The Business Divorce Law Report

March 16, 2021

Restrictive Covenant Term Tied to Vesting Schedule is Not Reasonable

A restrictive covenant that is in force during a vesting period for securities granted as part of an employee incentive program may present an issue for enforcement, if not tied to to the protection of an employer’s legitimate interest.
A court considering a preliminary injunction request blue-penciled the duration of a covenant not to compete or solicit customers to base the time period on termination, not the vesting period for stocks and options sought by the former employer.
The duration of a restrictive covenant may not be reasonable if the duration is not tied to the former employer’s protection of a legitimate interest.

Restrictive covenants that were tied to the vesting and exercise schedules pf securities awarded through United Healthcare’s employee incentive programs were not reasonable, a federal court held recently. The court then limited the duration of the time when a former employee would be restricted from competing with or soliciting the company’s customers. binding-contract-948442_1920-1024x683

The case involved a former executive, Jeffrey Corzine, who worked in strategic marketing for United in its program offered as an option in Ohio’s Medicare program. Corzine was terminated by United in a corporate reorganization and then went to work for a competitor, Humana, Inc., during the time that both companies were competing under a Request for Applications (RFA) for contracted Medicare services. The case was before a federal district judge on United’s application to secure a preliminary injunction. Continue reading

March 2, 2021

Restrictive Covenant Legislation Limits Enforceability of Agreements

by Jay R. McDaniel, Esq.

Restrictive covenants that limit the ability of former employees to compete have been the subject of legislative limits in a number of states, including Maine, Maryland, Massachusetts, New Hampshire, Rode Island, Virginia and Washington.
Bills that would limit the enforceability of restrictive covenants in New Jersey have been introduced into the legislature since 2017 but have failed to be adopted.
Legislative restrictions on agreements not to compete may require minimum compensation, restrict the geographic scope and time frame of the agreement and prohibit courts from “blue penciling” unreasonable restrictive covenants rather than refusing to enforce them entirely.

Restrictive covenants continue to be disfavored or limited by legislatures in a number of states. New Jersey is among the states in which no legislative action has been taken to limit the types of employees that may be subject to restrictive covenants or the scope agreements not to compete. Bills that would limit the enforceability of restrictive covenants have been introduced in the New Jersey legislature since at least 2017 without gaining adoption. (See Assembly Bill 1650) time-731110_1920

The Illinois legislature this week advanced legislation that will limit the enforceability of restrictive covenants against many former employees earning $75,000 or less and set limits for enforceability. These statutory limitations on the enforceability of restrictive covenants are becoming more widespread. Continue reading

March 1, 2021

An Email Does Not Make an Operating Agreement

by Jay R. McDaniel, Esq.

An email from the sole owner of a limited liability company announcing that employees had become partners with a profit interest was not sufficient to constitute admission as a member of the LLC.
The fact that the party claiming an equity interest in an LLC had refused to execute an operating agreement was a strong indication that the issuance of equity was still the subject of negotiations.
A court is likely to consider the completeness of the terms of an alleged oral agreement to admit a new member; without sufficient details the agreement will be deemed incomplete and unenforceable.
The issue of whether an individual is a member of a limited liability company is properly tried by a judge rather than a jury.

What does it take to make someone a member of a limited liability company? The Revised Uniform Limited Liability Company Act (RULLCA) as adopted in New Jersey and most operating agreements contain some requirement for unanimous consent. The requirement on unanimous consent reflects the policy underlying the “pick your partner rule” in smalll business organizations: no one should be forced to share ownership of a closely held business against their will. mail-1454731_1920-1024x1024

Unanimous Consent Required for Admission of New LLC Members

The contours of what is unanimous consent is often not clear, however. Does a promise of admission as a member or partner constitute consent? What about the formality of signing an operating agreement? These are facts that vary by the case and the circumstances.

The line between equity owner and a highly compensated senior employee – sometimes with the title of partner – is often blurred, particularly in certain professions such as lawyers in which the non-equity or contract partner is a common occurrence. In a case recently before the Appellate Division in New Jersey, the business at hand was a private equity fund and a senior employee. Continue reading

February 25, 2021

Share Purchase for $500,000 Required in Accounting Firm Breakup

by Jay R. McDaniel, Esq.

Accounting firm is compelled to repurchase the equity of departing shareholder who moved practice to competitor firm.
A shareholder agreement that is integrated and intended to be the parties’ complete agreement may preclude a claim for breach of corporate by-laws.
A shareholder in an accounting firm organized as a professional corporation did not breach any fiduciary duties by negotiating with a competitor and disclosing general information about his and the firm’s practice, even if he was to be compensated based on the clients who followed him to his new employer.

For 22 years Robert Dick worked in a growing accounting firm before he left for a competitor, taking with him a number of clients. Before giving his resignation, however, Dick put together an estimate of his billings and a description of his client base, although apparently not providing any details on client identify. This discussion – common in a professional move – was one of the principal defenses to a lawsuit that Dick brought to compel his former employer to repurchase his Acountant share repurchase shares.

Resignation of Account from Professional Corporation

Dick was a 30 percent shareholder in Koski Professional Group, P.C. who had built a following among health care clients, having purchased shares in the professional corporation on multiple occasions since 2005. In 2015 he moved his practice to a competitor, Bland and Associates under an arrangement in which he received base compensation plus a percentage commission on his client’s billings. At the time of his departure, Dick was one of four owners. He was followed by a number of clients, leading to the litigation and ultimately an appeal to the Nebraska Supreme Court. (Opinion here) Continue reading

February 17, 2021

United Health Care Rebuffed on Injunction Request

by Jay R. McDaniel, Esq.

Although a former executive was bound by a restrictive covenant, the fact that his duties after joining a competitor were directed to a different market made the scope of the restrictions unreasonable.
A restrictive covenant that is not narrowly tailored to protecting specific interests of the former employer at stake in a lawsuit is less likely to be enforced with a preliminary injunction.
A company that relies on the inevitable disclosure doctrine faces a high hurdle to show the certain use of a trade secret in a competitive manner.

An attempt by United Health Care to block an executive from joining a competitor failed when a federal judge found the medical insurance and services company had failed to establish it was likely to succeed when the case goes to trial. The dispute identifies some of the steps that a new employer take to prevent its just-hired employee from running afoul of a restrictive covenant.

The defendant Carlos Louro in this this case, United Health Care v. Louro, was an executive supervising the underwriting of national accounts at United. He had recently been promoted to vice president and served on a high-level, national accounts strategy group. He had also received stock options and restricted stock awards, which contained restrictive covenants and non-disclosure provisions..

The trial court construed Louros agreements with United that and restricted him from:“[e]ngag[ing] in or participat[ing] in any activity that competes, directly or indirectly, with any Company activity, product, or service that [Louro] engaged in, participated in, or had Confidential Information about during [Louro’s] last 36 months of employment with the Company” or assist anyone in any of those activities for one year after Louro’s termination of employment.” Continue reading

February 12, 2021

District Court Enjoins Former Executive from Competition

by Jay R. McDaniel, Esq.

An executive with national responsibilities may be subjected to a broad geographic restriction in an employment restrictive covenant.
Courts can and will enjoin a former executive from working for a competitor to prevent irreparable harm to the executive’s former employer when the restriction is reasonable.
Misappropriation and use of a company’s trade secrets by a former employee may also prevent an employee who has copied information from working for a competitor

A federal district court judge in New Jersey imposed a preliminary injunction that will prohibit a former executive from working for a competitor for at least a year. The decision was based on both the existence of a restrictive covenant and the departing executive’s having copied data from his prior employer at the time of his departure. sunbelt

Resignation by Executive to Work for Competitor

The case, Sunbelt Rentals, Inc. v. Love (opinion here) is particularly notable as a lesson in how not to resign a high-level position. Because even if the trial judge had not enforced the restrictive covenant in the executive’s employment contract, the fact that he copied proprietary information by emailing customer lists and other data to his brother before his resignation doomed any defense to the preliminary injunction. Continue reading

February 11, 2021

Restrictive Covenants May Be Enforceable Against Physician

by Jay R. McDaniel, Esq.

Physicians are subject to reasonable restrictions on post-employment activities that will limit their competition with a previous employer.
A restrictive covenant that prohibits competition must protect a legitimate interest, impose not undue hardship on the former employee and not injury the public interest.
Restrictive covenants must be narrowly tailored so as to only restrict activities in which the employer has a legitimate interest. Courts consider the geographic scope, duration and activities limited.
Enforcement of a restrictive covenant may also turn on such circumstances as how the covenant was agreed to and the circumstances of the separation of the physician.

Restrictive covenants limiting the activities of a physician may be disfavored, but they are not per se unenforceable. As with other restrictive covenants, the issue is whether the agreement not to compete is reasonable in scope and protects a legitimate interest of the beneficiary of the agreement not to compete. Cases-of-Note-Professionals-1024x536

The issue was last before the New Jersey Supreme Court in The Community Hospital Group v. More (full opinion here), a 2005 opinion in which the court was asked to overrule its existing precedent that permitted enforcement of restrictive covenants against physicians. The Supreme Court decided the issue just months after the appellate division had held that a restrictive covenant was unenforceable against a psychiatrist. (See Psychologists, Like Lawyers, Not Subject to Restrictive Covenants) Continue reading

February 5, 2021

Estate Plan Sows Father and Son Business Divorce

by Jay R. McDaniel, Esq.

Managers of a limited liability company owe to the company fiduciary duties of loyalty and care, must act in good faith, and refrain from reckless or unlawful conduct.
A member who seeks information about a manager-managed limited liability company must state the purpose for the request under the Uniform Limited Liability Act.
In a dispute involving a family farm, the trial court exercises equity to look through the details of disputed loan payments and find that they were to benefit of the limited liability company and its members.

Some cases make you wince when you think about the underlying relationship. This case in which a son sued his father over the repayment of a mortgage is one of them. It comes from the Iowa Court of Appeals and is interesting from my perspective because the underlying statute is the same as applies here in New Jersey and because it demonstrates the scope of equity to reframe disputed issues into a more manageable solution. field-213364_1920-e1612533257149-1024x379

The dispute in Erwin v. Erwin (opinion here) addressed the dispute between Michael Irwin and his son, Richard, that grew out of the father’s attempt to pass the family farm without incurring tax liability. The father and Richard’s mother, who owned the farm individually, formed a limited liability company, Erwin Farms II, LLC, in 2012 and passed the land to the company. At the time of the transfer, the land was subject to a mortgage. Richard received a block of non-voting membership units. The remaining membership units, including all of the voting units, were owned by the parents.

The operating agreement of the company named Michael Erwin as manager. In addition to the existing mortgage, after the land was transferred to the LLC, the Erwin parents took two loans for improvements. By the time of the trial, those loans had all been paid. Continue reading

February 2, 2021

One Business Divorce, Multiple Actions

by Jay R. McDaniel, Esq.

An agreement to arbitrate that is contained in the governance documents of a business, e.g, an operating agreement or shareholder agreement, may result in multiple proceedings when the dispute ripens into litigation.
A party may seek to stay a pending federal court action based on a collateral arbitration proceeding that is part of a state court action under the abstention doctrine, but it is sparingly applied.
Parties to a business dispute may be required to simultaneously litigate in different forums when not all of the parties are subject to an agreement to arbitrate the dispute.

Multiple lawsuits from a business divorce may not be entirely commonplace, but it does happen when the controlling governance documents contain an arbitration clause, but there are outsiders not bound by the agreement to arbitrate that are involved in the dispute. These may be former employees, agents, competitors or vendors. gavel-2492011_1920-1024x569

Simultaneous Arbitration and Litigation in Court

The result is that some of the parties may be obligated to arbitrate, or that some of the dispute may not be subject to the agreement to arbitrate. Consider the case in which there are disputed events that occurred while the parties still had fiduciary obligations to each other – such as between partners or employer and employee – and those that occur outside the fiduciary obligation. These might include unfair competition or claims arising from a competitor hiring someone under a restrictive covenant. Continue reading

February 1, 2021

A Non-Competition Agreement from the Great Beyond

by Jay R. McDaniel, Esq.

A case in which a restrictive covenant was enforced against an accountant who happened to be beneficiary under her deceased former employer’s will is among recent business divorce cases worthy of note.

Restrictive Covenant Given in Purchase Agreement Survives Death

A covenant not to compete given in connection with the sale of an accounting practice is enforceable against a beneficiary of will who happened to be a competitor of the practice that bought the Cases-of-Note-Non-Competition-1-1024x536 deceased account. Here is what happened in McCarthy & Co, P.C. v. Steinberg, a case before a federal court in Pennsylvania. Harris Fox sold his accounting practice to the plaintiff with a multi-year restrictive covenant. The terms of the sale provided for payment of 25 percent of the revenue earned from Fox’s clients during the five-year period. The restrictive covenant remained in place for three years after the last payment under the sale agreement. The defendant, Judith Steinberg, had worked for Fox for 24 years and at the time of the sale, Fox had asked that plaintiff hire her. Steinberg stayed for four years, then resigned started practicing with a direct competitor. Continue reading

A restrictive covenant that is in force during a vesting period for securities granted as part of an employee incentive program may present an issue for enforcement, if not tied to to the protection of an employer’s legitimate interest.

A court considering a preliminary injunction request blue-penciled the duration of a covenant not to compete or solicit customers to base the time period on termination, not the vesting period for stocks and options sought by the former employer.

The duration of a restrictive covenant may not be reasonable if the duration is not tied to the former employer’s protection of a legitimate interest.

Restrictive covenants that limit the ability of former employees to compete have been the subject of legislative limits in a number of states, including Maine, Maryland, Massachusetts, New Hampshire, Rode Island, Virginia and Washington.

Bills that would limit the enforceability of restrictive covenants in New Jersey have been introduced into the legislature since 2017 but have failed to be adopted.

Legislative restrictions on agreements not to compete may require minimum compensation, restrict the geographic scope and time frame of the agreement and prohibit courts from “blue penciling” unreasonable restrictive covenants rather than refusing to enforce them entirely.

An email from the sole owner of a limited liability company announcing that employees had become partners with a profit interest was not sufficient to constitute admission as a member of the LLC.

The fact that the party claiming an equity interest in an LLC had refused to execute an operating agreement was a strong indication that the issuance of equity was still the subject of negotiations.

A court is likely to consider the completeness of the terms of an alleged oral agreement to admit a new member; without sufficient details the agreement will be deemed incomplete and unenforceable.

The issue of whether an individual is a member of a limited liability company is properly tried by a judge rather than a jury.

Unanimous Consent Required for Admission of New LLC Members

Accounting firm is compelled to repurchase the equity of departing shareholder who moved practice to competitor firm.

A shareholder agreement that is integrated and intended to be the parties’ complete agreement may preclude a claim for breach of corporate by-laws.

Resignation of Account from Professional Corporation

Although a former executive was bound by a restrictive covenant, the fact that his duties after joining a competitor were directed to a different market made the scope of the restrictions unreasonable.

A restrictive covenant that is not narrowly tailored to protecting specific interests of the former employer at stake in a lawsuit is less likely to be enforced with a preliminary injunction.

A company that relies on the inevitable disclosure doctrine faces a high hurdle to show the certain use of a trade secret in a competitive manner.

An executive with national responsibilities may be subjected to a broad geographic restriction in an employment restrictive covenant.

Courts can and will enjoin a former executive from working for a competitor to prevent irreparable harm to the executive’s former employer when the restriction is reasonable.

Misappropriation and use of a company’s trade secrets by a former employee may also prevent an employee who has copied information from working for a competitor

Resignation by Executive to Work for Competitor

Physicians are subject to reasonable restrictions on post-employment activities that will limit their competition with a previous employer.

A restrictive covenant that prohibits competition must protect a legitimate interest, impose not undue hardship on the former employee and not injury the public interest.

Restrictive covenants must be narrowly tailored so as to only restrict activities in which the employer has a legitimate interest. Courts consider the geographic scope, duration and activities limited.

Enforcement of a restrictive covenant may also turn on such circumstances as how the covenant was agreed to and the circumstances of the separation of the physician.

Managers of a limited liability company owe to the company fiduciary duties of loyalty and care, must act in good faith, and refrain from reckless or unlawful conduct.

A member who seeks information about a manager-managed limited liability company must state the purpose for the request under the Uniform Limited Liability Act.

In a dispute involving a family farm, the trial court exercises equity to look through the details of disputed loan payments and find that they were to benefit of the limited liability company and its members.

An agreement to arbitrate that is contained in the governance documents of a business, e.g, an operating agreement or shareholder agreement, may result in multiple proceedings when the dispute ripens into litigation.

A party may seek to stay a pending federal court action based on a collateral arbitration proceeding that is part of a state court action under the abstention doctrine, but it is sparingly applied.

Parties to a business dispute may be required to simultaneously litigate in different forums when not all of the parties are subject to an agreement to arbitrate the dispute.

Simultaneous Arbitration and Litigation in Court

Restrictive Covenant Given in Purchase Agreement Survives Death