Employees: Friend or Foe?


Protecting the company’s customers, confidential and proprietary information

It should be no surprise that “business governance” is not just about the relationship between the business owners. It also includes the employment relationships including the relationship between the company and its consultants.  Employment relationships are typically documented in the following types of agreements: basic employment agreement, executive level employment agreements, indemnification agreements, independent manager agreements, non-compete agreements, non-solicitation agreements, and employee handbooks.

Remember that from a tax perspective failing to properly treat an individual as an employee (and instead treating them as an independent contractor) can have dire consequences. The I.R.S. follows a 20-part test (see appendix “a”), for determining whether one should be considered an employee or a contractor. If they’re deemed an employee you may be subject to numerous state and federal tax filings, penalties, and other fees from agencies such as the I.R.S., Department of Labor, and Worker’s Compensation Board.

For instance, I had a client who hired someone as an independent contractor. That contractor was driving a company vehicle when he got into a car accident that totaled the vehicle as well as injuring the contractor. The injured contractor filed a claim with the worker’s comp. Board which triggered an audit of my client’s company. The worker’s comp board fined my client $18,000 for not having workers compensation insurance (required if you have employees), and as I write this we’re battling with the Worker’s Compensation Board over whether the injured worked is indeed a contractor or whether he should be deemed an employee and therefore covered under Worker’s Compensation Insurance. Because my client’s company does not have Worker’s compensation insurance, if the individual is deemed an employee, my client, not just his company, might be personally responsible for paying the fines and other fees associated with this legal battle.

Some factors courts will consider in determining if an individual is a true independent contractor vs. an employee are: (1) does the individual have control over their own schedule (2) are they getting paid a flat fee or an hourly fee (3) the level of autonomy in how the individual performs the work. It sounds like a simple test but it requires very careful analysis.

 However, documenting the employment relationship isn’t just about the potential tax and financial consequences. It’s also most certainly about protecting the company from the employee. For instance, one could argue that a company’s intellectual/proprietary property walks out the door every day when its employees leave the building. The information that is entrusted to a company’s employees is its lifeblood. All too often, however, start-up companies do not do enough to protect their own intellectual property or customer goodwill after their employees leave the company, or even leave the building.

Unfortunately, some companies take a superficial approach to this critical issue. Many emerging companies use a standardized offer letter and intellectual property agreement, focused on non-disclosure of information, assignment of inventions, and, in some instances, non-competition and non-solicitation restrictions. As a starting point, this may suffice, but planning and vigilance are necessary to ensure that companies are in an optimal position to enforce such agreements down the road.

Companies should give careful thought to tailoring restrictive agreements to particular employees or job classes, rather than using a boilerplate agreement provided to many categories of employees, as a more focused, narrowly tailored agreement is more likely to be enforced in court. In short, one size does not fit all.

Companies should also consider defining what they consider to be “competitive” activity rather than simply barring employees from joining any employer that “competes” with the company. Being more specific, especially in the context of restrictive covenants, will only benefit you as an employer.

Companies should also give careful thought to defining what they consider to be confidential, proprietary information, beyond the typical (and important) boilerplate about “inventions and developments, customer lists, business plans, etc.” For the same reasons as above, specific is terrific.

Companies should be mindful of using a “one-size fits all” strategy when they have locations, employees, or independent contractors in different states. Non-compete agreements for California employees will not be enforced to the same extent as non-compete agreements for New York employees. State law can vary significantly with respect to these matters. As a result, companies must consider using agreements tailored to the specific laws of the states in which they have employees. This tends to concern many of my clients because they view the non-compete agreement as their only recourse in the event an employee steals confidential information, solicits customers, or does anything else to that effect post-employment.

But there are numerous other remedies available. If a high-level employee leaves your company and then starts a competing business using stolen or proprietary company information, you could still have claims for unjust enrichment, unfair trade practices, conversion (stealing), in addition to a breach of contract claim.

Companies should also be careful about the process by which these agreements are signed. For instance, when a company fails to have a new hire sign a non-compete agreement at the time the employee is hired, then there is a significant argument that the non-compete agreement is not enforceable because of lack of consideration. This can be true even where an employee signs the non-compete agreement just a week after being hired! When imposing a restrictive agreement such as a non-compete agreement, upon the employee, you want to make sure that there is sufficient consideration paid to the employee so that such an agreement is deemed enforceable.

Ultimately, when attempting to enforce a restrictive agreement in court, the company will be arguing that its confidential information is at risk based on the former employee’s actions; agreements should be drafted to maximize the likelihood that this argument will be accepted.

So, other than the points noted above, what are some things a company can do to ensure enforcement of restrictive covenants and protecting valuable proprietary or confidential information? Here are a few steps you as a business owner can take:

  • Regular dissemination of a confidentiality policy,
  • Regular dissemination of updates to employee handbooks.
  • Education and training of employees on intellectual property issues,
  • Restricting access (via passwords, locks, etc.) To sensitive information to those employees who need such access,
  • Labeling confidential documents (both hard copy and electronic),
  • Create an exit process (a termination process) such as the consistent use of a termination checklist that reminds workers of their obligations under existing policies and agreement.
  • Create an exit process that ensures the company immediately collects company property such as laptops, storage media (discs, drives) and hard copies of documents. If the company has any suspicions about the outgoing employee’s conduct and/or intentions, immediate consideration should be given to actually investigating the employee’s computer-related activities prior to his or her departure.
  • In many instances, retention of a third-party data recovery expert may be advisable both because of the technical challenges involved in investigating electronic activity and because of the need to preserve evidence of that activity,
  • Consider implementing an ip protection process such as communicating to your former employee and his or her new employer about the existence and continued applicability of the employee’s restrictive covenants and the company’s expectations about compliance with those promises.

Taking all of these steps will significantly improve a company’s chances of protecting its intellectual/proprietary property especially following a valued employee’s departure.

Establishing an employment protocol

Generally, most employees are employees-at-will meaning they can be fired for any reason or no reason at all so long as those reasons aren’t discriminatory.  However, problems arise when the employer’s reasons for firing an employee are not properly documented and the employee later returns as a disgruntled employee using one of the big law firms as the method of squeezing out a few (or much more than a few) dollars from you the employer under the fair labor standards act (FLSA) and other similar statutory bodies of law.

I have a client who purchased a business and then months after purchasing the business fired an older (70 year old) independent contractor. The former contractor brought an age discrimination claim against my client’s company under New Jersey law (which even permits age discrimination claims from independent contractors). In hindsight my client should have offered a severance agreement, paying the independent contractor in exchange for what is basically a “do not sue the company” agreement. My client’s arbitration fees will be at least $20,000.00 based on the American Arbitration Association fee schedule.

The solution to creating strong employment contracts is not as difficult as most business owners think and it is always worth it. Yes, it requires some organization and some systematization in your employee monitoring, hiring and firing processes, but the results mean less chance of being exposed to a baseless or frivolous lawsuit that will cost you tens of thousands of dollars and the risk of a possible judgment. We get into some of these processes in greater depth in the sections below.

Document your employee’s performance

Documenting your employee’s performance on a monthly or quarterly basis is a simple process. It means keeping a record of the positive and negative things that stand out in the employee’s performance, recommendations for improvement, and even making note of certain goals you want the employee to achieve with respect to his or her performance. There is no specific format. Rather, the key is being systematic about your process and making sure that your employees are aware that they are subject to performance reviews which can effect their (1) hours (2) compensation or (3) employment status – both positively or negatively.

Making your employees aware that they are subject to a performance review on a monthly or quarterly basis can also lead to more positive result in their performance. For instance, implementing an employee review process that otherwise effects their bonuses or other forms of compensation is an incentive for them to improve themselves and become a more valued employee for your organization. 

In addition, having a process where you keep track of employee performance helps you as the employer identify who your most valued employees are or whether they are objectively entitled to receive bonuses, increased compensation or promotions. More often than not, small business owners make decisions about their employees from an emotional or sympathetic viewpoint rather than one based strictly on a quantifiable and documented process. It’s not about emotions, it’s about business and creating a productive and rewarding culture for your employees within your business.

Document your employee’s time

When you’re dealing with worker’s compensation claims or overtime hours claims, the key to a successful defense is documenting your employee’s time to the minute. It’s not a difficult problem to solve. Use time cards, and make sure your employees sign their time cards at the end of each day.  And to any business owner “sharing employees” with another business they own, I especially caution you against doing that.

If your employees work remotely, have them log in at the end of each day in an easy to integrate time-tracking system or have them email your manager at the end of each day with a log as to where they were, during what time periods, and when they ended the day. Overtime claims are an incredibly easy claim to defend if you have the proper documentation. Unfortunately, many employers neglect simple documentation procedures which can save them tens of thousands of dollars in litigation costs.

Document and memorialize your employee’s termination 

Finally, when you are making the dreadful (or relieving decision) to terminate an employee, regardless of the level of their employment, you want to make sure you do and have the following:

1. Have a proper termination/exit interview with a proper managerial witness from your staff (if possible) outlining the reason for the termination or suspension

2. Have the employee sign a release and severance agreement

3. Provide a termination letter to the employee outlining in simple terms the basis for the termination and the next steps.

The above tasks may on some level sound mundane, however if they mean saving you 10, 20 or 100,000 dollars, then why not make it a part of your day to day practices?

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