Virginia Court Finds Non-Compete Agreement Unenforceable
A recent decision from a Virginia Circuit Court serves as a worthwhile reminder to Virginia employers that not all non-compete agreements are enforceable. Although there was a non-compete agreement in place between a wholesale business and a former employee (who served as an account representative), the court in Specialty Marketing, Inc. v. Lawrence dismissed the breach of contract action because the agreement was geographically and functionally overbroad.
As we recently detailed in our series on business litigation claims, restrictive covenants (e.g., non-compete agreements) are disfavored in Virginia as they are restraints on trade. As such, it is the employer’s burden to prove that the restrictions are: 1) no greater than necessary to protect the employer’s legitimate business interest; and 2) not unduly harsh or oppressive in curtailing an employee’s ability to earn a livelihood. To determine whether an employer has met its burden, a Virginia court will look at the function, geographic scope, and duration of the non-compete agreement.
In Specialty Marketing, Inc. v. Lawrence, the non-compete agreement at issue provided that the employee could not “be employed by . . . any business competitive with Specialty in areas where Specialty has a market for its business.” The court concluded that this language was overbroad and unenforceable because it was unlimited in functional scope and far exceeded whatever limitation was necessary to protect the employer’s business interests. Additionally, the non-compete agreement was geographically overbroad as it was not limited to the area formerly serviced by the employee; nor was the agreement limited to a specific mile radius from the employee’s former territory.
As this case illustrates, simply having an agreement in place may not properly protect a Virginia business from competition by a former employee. To be upheld under Virginia law, the non-compete agreement must be narrowly tailored in terms of function, geographic scope, and time.
Q & A: Buy-Sell Agreements In Virginia
As a lawyer with a small business clientele in Virginia, I am frequently asked about Buy-Sell Agreements. Although most small business owners are generally familiar with the concept of a Buy-Sell Agreement, I find that most do not truly understand the purpose of a Buy-Sell Agreement or the form in which these contracts typically exist. Accordingly, here is a brief primer on Buy-Sell Agreements in Virginia.
What is a Buy-Sell Agreement?
A Buy-Sell Agreement is a contractual arrangement between the owners of a business (e.g., a corporation, limited liability company, or partnership) that sets forth the process by which an ownership interest can be sold upon the occurrence of certain triggering events (e.g., retirement, divorce, bankruptcy, disability, death, or a third-party offer) as well as the price or formula for such sale.
Is a Buy-Sell Agreement a stand-alone contract?
Not necessarily. A Buy-Sell Agreement can either be a stand-alone contract or a series of provisions that are incorporated into the governing documents of a business (e.g., By-Laws for a corporation or the Operating Agreement for a limited liability company).
What are the advantages of having a Buy-Sell Agreement?
By having a Buy-Sell Agreement in place, the owners of a company can completely control the disposition of an ownership interest in the business as well as control the composition of the ownership group. In a closely-held company (such as a small, family-owned business), the ability to restrict the transfer or sale of an owner’s interest in the company is an extremely important consideration as it keeps outsiders from assuming a share of the business.
What are the types of Buy-Sell Agreements?
There are three types of Buy-Sell Agreements:
- Redemption Agreement: The selling owner must either sell his ownership interest to the company or provide the company with a right of first refusal. In essence, the company is “redeeming” the shares of the owner.
- Cross-Purchase Agreement: The selling owner must either sell his ownership interest to the remaining owners or provide the remaining owners with a right of first refusal.
- “Hybrid” Agreement: A Hybrid Agreement is simply a blend of a Redemption Agreement and a Cross-Purchase Agreement.
How is a purchase funded under a Buy-Sell Agreement?
Many small businesses do not have the capital reserves to fund the purchase of an ownership interest. As such, a common approach (utilized by businesses and individuals alike) is to purchase and maintain an insurance policy from which the proceeds (upon the disability, death, or retirement of an owner) are used to purchase the available ownership interest. Other funding options include installment plans and loan arrangements.
For one reason or another, every small business is eventually confronted with the loss of an owner. As such, whether you have a startup company or an existing small business, it is of critical importance that you have a well-drafted Buy-Sell Agreement in place to maintain business continuity and to proactively limit any issues relating to the departure of an owner.
Proposed Federal Law Will End Transparent Incorporation Practices
From the National Law Journal comes a report on the Incorporation Transparency and Law Enforcement Assistance Act, a proposed bill that is currently pending before the United States Senate Committee on Homeland Security and Governmental Affairs. The bi-partisan bill (S.569), which was introduced by Sens. Carl Levin (Michigan), Charles Grassley (Iowa), and Claire McCaskill (Missouri), would require states to collect and maintain information on the “beneficial owners” of corporations and limited liability companies in furtherance of preventing terrorism and money laundering.
If this legislation passes, each applicant seeking to form a corporation or an LLC would have to disclose, during the formation process, the names and addresses of its beneficial owners. Corporations and LLCs already in existence would have to provide this information in its annual filing or, if no annual filing is required, each time a change is made in the beneficial ownership of the company. Under the bill, the term “beneficial owner” is ambiguously defined as
an individual who has a level of control over, or entitlement to, the funds or assets of a corporation or limited liability company that, as a practical matter, enables the individual, directly or indirectly, to control, manage, or direct the corporation or limited liability company.
States would be required to maintain beneficial ownership information for a 5-year period and would have to provide such information upon receiving a subpoena or summons from a state agency, federal agency, or congressional committee. If a corporation or LLC provides false beneficial ownership information, it may face civil or criminal penalties.
The proposed law would have a tremendous impact on businesses in states, such as Virginia, where little, if any, information about the identity of a company’s ownership is required. (For instance, an applicant for an LLC in Virginia does not have to disclose any ownership information upon formation.) States and businesses alike will bare a potentially onerous administrative burden in their respective efforts to comply with the law. The bill’s sponsors aver that such a burden is a small price to pay for information that will help law enforcement detect, prevent, and punish terrorism and money laundering.
Although I am certainly in favor of eradicating terrorism and other forms of criminal activity, I have a number of issues with the proposed legislation. As an attorney with small business clients, I can think of several non-criminal examples where privacy is of paramount significance to business owners – particularly those businesses that are formed to invest in legitimate projects.
Additionally, as is often the case with legislation of this nature, the ultimate burden will fall on the very companies that are least likely to break the law. While the vast majority of corporations and LLCs are expending time and resources to understand the definition of a “beneficial owner” so as to avoid the imposition of a penalty, those with illicit intent will simply exploit other business structures for criminal gain.
Currently, the Incorporation Transparency and Law Enforcement Assistance Act is in the beginning stages of the legislative process. Given the attention that it is already receiving, it will be interesting to see whether it will garner the requisite support to become a law.
Contract Forum Selection Clauses Are Critical When Doing Business with Out-of-State Companies
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In the event of a contract dispute, litigating the matter in Virginia has its advantages to Virginia businesses – Virginia litigation limits travel expenses to out-of-state jurisdictions, provides familiarity with judges and opposing counsel, and assists in the prevention of inconsistent application of laws to your business contract. However, the only way to ensure that you have the “home team” advantage is to incorporate a forum selection clause in your business contract.
A forum selection clause provides the particular location where any and all lawsuits relating to the contract will be litigated, and is critical when doing business with out-of-state vendors, customers and other business partners. If your business contract is silent with respect to where such disputes will be resolved, you may find yourself litigating in far away places.
Two recent cases involving eBay highlight the importance of a forum selection clause - Tricome v. eBay, Inc. and Universal Grading Service v. eBay Inc. In both cases, eBay business users attempted to sue eBay in their home jurisdiction on the East Coast. In response to the litigation, eBay moved to transfer the cases to Santa Clara County, California, based on the forum selection clause contained in the User Agreement between eBay and the plaintiffs. The Judge found that eBay could name the forum in its contracts with users and that the users assented to this jurisdiction when they clicked on the box acknowledging the terms and conditions of the User Agreement; thus, eBay prevailed and successfully forced these plaintiffs to litigate on its home turf.
If you are a Virginia business, you should make sure that all of your business contracts contain a forum selection clause that designates a Virginia court (preferably in the city or county where your office is located) as the forum for litigation.
Teaming with a Large Company to Pursue Government Contracts? Watch Your Small Business' Intellectual Property!
In the current recessionary economic climate, there is one customer that is arguably still spending a lot of money to receive goods and services – the U.S. federal government. For many small businesses trying to team with government agencies, the best approach may be to team with a larger company that can supplement your small business' skill sets, and provide leverage and credentials you may not yet have acquired. In pursuit of these contracts, it is vital to pay attention to your small business’ intellectual property (patents, trademarks, copyrights, trade secrets).
By encouraging teaming of large government contract firms with small businesses, government agencies can benefit. Government agencies fulfill their goal in carrying out the principal tenet of the original Small Business Act (1953) – to encourage and develop small business growth. By consolidating their buy requirements with a single contractor, government agency buyers of goods and services can reduce their administrative burden, program management costs and risks, all while expanding opportunities for small business that result in overall increased competition and the fostering of innovation.
So, what’s in it for the large firms? Well, both small and large companies benefit from teaming. While a small company can tap its larger counterpart’s knowledge, experience and purchasing power, the larger firm gains access to small business set-aside opportunities. For example, by partnering with Service-Disabled Veteran Owned Small Businesses (SDVOSB), large firms can access one of the hundreds of monthly set-aside contracting opportunities for which they would otherwise be ineligible to compete. Also, partnering with a small business can enhance a large business’ relationship with various federal contracting agencies as many struggle to meet their set-aside goals. The mutually beneficial relationship of the teaming arrangement results in a highly-efficient and diversified team capable of winning new business and providing excellent customer service to the government.
Regardless of the mechanics of a large government contractor-small business teaming arrangement, smaller firms – simply because they are small and are eager for new business – have to be vigilant about their intellectual property rights. For example, unbeknownst to many small, high-tech firms is that Section 52.227-11(k)(3) of the Federal Acquisition Rules makes it illegal for a large firm to require a small business it is partnering with on a government contract to give up any IP rights as a precondition to working on the contract. Thus, there is a statutory framework that levels the playing field in negotiations with large firms. This statutory level playing field, however, only applies to patent rights. For a small firm’s innovations protected by trade secret, copyright or trademark, extra vigilance is required when negotiating such agreements to preserve these forms of IP rights.
Fourth Circuit: A Court Cannot Overturn an Arbitrator's Construction of Business Contract
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Based on a recent decision by the Fourth Circuit Court of Appeals, business owners may want to think twice before including an arbitration clause in a contract. In the case of PPG Industries, Inc. v. Int’l Chemical Workers Union Council, the Fourth Circuit considered whether a reviewing court must defer to an arbitrator’s construction of a contract even when the court believes that the arbitrator construed the contract incorrectly. In a decision that may be of some surprise to business owners, the Fourth Circuit held that even if a court is convinced that the arbitrator committed serious error, a court cannot overturn the arbitrator’s decision.
In its reversal of the district court, the Fourth Circuit held that, except in “very limited” instances, a court has no right to determine the correctness of an arbitrator’s award when the parties to a contract have agreed that disputes should be submitted to arbitration. Once the arbitrator has ruled, then the court’s only function, with respect to that decision, is to determine “whether the arbitrator did his job – not whether he did it well, correctly, or reasonably, but simply whether he did it.” Unless the arbitrator ignores “the plain language of the contract,” a court cannot overturn a clearly erroneous award.
Although the PPG Industries, Inc. decision isn’t new law, business owners should pay it special attention. Over the past couple of years, I have had many clients request an arbitration clause in a business contract because they believe that it is a quicker and cheaper alternative to court litigation. While arbitration does have some advantages over litigation, those advantages come at a heavy price: the substantial risk of having no recourse for a bad or incorrect arbitration award.
In Virginia, where courts are renowned for their “rocket dockets”, business owners may want to think twice before inserting an arbitration clause into a contract. Without the advantage of a quicker resolution, it may be best to forego an arbitration clause in favor of permitting court litigation. Although courts and juries aren’t always perfect, at least you will have the option to appeal an erroneous decision.
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