The power of restrictive covenants
By Elisabeth Boone, CPCU
In today’s competitive business landscape, safeguarding company interests is paramount. Program administrators had the opportunity to learn about the critical role of restrictive covenants in protecting their business. The venue: a panel discussion that delved into the various types of restrictive covenants, their legal framework, and best practices for implementation and enforcement. John Colis, chief executive officer of Euclid Program Managers, led a discussion of restrictive covenants as they apply to program administrators.
Diana Estrada, a partner in the law firm of Wilson Elser and a co-chair of its employment practice group, helped lay the groundwork. “In a traditional non-compete agreement, a worker agrees that after he or she leaves the employer, he or she will not go to a competitor or start a business that competes against the employer.
“In a non-solicitation agreement, the employee agrees that should he or she leave, he or she will not raid the employer’s employees, vendors, or clients,” she continued. “In a confidentiality agreement, the employee agrees not to reveal business confidences to competitors or others outside the employer’s business.
“A less common agreement is the garden leave agreement in which the worker stays with the employer for a set amount of time during which he or she receives a salary and agrees not to compete with the employer,” Estrada noted.
In April of this year, the Federal Trade Commission issued the Non- compete Clause Rule banning post-employment noncompete agreements nationwide. Assuming it withstands legal scrutiny, it will not only ban the future use of noncompete agreements, but it will also void existing post-employment noncompete agreements, with the exception of those agreements entered with senior executives prior to the Rule taking effect.
The Rule does have some express exceptions. The first is the sale of business exception. If an owner or substantial shareholder sells their shares back, the employer can have them enter into a noncompete agreement.
“The second express exception to the rule is if the employer has an existing cause of action seeking to enforce a non-compete agreement, which existed before the FTC rule goes into effect, that can still move forward,” Estrada said.
“We use restrictive covenants in the businesses we own, as well as with production underwriters and business development specialists.”
—Matt Sackett
Chief Executive Officer and Co-Owner
DOXA Insurance
“The third express exception is called the good faith belief: If the employer has a good faith belief that the non-compete agreement with an executive or employee does not violate the FTC rule,” she continued.
Asked if she thought the FTC rule would survive, Estrada said no. She pointed to lawsuits that have been filed to challenge the rule.
“In California, where I practice, at the beginning of this year the legislature said that no person can enter into a non-compete agreement, and other states have introduced restrictions against these agreements,” Estrada said.
Colis asked Chris Pesce, national program practice leader of One80 Intermediaries, if he used non-solicitation agreements, if he sees them being used in the companies his organization is acquiring, and if so, who is being covered.
Pesce responded, “The non-solicitation agreement is the most practical and most enforceable. Most of the companies we acquire have these agreements in place. This component has an economic value tied to the program administrator’s business.
“The non-solicitation agreement is the most practical and most enforceable. Most of the companies we acquire have these agreements in place.”
—Chris Pesce
National Program Practice Leader
One80 Intermediaries
“That’s one of the concerns we have about this potential FTC ruling,” he added.
Those impacted, Pesce said, are “production underwriters. Renewal underwriters typically are not covered; they’re just processing the business. Production underwriters have access to all the data associated with an account, so we make sure they’re covered by a non-solicitation agreement.
“The non-solicitation agreement is the most practical to enforce,” Pesce continued. “Our goal is not to keep anybody out of the business, but if you want to leave, you can’t take our book of business with you. It’s a mixed bag whether underwriters have non-solicitation agreements; most of ours do. It’s common in the wholesale broker space.
“We’re more protective of a business we acquire, he said. “We won’t not acquire a business in California, but we will proceed carefully given the situation because there’s nothing to stop them from walking out the door.”
Matt Sackett, chief executive officer and co-owner of DOXA Insurance, agreed with Pesce about not allowing an employee to take the book of business when leaving a company.
Sackett discussed the use of restrictive covenants. “We use restrictive covenants in the businesses we own, as well as with production underwriters and business development specialists. From an acquisition standpoint, we’re paying for forward earnings on a business. If we’re paying a multiple of nine or ten times EBITDA, we hope that business will grow.
“The multiple gets smaller over time,” he added, “but that’s hard to do when you’re questioning how protected that business is. Outside of an agreement, we look for how many points of contact within the business there are for a particular client because it’s not always one relationship that keeps the business but several.”
“In a confidentiality agreement, the employee agrees not to reveal business confidences to competitors or others outside the employer’s business.”
—Diana Estrada
Partner and Employment Practice Group Co-Chair
Wilson Elser
What about a broker? Colis posed a question to the panel: “If an employee who is covered by a non-solicitation agreement decides to leave the company and does not take the business but is approached by a broker, does the non-solicitation agreement have any effect?”
Replied Pesce: “It depends on the size of the book of business and how aggressively I want to go after it. If I bought a book of business and someone tried to do that, I would go after what was written in the contract and get every amount of protection I possibly could.”
Asked Colis: “Does a non-solicitation agreement cover just clients of the MGA or the entire MGA, or both?” Sackett responded: “The clients.” Pesce agreed.
“It matters how you structure it—not just the fact that the contract is in place but that there’s consideration that’s specifically tied to it,” Sackett asserted. Added Estrada: “This needs to be more than just salary if you want it to be strong.”
“I believe in complete transparency and brutal honesty,” Sackett said. “The best time to have this conversation is at the beginning of the relationship. I’m going to invest our intellectual capital in you, introduce you to our brokers, and possibly give you equity, and here are our expectations of you.”
Note: Quotes have been edited for clarity and brevity.
The author
Elisabeth Boone, CPCU, is a freelance journalist based in St. Louis, Missouri.
