            Check the Old Restrictive Covenants – Do They Exist?  Are They Enforceable?.  Start early in the process.  During due diligence, check whether the target company has its key people under enforceable restrictive covenants.  Don’t just inventory HR files.  Analyze what restrictions are in the contracts.  Where are the employees located?  Are those restrictions enforceable in those states?  Were the contracts signed at the inception of employment or later?  If they were signed later, then consideration may be an issue, depending on the state. 

            Will You Have Standing to Enforce the Old Covenants After the Deal Closes?.  Even if there are non-compete agreements in the file for the right groups of employees, you must determine whether you – as the acquiring entity – will have the right to enforce the old non-competes after the deal closes.  Do the covenants have clauses providing that the agreement is assignable, or better yet automatically assigned, to a successor upon merger or acquisition?  If the clauses are there, you probably can enforce.  If not, the question may be much trickier – it will depend on the state’s law that governs, and on the form of the transaction.  Mergers and stock purchases are more likely to transfer the right to enforce.  Asset purchases are less clear. 

            Think About New Covenants.  If you find that many of the old contracts are not enforceable, then you want to build into the negotiation a strategy for getting newer and better agreements from the key people, especially for executives you want to retain after the merger.  Everyone knows that.  But make sure you identify the types of attrition that can turn a great deal into a disaster.  Often the sales force is a key.  In September 2005, Wall Street giant Merrill Lynch agreed to purchase AXA’s Advest brokerage unit for $400 million.  By May 2006, it was being reported that 417 out of Advest’s total of 505 brokers had jumped ship.  See K. Burke, “Failure to Launch,” Registered Rep (May 1, 2006).  It literally became a case study of a failed merger.  See S. Grantham, Risk Assessment as a Function of a Successful Merger: Merrill-Advest Merger, 11 Journal of Communications Management 247-57 (2007). Mergers and acquisitions can be especially stressful for employees lower down the chain of control, who have access to less information.  As one study noted, mergers “can change an individual’s working life significantly but fail to provide the individual with any control over the event.”  Julie K. Anderson, “People Management: The Crucial Aspect of Mergers and Acquisitions,” Industrial Relations Centre, Current Issue Series (1999).  Don’t make the mistake of only worrying about the top few executive non-competes.  Carefully assess points of exposure to potentially damaging employee defection, and then craft restrictive covenants that will protect the company.

Consideration for New Agreements.  If new contracts are required, you must address issues of timing and consideration.  The demands of adequate consideration vary depending upon the form of your transaction, and the states in which key employees are located.  In a statutory merger or stock purchase situation, the employment of target-firm employees continues uninterrupted through and after closing.  In many states, simply agreeing to continue employing people is legally sufficient consideration to support execution of a covenant not to compete executed during the midst of employment – what some cases refer to as “mid-stream” covenants.  But in a substantial and important minority of states, merely keeping someone on the job is not sufficient consideration for a mid-stream covenant.  In these states – North Carolina and Pennsylvania are two examples – you must give each employee new and sufficient consideration.  Sufficiency will be measured in proportion to the employee’s pay level and duties.  A check that would be sufficient for one employee will not be seen as sufficient for a much higher compensated employee.    

Determine Whether Key Employees are Located in “Problem States”.  It is inconvenient, to say the least, that nearly all of the legal issues relevant to the risk of employee defection are governed by varying state laws, rather than by one consistent federal standard.  In fact, it is so inconvenient that many companies simply ignore this undeniable reality.  They do so at great risk to their ability to protect themselves against defections.  One size rarely fits all when drafting restrictive covenants.  If you roll out one version of your agreement, it may well fail in any number of key locations, including tricky states such as California, Georgia and others.  You probably can cover the national map with anywhere from three to six versions of an agreement, depending upon how many different types and levels of employees you are signing up.  You may be tempted to side step this problem by inserting choice-of-law/forum clause, but this often fails and is inadvisable in any case.  It is dangerous to put all your eggs in one basket.  If things turn bad in your chosen state, you are out of luck everywhere.    

Don’t Forget to Use Carrots with Your Sticks. The company of course is even better off if employees decide to stay on board, and are happy about doing so.  This is why the most effective method is to roll out an attractive employee retention plan designed to induce important players at all levels to stay around long enough get to know what is good about your company.  Consider stay-bonuses, with repayment obligations that kick in if an employee leaves within a year (or two or three  years, as the case may be) after receipt.  Salary or minimum bonus guarantees also can ease concern about transition into a new compensation environment.  At a minimum, you can use retention agreements to be sure key employees stay with you long enough to get through the transition period after the deal closes. 

Communicate Your Retention Offers Early.  Retention packages are more effective tools when deployed rapidly and when their benefits are communicated effectively.  Deal with this immediately after announcement of the pending merger.  Don’t wait until closing.  Headhunters will waste no time starting to recruit the most valuable employees from your target company.  The last thing you want is for the dominant voices to be those of recruiters calling in and reinforcing the natural fears of employees whose company is being acquired. “[T]he period following the announcement of the takeover is one of intense personal risk analysis, in which the individual decides whether s/he will leave the organization or stay.”  Gunter K. Stahl & Sim B. Sitkin, “Trust in Mergers and Acquisitions”, in Mergers and Acquisitions: Managing Culture and Human Resources (G.K. Stahl & M. Mendenhall, eds., Stanford University Press 2004).  Effective retention packages offer sufficient financial inducement for employees to remain on board, and ideally are communicated before the headhunters are out in full force.  You know the announcement is coming before they do.  Take advantage of that head start -- don’t announce until you are ready to convey information about retention packages almost simultaneously. 

Employee attrition will always be a risk factor in mergers and acquisitions, but careful attention to restrictive covenants and retention packages can go a long way toward minimizing those risks.