You have finally found a prospective employee who meets all of your search criteria and is a superstar (or prospective superstar) in the field.  You want to move forward with the hiring process on an expedited basis.  You extend a generous offer, which is promptly accepted.  And then you discover, one way or another, that this individual has a restrictive covenant agreement (a “Covenant Agreement”) with a prior employer.  What should you do?  What if you don’t find out about the Covenant Agreement until after you have hired the individual?

Covenant Agreements are becoming ever more common and they come in many forms.  This article will familiarize you with Covenant Agreements generally and will provide you with guidance regarding what you can do to protect yourself from legal liability and business disruption.

I.  LIABILITY AND DISRUPTION: RISKS TO YOUR BUSINESS

A.  What is a Covenant Agreement? Let’s be clear about what we are talking about.  For purposes of this article, a Covenant Agreement is a contract between your (prospective) employee and a current or prior employer that restricts the activities of the employee after the employment relationship terminates.  The restrictions can take many forms and the terms vary significantly from one Covenant Agreement to another.

Covenant Agreements are often referred to as “non-competes” or NDAs (short for “non-disclosure agreement”) and some are indeed just that.  Non-competes include terms that restrict an employee from engaging in activities that compete with the prior employer.  NDAs restrict the use of the former employer’s confidential information and trade secrets.  In most cases, however, Covenant Agreements include a number of different restrictive covenants so, if a prospective employee tells you he or she has an NDA with a prior employer, do not assume the document is indeed “just” a non-disclosure agreement.

Indeed, the majority of Covenant Agreements include at least two and often several different post-employment restrictions on conduct, such as provisions restricting the employee from:

• contacting customers, suppliers, and/or employees of the prior employer;
• saying or otherwise communicating damaging or negative information about the prior employer;
• using materials that the employee developed with the prior employer;
• keeping information or documents acquired in connection with the prior employment; and
• using information acquired in connection with the prior employment.

Also, Covenant Agreements are not necessarily separate, stand-alone agreements.  They may be included in the terms of another, broader agreement, such as an employment agreement or a separation agreement.  Covenant Agreements may also be embedded in equity and bonus award agreements, transaction agreements, and deferred compensation agreements.  In short:  when assessing whether a prospective new hire is bound by a Covenant Agreement—and, if so, what restrictions apply to the new hire—do not depend on the “label”; review the document itself.

B.  Why Do I Need to be Concerned? I’m Not a Party to the Covenant Agreement.  It is basic contract law that a party to a contract can pursue its remedies against the other party to the contract in the event the other party breaches the agreement.  Clearly, a former employee who breaches a Covenant Agreement is liable for whatever damages are imposed by law or contract.  But how can a Covenant Agreement impact a subsequent employer who isn’t a party to the Covenant Agreement?  The answer is:  it depends on a number of factors, but the following is a brief summary of the possible ways a Covenant Agreement can disrupt the business of—or even create legal liability for—the subsequent employer.

Injunctions Against the Employee.  Practically without exception, Covenant Agreements permit the former employer to seek an injunction.  An injunction is a court order preventing the former employee from engaging—either temporarily or permanently—in the conduct that the former employer alleges is a breach of the Covenant Agreement at issue.  For example, if the employee has allegedly breached the Covenant Agreement by working for his or her current employer, the injunction can bar the employee from continuing such employment.  If an employer is relying on the skills and contribution of that employee, an injunction can be very disruptive.

Legal Claims Against the Current Employer.  A former employer that is a party to a Covenant Agreement has many causes of action that it might allege against the current or future employers even though there is no contract between the two employers.  These include: tortious interference with a contractual relationship; intentional interference with business relations; inducement to breach; civil conspiracy; misappropriation of trade secrets and proprietary information; conversion; and unfair competition.

It is important to note that, in some instances a candidate’s behavior may be actionable even in the absence of any Covenant Agreement. In most jurisdictions, employees have a common law duty of loyalty (and often a fiduciary duty) to act in the best interest of their current employer, even after tendering a notice of resignation. Violation of this duty of loyalty can result in substantial damages against the employee and, to the extent a subsequent employer is found to have assisted the employee in breaching his duty of loyalty, there is potential exposure to the new employer for aiding and abetting the employee’s breach.

C.  What Can an Employer Do? Whether the hiring employer will be directly liable to the former employer is largely predicated on the hiring employer’s intent and good faith, and whether it actually benefitted from the new hire’s unlawful conduct. Being able to show the following can provide a powerful defense for the hiring employer against this liability:

• The hiring employer took diligent steps to determine at the pre-hire stage whether the employee was subject to post-employment restrictions.
• The hiring employer was advised by legal counsel that, by hiring the employee, it would not interfere with an existing contractual restriction.
• The hiring employer instructed the new hire that he or she was not expected or permitted to (1) use or disclose any trade secrets or confidential information belonging to his or her former employer, (2) improperly divert business opportunities belonging to the former employer, or (3) engage in any other conduct that would breach his or her Covenant Agreement.
• The hiring employer instituted internal protocols to ensure against the inadvertent use or disclosure of the former employer’s trade secrets or confidential information.
• The hiring employer continued to monitor the new hire’s conduct to ensure continued compliance with any post-employment restrictions that the former employer imposed.
• The hiring employer used due diligence to ensure that it did not benefit from the new hire’s use or disclosure of the former employer’s trade secrets or confidential information.

II.  INVESTIGATE COVENANT AGREEMENT ISSUES DURING THE INTERVIEW PROCESS

Ask the Candidate If He or She Is Subject to Any Covenant Agreements.  The first thing an employer should do is ask a prospective employee whether he or she is subject to any Covenant Agreement.  This should be thoroughly vetted well before a decision is made regarding hiring the individual.  If the employer engages in adequate due diligence before it hires a candidate who is subject to a Covenant Agreement and makes a reasonable hiring decision based upon such due diligence, it would be very difficult for the former employer to assert any of the causes of action indicated above against the new employer.  (This, however, would not allay the possibility that the candidate would be enjoined from working for the new employer, in whole or in part, temporarily or permanently.)

Keep in mind that, as a general rule, restrictions imposed by Covenant Agreements may extend for a period of two years after employment terminates and in certain cases even longer.  Therefore, you should inquire not only about a candidate’s current or immediately prior employer, but also about earlier employers. The take away here is that when you endeavor to determine whether a candidate is a party to a Covenant Agreement, be sure to ask the right questions and review all agreements between the candidate and its prior employers.

If the Answer is “No” – “I Don’t Have A Covenant Agreement” and Other Tall Tales.

Going back to the facts described in the first paragraph of the introduction above, let’s assume that you asked the prospective superstar-employee whether he or she is subject to a Covenant Agreement and he or she says, “no.”  That should not be the end of your inquiry for a number of reasons.  First, strange as it may seem, employees often forget that they have signed Covenant Agreements.  Second, if the Covenant Agreement is embedded in another agreement, they might not realize that they are subject to one.  Third, the employee may unilaterally decide that although he or she has a Covenant Agreement, employment with you would not breach it and that therefore not disclosing it to you would do no harm.  Fourth, the prospective employee may want the job you are offering badly enough or believe the risk of enforcement is low enough that he or she decides to not disclose the fact that he or she is a party to a Covenant Agreement with a prior employer.

If the candidate affirms that he or she is not subject to any Covenant Agreement and you decide to hire him or her, then, as a pre-requisite to employment, require him or her to sign a notarized statement verifying that he or she is not subject to any Covenant Agreement with any current or former employer and stating that this verification is a pre-condition to the hiring decision, and that if the foregoing proves to be false for any reason, he or she would be subject to immediate termination of employment and be solely liable for any costs and expenses you incur if any action is brought against you because of it.

If the Answer is “Yes.”

Ask for a copy of the Covenant Agreement and have it reviewed by legal counsel who is knowledgeable about Covenant Agreements and the law implicated by them.  Your legal counsel should provide you with an assessment of whether the Covenant Agreement is enforceable, along with a plain English translation of what the Covenant Agreement prohibits, including the time limits, geographic scope, and the precise activities prohibited if the Covenant Agreement is enforceable and enforced.  Be sure to give your attorney enough specific information about what activities the prospective employee would perform for your company, if hired by you, so your attorney can advise you as to whether the prospective employee would violate the Covenant Agreement by working for you.

If you and your attorney determine that a candidate would be in breach of a Covenant Agreement by working for you and that the former employer is likely to sue, you can avoid that liability completely by not hiring the individual.  However, the issues are most often not so black-and-white.  In this case, you would need to consult with your attorney to weigh various factors to arrive at the decision as to whether to hire the candidate, including, for example: (i) the risk (and potential cost) of litigation and the potential disruption to your business (including the risk that your new hire will be enjoined from working for you, either temporarily or permanently); (ii) the likelihood that the former employer will be successful in enforcing the Covenant Agreement and your business’s potential liability for money damages; and (iii) any steps you can take to minimize or avoid a claim that the new hire is violating the Covenant Agreement.

III.        MANAGING COVENANT AGREEMENT ISSUES

Because Covenant Agreements are so common these days, there is a high likelihood that any new hire will be subject to a Covenant Agreement.  Even if you have determined that the anticipated scope of duties the candidate will perform for your business isn’t likely to violate a Covenant Agreement, you should still implement policies—whether in your standard employee manuals, offer letters, and/or employment agreements—to demonstrate your expectation that your employees will comply with their obligations to prior employers, such as a prohibition on the unauthorized use or distribution of property, confidential information, or trade secrets of a third party.

However, if you and your legal counsel determine that a candidate is subject to an enforceable Covenant Agreement, and that the position for which the candidate is being considered might be construed as requiring the candidate to violate the terms of that Covenant Agreement, there are a number of things you can do to minimize the risk of litigation if you decide to proceed with hiring the individual.  Possibilities include: (i) if feasible, restructuring the position so that the duties and responsibilities do not run afoul of the Covenant Agreement (or at a minimum), placing the new hire in a temporary position that does not violate the Covenant Agreement for the duration of any contractual restriction period; (ii) asking the former employer to waive the restrictions or negotiate restrictions that both of you can live with; or (iii) structuring the new hire’s work to insulate him or her from departments or projects involving confidential information or clients for which the new hire might possess competitively valuable information belonging to his or her former employer.  Also, the hiring employer should consider whether it should leave itself an “out” by requiring the candidate to acknowledge and agree that if litigation is threatened or arises over any Covenant Agreement, it reserves the right to terminate the candidate or alter the candidate’s job requirements.

Lastly—and regardless of the steps you may have taken to avoid or minimize the risk that your new hire is violating a Covenant Agreement—there is always a risk that the prior employer will nonetheless suspect a violation or threaten legal action against you.  As such, there are actions you should take after hiring an employee who is subject to a Covenant Agreement if you receive a “cease and desist” letter or any other communication regarding the terms of the Covenant Agreement from the former employer.  Proper management of this situation can reduce, limit, or eliminate your potential liability in connection with an employee’s Covenant Agreement with a prior employer.  You should contact your attorney immediately, both to formulate a strategy for responding to the prior employer and to ensure that you are taking the proper internal steps to preserve evidence that may become important if the matter proceeds to litigation.

If you have any questions or would like additional guidance regarding restrictive covenant agreements or other employment law issues, please contact Suzanne Arpin at SArpin@fh2.com or (770) 399-9500.

Classifying Your Employees as “Exempt” or “Nonexempt”
under U.S. Wage and Hour Laws:

Important – and Potentially Costly – Changes
You Need To Know About

Exempt Employees May Become Nonexempt: What You Should Consider Now

The U.S. wage and hour laws (the “Fair Labor Standards Act” or the “FLSA”) require employers to pay every employee a minimum wage and overtime—unless the employee is exempt from the law.  If an employee is exempt, the FLSA does not apply to or protect such employee.

The FLSA puts the burden on employers to classify employees correctly as either “exempt” or “nonexempt” in accordance with regulations promulgated by the Department of Labor—and the employer can be subject to onerous liability for failing to classify employees properly.

You need to be aware that the Department of Labor has promulgated new regulations that could have a significant impact on whether you choose to—and even whether you are able to—continue to classify certain of your employees as exempt.  As discussed further below, as of December 1, 2016, certain employees may no longer be classified as “exempt” unless they are paid significantly more—meaning you, as an employer, will need to decide whether to:

• increase the employee’s compensation to the new threshold amount in order to continue classifying him or her as “exempt” under the FLSA; or

• re-classify him or her as “nonexempt” and become subject to payment of FLSA-mandated minimum wage and overtime.

This may present a serious challenge for employers with exempt employees who are expected to, and regularly do, work more than 40 hours in a given week to complete the required responsibilities of their positions.

THEREFORE, NOW IS THE TIME TO MAKE SURE:

• you are currently classifying all your employees properly under the FLSA; and

• you identify any of your currently “exempt” who employees will become “nonexempt” on December 1^st, absent an increase in their compensation.

With respect to any such employees who may be subject to reclassification, you then need to decide whether to reclassify them (and pay overtime) or increase their compensation in light of the new regulations issued by the Department of Labor.

I.  Classification of Employees as “Exempt” and “Nonexempt”: A Brief Summary

The FLSA requires that most employees in the United States be paid at least the federal minimum wage for all hours worked and overtime pay at time and one-half the regular rate of pay for all hours worked over 40 hours in a workweek. However, there are a number of categories of employees that are exempt.  Those exempt groups include bona fide:

• executives;
• administrative employees;
• professional employees, both “learned” and “creative”;
• certain computer employees;
• outside sales employees; and
• highly-compensated employees.

Together, the forgoing exempt groups are referred to as the “white collar exemptions.”

The White Collar Exemptions

As a general rule, to qualify for one of the white collar exemptions, employees generally must meet certain tests regarding their job duties and be paid on a salary basis at not less than $455 per week (until November 30, 2016—starting December 1, 2016, this number goes up to $913 per week.)  But, even then, the exemption requirements are not as straightforward as they appear at first glance—for example, a different salary test applies to the “highly-compensated employee exemption”, and the “outside sales employee exemption” is subject only to a duties test and does not have a minimum compensation threshold at all.  So careful attention must be paid to the specific requirements of each exemption when considering whether a given employee is exempt from minimum wage and overtime requirements.

Job titles do not determine exempt status. In order for an exemption to apply, in addition to meeting any applicable threshold compensation requirements, an employee’s specific job duties must meet all the “duties” requirements of the Department of Labor’s regulations (the “duties tests”) for the specific exemption claimed.  For example, simply giving an office worker an “administrative” title does not automatically entitle you to claim that the employee is subject to the “administrative exemption”—as that exemption is only available to administrative employees whose primary duties include the exercise of “discretion and independent judgment with respect to matters of significance.”  Similarly, merely giving an employee a title indicating they are a “professional” does not mean he or she will be entitled to the “professional exemption”—that exemption is reserved for employees whose primary duties include performance of work requiring “advanced knowledge . . . in a field of science or learning . . . customarily acquired by a prolonged course of specialized intellectual instruction.”  The “outside sales employee exemption” is reserved for your sales employees who are “customarily and regularly engaged away from the employer’s place or places of business”—employees who primarily work in your offices to receive and facilitate sales (such as in a call-center or sales department) would not be covered by this exemption.

Nonexempt Employees (Including “Blue Collar” Employees)

Obviously, your employees who do not meet the applicable compensation and duties tests for any available exemptions must be treated as “nonexempt” under the FLSA.  But you should also be aware that certain employees must be treated as “nonexempt” no matter how highly they are compensated.

The white collar exemptions do not apply to manual laborers or other “blue collar” workers who perform work involving repetitive operations with their hands, physical skill and energy.  FLSA-covered, non-management employees in production, maintenance, construction and similar occupations such as carpenters, electricians, mechanics, plumbers, iron workers, craftsmen, operating engineers, longshoremen, construction workers and laborers are entitled to minimum wage and overtime premium pay under the FLSA, and are not exempt no matter how highly paid they might be.

The Consequences of Misclassification

In recent years, FLSA cases have become very attractive to plaintiffs’ employment lawyers, who began filing lawsuits after realizing that many employers are in violation of the FLSA. These lawsuits often turn into very expensive class actions.

One of the most common mistakes employers make is misclassifying nonexempt employees as exempt.  The penalties are quite harsh and are not very flexible or negotiable.  In addition to back pay, employees may recover what are referred to as “liquidated damages” equal to the pay employees should have received.  In other words, employees can recover double “back pay” damages for unpaid overtime.  In addition, successful plaintiffs are entitled to recover the full amount of their attorneys’ fees which often are more than the double back pay damages.

Part-Time Versus Full-Time: Same Rules Apply.  The same compensation and duty tests apply to part-time and full-time workers.  Therefore, part-time workers must meet the exact same minimum threshold salary and duty tests as full-time employees in order to be exempt from the FLSA.  No proration applies to the minimum threshold salary levels for part-time employees.

II.  The New Regulations: Redefining the White Collar Exemption

In 2014, President Obama directed the Department of Labor to reevaluate and update the regulations defining which white collar workers were subject to overtime laws.  New regulations were published in May, 2016.  Unless Congress acts to change the regulations, they will become enforceable on December 1, 2016.  The Department of Labor estimates that over 4 million additional U.S. workers will be subject to the minimum wage laws and be entitled to overtime pay in 2017 as a consequence of the new regulations.

Key Provisions: New Minimum Salary and Annual Compensation Thresholds

The new regulations focus primarily on updating the salary and compensation levels needed for executive, administrative and professional workers to be exempt.  Currently, to qualify for the white collar exemption, a worker must have the required job duties and either receive a minimum salary of $455 per week or $23,660 per year (the “salary basis test”) or total compensation of at least $100,000 to qualify as a highly compensated employee.

On and After December 1, 2016:

• the threshold salary level for the salary basis test will be $913 per week (or $47,476 annually); and

• the minimum total annual compensation requirement for highly compensated employees will be $134,004 (which must include at least $913 per week paid on a salary or fee basis).

Notable Other Terms of the New Regulations:

• If an executive, professional, or administrative employee’s salary is close to the new salary levels, an employer may use nondiscretionary bonuses or incentive payments (including commissions) to satisfy up to 10 percent of the new threshold salary level. These payments must be made during the year, at least quarterly.  For highly compensated employees, a catch-up payment equal to the amount necessary to meet the annual threshold may be made in the last pay period of the payroll year.

• The salary and compensation levels will be automatically reset every three years, beginning on January 1, 2020.

III.  What Does This Mean for You?

From a Financial and Budgeting Perspective.  The new regulations significantly narrow the scope of the white collar exemption and, thus, significantly broaden the number of employees who are subject to the FLSA.  Employees who were previously “exempt” may soon be “nonexempt” and entitled to overtime pay if they work more than 40 hours a week.  After December 1, 2016, all employees (other than those subject to the outside sales employee exemption) who earn less than $47,476 per year must be classified as nonexempt and be paid overtime at “time and one-half” for all hours worked over 40 hours per week. 

As you plan your staffing and budget for 2017, you should anticipate these changes and determine how best to address them from a business perspective.  If overtime is truly a necessary component of any reclassified employee’s work, you may have to budget for more payroll.

From an Employee Morale and “Business Culture” Perspective.  If you decide to raise salaries in order to meet the new threshold, you will likely have happy employees.  However, if you are instead leaning toward maintaining salaries at their current levels, you should also consider the consequences of reclassifying formerly-exempt employees as “nonexempt.” At first blush, it may sound advantageous to be reclassified as nonexempt and be entitled to overtime pay.  However, such reclassification may be detrimental to employee morale and you will need to address this.

The over-arching concern of the FLSA is that nonexempt employees be paid for time actually worked, and if that time exceeds 40 hours a week, overtime must be paid at time and one-half.  The flip side of this apparently good intention is that employers must very strictly monitor and control the time an employee spends working.  You might consider the effect the following may have on your employees and your established business culture:

• Start times, stop times, breaks, lunch hours, quitting times and, of course, overtime must be subject to rigid rules and carefully monitored. Many exempt employees enjoy a great deal of flexibility with respect to, for example, their lunchtime from day to day, working long hours on a project when they are “on a roll” and choosing when they arrive at and leave work.  This will have to change radically when an exempt employee is reclassified as a nonexempt employee.

• The reclassified employees will be obligated to track their time precisely, incurring annoying recordkeeping responsibilities they did not have before.

• The employer may be compelled to pay a reclassified employee less basic compensation in order to budget his or her overtime pay, which may or may not ultimately be paid. This will create financial uncertainty for the employee.

• If an employer prohibits overtime, the reclassified employee may feel his or her ability to get the work done in the time allowed has been compromised.

All this may feel a lot like a demotion to a reclassified employee.  In order to avoid this, you should communicate early and often with the affected employees and give them training and easy access to designated management so that their concerns can be vetted and addressed.  You should consider doing the following:

• Emphasize that the new rules are law imposed by the US Federal government; they are not your idea. However, you are required to comply.  Reassure reclassified employees of their value to the company and let them know where to go to express their concerns and get answers to their questions.

• Provide training on the new timekeeping requirements and educate employees as to the importance of accurately documenting their time worked –even if it’s something as “trivial” as answering some emails in the evening at home. This is a very hard habit to start.

• Prohibit working “off the clock.” It is common for reclassified employees to decide that they will simply work the hours they need to and not record them if additional hours are required. This is absolutely illegal under the FLSA and if the employer permits it, the employer is liable for substantial penalties, in addition to paying the employee for any applicable overtime.

• Be aware that if your reclassified employees are required to travel, special rules apply to what portions of travel time are compensable and how.

Review Your Policies and Handbooks: Decide Whether Changes Should Be Made.  If your workforce can operate efficiently without overtime hours, consider prohibiting it absent express written authorization from management.  Whatever policy you adopt, be sure to review your handbooks, policies, or notices to be sure your employees are aware of company policy as well as their right to receive approved overtime if they are nonexempt.

Consider Structured Agreements with Reclassified Nonexempt Employees.  To create some predictability for both the employer and the employee, one option is to implement a compensation structure that pays nonexempt employees an annual salary factoring in a certain amount of overtime.  The FLSA permits this—however, there must be an express written agreement in place and regardless of the agreed working hours, if the employee works more overtime than contemplated, he or she must be compensated for it at time and one-half.

Beware of Perceived Discrimination.  If you have employees with the same job title or duties that are paid differently, with some exempt and some nonexempt, be careful.  Although there is no requirement that such a group be classified the same, generally speaking, employees with the same job title who perform the same duties and responsibilities should be paid similarly, unless you can clearly articulate a justification for the difference.  Otherwise, the difference may give rise to a claim of discrimination under various federal laws.

IV.  Do Not Panic: Create an Action Plan Now

Bottom Line: 

As of December 1, 2016, it’s likely that many of your employees who earn less than $47,476.00 per year must be classified as nonexempt and paid overtime at a rate of time and one-half times their regular rate.

Action Plan: 

• You need to evaluate your employee population to determine whether any of your currently exempt employees will become nonexempt on December 1, 2016 absent increased compensation.

• You should take the time to review your work force as a whole to identify any employees who have been misclassified as exempt or nonexempt.

• If any of your exempt employees will become nonexempt on December 1^st under the new regulations, you need to decide what makes sense from a financial and budgeting perspective—should you increase their compensation so that they remain exempt or reclassify them as nonexempt as of December 1, 2016?

• Based on that evaluation, develop an action plan as needed to educate reclassified employees and to make the transition as smooth as possible.

Need Help?  Have Questions?

If you need help or have any questions about properly classifying your employees under the FLSA or about other employment law matters, please contact Suzanne Arpin at sarpin@fh2.com or (770) 399-9500.