Protecting Your Business from President Biden's "New Deal" for FTC to Curtail "Non-Compete Clauses"

 

                 On July 9, 2021, President Biden issued an Executive Order to coordinate all federal agencies around a national policy to promote competition, prevent and curtail abusive monopolies and monopolistic practices.  

 The Executive Order calls upon the Federal Trade Commission (FTC) to “address agreements that may unduly limit workers' ability to change jobs.”  Under Section 5(a) of the FTC Act, the FTC can regulate “unfair or deceptive trade practices in or affecting interstate commerce.”  Existing 2015 FTC policy targets “the promotion of consumer welfare.”   President Biden seeks to expand that policy to include worker mobility: “to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”  But “unfairness” is not defined by statute.  If a non-compete agreement is too restrictive, a worker might not find a new job with higher wages or better employment opportunities.

                For business owners and tech investors, it is time to anticipate and manage potential challenges to non-competition covenants. 

                For employees, consultants, business service providers and strategic alliance partners, new federal regulations probably cannot replace the need for smart negotiations to prevent possible abusive enforcement of a valid restrictive covenant.  

                What is a Non-Compete Clause?  A non-competition clause or “covenant” is a contractual obligation by an employee not to compete with the employer’s business during employment and for some limited period after employment.  This restricts the employee from joining a competitor until after a reasonable “cooling off” period.  But the restriction is limited in scope, duration and, if appropriate, geography.  Every situation is different, so courts analyze the benefits, burdens and reasonableness.  The non-compete clause typically includes protections for trade secrets, which can exist forever (e.g., Coca Cola’s secret formula for its soft drink).

Why Businesses Require Non-Compete Clauses.  Non-compete clauses serve valid competitive purposes.  They protect a business against:

·         Poaching of the business’s clients and employees (but not forever);

·         Unauthorized disclosure of trade secrets (both of the employer and third parties doing business with the employer) and other employer confidential information; and

·         An employee’s abuse of his or her duty of loyalty while an employee.

 What are the Public Policy Limitations on Enforcement of Non-Compete Covenants.  In New York, such clauses are permitted as a matter of long-standing public policy (“common law,” not statute) to protect an employer.  (An exception exists for the broadcast industry.)  New York common law (“public policy”) already limits non-compete covenants.  The covenant must be reasonable in scope of work (relating to the first employer’s business activities), duration and geography.  As summarized by a former New York attorney general in 2017:

A non-compete [agreement] is only allowed and enforceable to the extent it (1) is necessary to protect the employer’s legitimate interests, (2) does not impose an undue hardship on the employee, (3) does not harm the public, and (4) is reasonable in time period and geographic scope. An employer’s legitimate interest may include protecting an employer’s trade secrets and confidential information and preventing employees from taking specialized skills they gained on the job to a competitor. A non-compete’s restrictions must be no greater than necessary to protect the legitimate interests of the employer. To determine if a non-compete is enforceable, courts consider an employee’s job duties, the employer’s business interest, and the language of the agreement.

In contrast, a California statute bans non-competition covenants as a “restraint of trade” unless negotiated as part of the sale of shares or the employer’s business.  Exceptions apply to situations involving business exit transactions including the sale of the goodwill of a business, the seller’s entire ownership interest in the business entity, or all or substantially all of a business’ operating assets together with the goodwill.  Calif. Bus. & Prof. Code §§ 16600 and 16601.

 Negotiated Contractual Limitations on Non-Compete Clauses. To limit an overly broad limitation on mobility of workers and business service providers, employees, business service providers, licensors, strategic partners and others can negotiate limitations on non-compete clauses.  For example, one might negotiate an exclusion for information and know-how that is “general skill and knowledge” in an industry.  Or an employee might negotiate a separation bonus can seek some compensation, particularly where the employee to cover the post-termination period, especially where the termination was “without cause.”   For new senior executives coming on board with broad substantive and strategic knowledge, a blacklist of “competitors” and a whitelist of “non-competitors” might be identified to give comfort to both employer and executive.

 Planning How to Improve your Chances of Enforcing a non-Competition Clause.  Anticipating new FTC regulations on interstate businesses, you can improve your odds of judicial enforcement of your non-competition covenants.  In addition to carefully crafting your non-compete clauses, you can:

 ·         Pay some money that is earned only during the post-termination period.  This provides special “consideration” beyond one’s normal salary. 

-        In England, they send such employees to “garden leave” to do nothing but grow a garden. 

-      In Japan, the “corner office work” serves the same function, where job duties are restricted with full pay.

·          Limit the scope to what is needed for saving your customers, your employees and your trade secrets from poaching.  

·         Protect trade secrets through internal management practices, manuals, trainings and segregation of functions, as well as clauses in employment agreements, licensing agreements, business services agreements (outsourcing), non-disclosure agreements, financings, strategic transactions, and any transaction for a change of control.

·         Protect existing and prospective client relationships and employees from being poached by delivering good customer experiences and employee satisfaction.

·         Link non-compete clauses to stock options, restricted stock units and/or deferred compensation.

·         Negotiate with your new employees (and their attorneys) to have them agree the restrictions are reasonable.

·         Require disclosure to new employers so that they can evaluate whether there is a risk of conflict and breach.

·         Consult an attorney who understands your business model and can help you build, protect and securely exit your business.

How to Modify Your Contracts to Reallocate Risks When Quixotic Presidential Orders Strike

In last week's blog post, I reviewed how “force majeure” issues  might excuse a contractual party’s non-performance and ways in which they might be addressed to avoid this problem.  The focus was on President Trump’s executive orders and legislative changes that could act like a hurricane to destroy predictability in international business.   Perhaps they might be merely lofty and chivalrous but impulsive and impractical, as Miguel Cervantes’ 1600’s story of Don Quixote.

This blog post looks at ways in which restructuring your contract can aid buyers and sellers under state laws for sale of goods.

The sale of goods is governed by the Uniform Commercial Code (UCC) in the 50 states.  The UCC sets forth minimum “obligations of good faith, diligence, reasonableness, and care” that “may not be disclaimed by agreement.”  UCC Section 1-302(b).  Contingency planning thus needs to consider the UCC legal framework for escaping or mitigating the impact of a new presidential executive order, law or regulation.

Pre-Contract Planning.  Risk mitigation planning starts with contract design and limitation of liability under the contract.

1. Negotiated Limitation of Liability.   Be specific and state all limitations of liability, indemnifications and non-performance scenarios (such as liquidated damages).

2. “Irrevocable” Firm Offers.  Sellers should shorten the duration of any “irrevocable” or “firm” offer  and set a reasonably early date for the expiration of the offer (See UCC 2-205), given the unpredictability of the current economic climate.  In any event, the UCC limits such “firm offers” to a maximum of three months.

Contract Restructuring.  There are several UCC rules on contract revisions. If neglected, they could result in unforeseen liability and costs.

1. Commercial Impracticability.  The UCC allows parties to be excused from performance due to “commercial impracticability.”  In other words, a contingency happened that wasn't supposed to or ordinarily would rarely happen.

2. How to Wiggle out of your Contract?   What’s necessary for modification, rescission or waiver of a contract?  If you want to wiggle out, wiggle carefully!  To modify a signed contract for the sale of goods, the changes must be in writing (except “as between merchants”).  UCC 2-209. By requesting modification or rescission, the party seeking the change may be deemed to have waived any non-performance by the other party.  To avoid this risk, the request for modification or rescission should be carefully written.  If the other party has waived a clause, the waiving party may retract the waiver by reasonable notification that strict performance will henceforth be required for any term waived.  However, such a retraction of waiver is invalid if “the retraction would be unjust in view of a material change of position in reliance on the waiver.”  So, once you waive a breach (such as for force majeure), you can’t retract it if your counterparty detrimentally relied in a material manner.

3. Kicking Your Own Bad Habits.  Similarly, have you been too lenient with your supplier by putting the contract in the drawer and forgetting the performance standards and service level agreements?  it may be time to disrupt any “course of dealing” or “course of performance” (or even “usage of trade”).  Kick your “bad habits” by expressly re-affirming that strict compliance with contract terms is required (if you are the buyer) or by proposing a modification or waiver (if you are the seller).  UCC 2—208 holds the parties to an implied contractual provision where the contract for sale involves “repeated occasions for performance by either party with knowledge of the nature of the performance and opportunity for objection to it by the other, any course of performance accepted or acquiesced in without objection.” If you don’t object, you’re stuck with the practical construction of the contract by course of performance, you’re committed to it.

4. Play the Game.  Don’t forget your duty to cooperate, particularly as a buyer.  UCC 2-311 allows one party to a sale contract to treat non-cooperation by the other party relating to delivery or acceptance of the goods as either (i) an excuse for his own delay, (ii) a breach, or (iii) an opportunity to proceed in a reasonable manner.

5. How Bad Must it Be Before You Can Invalidate the Deal?  Was the contract “unconscionable” at inception?  If so, the UCC 2-302 allows a court to invalidate the entire contract or just the provisions that are unconscionable.  This rule generally applies only to the sale of consumer goods.

6. Feeling Insecure about the Contractor’s Performance?  What if President Trump’s executive orders give a buyer or seller reasonable grounds to feel insecure about the future performance of its counterparty?  The UCC resolves this by allowing a party to demand “adequate assurances” and, if it does not receive them, to suspend or cancel the contract.  Under UCC 2—609, each party has a right to adequate assurance of performance by the other.  If there is no “assurance of due performance” within a reasonable time (not more than 30 days) of a receipt of a justified demand, failure to provide adequate assurances can be treated as a repudiation of the contract.

7. Launch a Pre-emptive Strike.   Whether or not a party requests and gets “adequate assurances” of performance, a contract may be canceled if one party acts in “anticipatory repudiation” under UCC 2—610.  This could be a defensive tactic used when either party can foresee that its performance may not be up to par in accordance to their contract.  Of course, a repudiating party can retract his repudiation “with due excuse and allowance to the aggrieved party for any delay occasioned by the repudiation.” UCC 2-611.

In conclusion, when force majeure clause or “commercial impracticability” under UCC 2-615 is not available as an excuse for non-performance, principles of contract restructuring may be available. However, care should be taken to avoid inadvertent technical breach by anticipatory repudiation or inadvertent waiver.

Wiggle carefully!

Legal Escapes from Disasters: Force Majeure and other Excuses for Contractual Non-Performance under Sudden Changes in Presidential Executive Orders

What’s the difference between a hurricane and a presidential order of Donald Trump? Legally, maybe not much.

President Trump’s unexpected executive order in January 2017, which banned any nationals from 7 countries from entering the U.S. for 90 days, surprised not only the would-be terrorists but also the law-abiding business community. More disruption may be foreseeable. NAFTA could be terminated or restructured. Business visas could be curtailed. Imported goods and services could be subject to a new “border adjustment tax,” while exports would be exonerated. Other disruptions to the global supply chain are clearly foreseeable, but the parameters remain to be seen.

Plan Ahead Now. Every buyer or seller of goods or services across borders should be making plans to deal with potential sudden changes in U.S. law or policy. Let’s consider “force majeure” and other legal excuses for contractual non-performance under the Uniform Commercial Code ["UCC"] (applicable in all 50 states). Possible action steps include contingency planning, review and renegotiation of contracts, repricing, workforce redeployment or restructuring, hedging contracts, business interruption insurance, business continuity planning, disaster recovery procedures, diversification of risk portfolio by sourcing from backup suppliers, and internal and external audits of procedures.

What is “Force Majeure”?   “Force majeure” is a common law concept of equity that excuses non-performance by a seller. Typically, “force majeure” clauses in a contract define the types of events: natural disaster or regulatory prohibition. Less obvious is whether the “force majeure” concept gives a valid excuse not to deliver due to a sudden increase in the price of components or commodities, and, if so, whether such an excuse depends on whether the new shortages in global supply arise from speculators seeking to corner the market, hoarding by merchants to hedge against future risks, uncertainty or a other sudden increase in demand for the item in the marketplace. Even less obvious is whether a sudden new regulation qualifies as a force majeure if it merely increases the cost of doing business, adds a new tax to a type of transaction (such as a tax on imports of products or components needed for manufacturing), or imposes a new requirement for a governmental license. 

Drafting (or Reviewing) Force Majeure Clauses. It’s time to review your contracts and perhaps seek modification to your “force majeure” clauses.

1. Definition.  What is a “force majeure” event for purpose of this contract? The contract should define it by including specific examples and excluding cases that might be recurring, predictable and thus “ordinary” risks to be allocated expressly by contract. Must the event be unforeseeable, or merely overwhelming?

2. Impossibility?  or Mere Change in Costs of Delivery? Must the impact make performance impossible, or will the contract be changed if there is merely an extreme difficulty or higher cost? Where possible, the parties should allocate risks by specifying outcomes of predictable contingencies, such as (i) sudden shortages in the marketplace, (ii) changes in pricing or exchange rates, (iii) regulatory changes that affect the normal supply chains for labor and goods.

3. Required Mitigation?  What actions must the affected party take before the impact of the force majeure event can validly excuse non-performance or delay performance? At a minimum, one might ask the affected party to take reasonable measures using reasonable effort to overcome the adverse impact.

4. Option to Pay to Cure?  May the unaffected party insist on the right to pay extra to get a “cure” and thus enjoy the benefit of the bargain, albeit at a higher cost?

5. Notice and Other Conditions for Being Excused.  Must the affected party give notice of inability to perform due to a “force majeure” event? And how soon, to be “timely”? What kind of notice is needed? What are the consequences of not giving timely notice? Is the giving of notice excused when the unaffected party has actual or constructive notice (such as by reading newspapers or watching a TV journalist’s nightly critiques of Trump’s operations)?

6. Duty of Cooperation?  What level of cooperation (and effort and payment of money to overcome the force majeure’s impact) is required from the un-affected party?

7. Cancellation.  How long must the parties wait before treating the contract as cancelled?

8. Practical Risk Management Solutions.  What alternative solutions exist when both parties refuse to accept a risk?

a.  Insurance.  Either party can purchase business interruption insurance and thus quantify the allocation of risk. Insurance also can cover loss of the goods. What conditions are necessary to have such insurance coverage? When does the insured acquire an insurable interest?

b.  Disaster Preparedness.  Procurement officers normally insist on the seller’s or service provider’s having a business continuity plan and disaster recovery procedures, which would be audited under SOC II or SSAE 16 Type II audit processes.

c.  Resiliency in the Global Supply Chain.  Potentially, goods or services could be provided from centers located in geographies with different disaster profiles. A portfolio approach could be used to mitigate risks (political, technical, economic, pricing, regulatory, etc.) that are related to any one particular supplier.

Force Majeure in the Sale of Goods: "Commercial Impracticability" and Legal Prohibition.   In two scenarios, a seller of goods is excused from non-performance under UCC 2-615 (with caveats):

• “if performance as agreed has been made impracticable by the occurrence of a contingency the non-occurrence of which was a basic assumption on which the contract was made. “ In other words, a contingency happened that wasn't supposed to happen or ordinarily would rarely happen. Or


• “by compliance in good faith with any applicable foreign or domestic governmental regulation or order whether or not it later proves to be invalid.”

Few contracts identify the “basic assumptions” that underlie the commercial reasonableness. Hence, the “commercial impracticability” defense under UCC 2-615 is so vague that it invites mediation, negotiation and settlement. Once it applies, though, the supplier must allocate resources in a fair and reasonable manner.

In this Trump era, unexpected and sudden changes in U.S. laws, regulations and policy may be the order of things to come. Service providers, supply chain managers (from CEO’s, CFO’s and CIO's all the way down to procurement officers) and e-commerce merchants need to rethink contingency planning, including redefining Force Majeure clauses.

More on this in my next blog.

Redesigning the U.S. Business Workforce by Obama Fiat

If you thought Obama’s recent fiat on immigration only on focuses on Hispanic families and other illegal aliens, you are wrong. It targets business growth across the size, maturity and territorial footprint of a wide array of US businesses.

On November 20, 2014, President Barack Obama announced an Executive Order changing the legality of current illegal residents, creating  a path to regularization and amnesty for some 4 million to 5 million illegal aliens who have been in the United States for over 5 years, are not felons and will pay taxes.  But the real economic impact of his governing by “national interest waiver” and “parole” of foreigners into the U.S. will be felt more broadly, in startups, technology-based businesses and outsourcing services.

His proposal is to govern not by enforcing law, but by waiving enforcement and announcing it as an executive fiat rather than by legislative reform.  For politicians, this will potentially expose his waiver policy to judicial scrutiny and political contests in Congress, so much so that I believe that true legislative reform is highly unlikely in the next two years.

The political impetus was humanitarian aid to foreign parents of U.S. citizen children.   The economic impact will be felt broadly, not only in industries (such as restaurants, food processing, farming, landscaping and small business) that have traditionally employed illegal foreign workers.  Indeed, the greater impact will be felt across broad sectors involving STEM technology, startups, venture capital, outsourcing, global consulting and multinational companies.

• Domestic business owners will face increased costs of compliance with new administrative regulations. Those businesses that have relied upon illegal foreign workers will likely have to increase wages because the newly protected illegal foreign workers will have new portability of their work at one employer as a basis for adjustment of status to lawful permanent resident.  The new rules for the “Deferred Action for Childhood Arrivals” (DACA) program will impact every U.S. employer who will need to adopt new employment eligibility reviews, on terms to be defined under future regulations.

• Startup Mania.

• Foreign-owned startups won’t need to worry about H1-B’s.  They will benefit either by “national interest waivers” or (on a case-by-case basis for “urgent humanitarian reasons or significant public benefit”) by “parole.”  For foreign inventors, researchers and founders of start-up enterprises, the Obama administration has set an agenda to “clarify the standard by which a national interest waiver may be granted to benefit the U.S economy.”  Under individual decisions on to “parole” a foreigner, the USCIS will evaluate and grant individual requests for admission from abroad or even extend the right to “stay in place” in the United States.  According to USCIS, waivers and paroles will be granted to “eligible inventors, researchers and founders of start-up enterprises who might not yet qualify for a national interest waiver,” but who (i) have been awarded “substantial U.S. investor financing”; or (ii) “otherwise hold the promise of innovation and job creation through the development of new technologies or the pursuit of cutting-edge research.”  http://www.uscis.gov/immigrationaction/. 
• Startup Investors.  The US government estimates that this will benefit about 400,000 highly skilled foreign workers.  U.S. angel investors, venture capitalists, startup incubators and their operational supporters will be overjoyed, though the details remain to be seen. 
• Domestic startups will probably have greater access to foreign inventors, researchers and co-founders.

• Foreign investors in US companies, global consulting companies and foreign outsourcing companies dodged a bullet.  Foreign outsourcers will probably be able to continue to send large numbers of skilled foreign workers to fill gaps in the US workforce.    However, I suspect that new regulations will be drafted to adopt (tacitly or explicitly) the restrictions and additional governmental scrutiny under the draft Border Security, Economic Opportunity and Immigration Modernization Act, see S. Rept. 113-40 (113th Cong., 1st Sess.), as passed by the Senate in mid-2013.  Thus, H1-B skilled worker dependent employers would likely need to take good faith steps to recruit U.S. workers first, advertise H1-B jobs on a U.S. Department of Labor website and offer the job to a any U.S. worker who applies and is equally if not better qualified than a potential H1-B skilled worker.

• Foreign spouses of H1-B skilled foreign workers will get the right to work. This will bring additional foreign skills and competition to the American labor market.  But Indian and other foreign outsourcing companies were disappointed not to get an increase in the current 65,000 ceiling on H1-B visas, though they must accept that such an increase would take a new law, not a new “waiver” or “parole.”

• Foreign students will likely get increased access to work in the U.S. after U.S. university training under an expanded and extended definition of “optional practical training.”

• Foreign skilled workers who entered the country legally and are in limbo waiting for green cards (lawful permanent residency) will have new flexibility to change jobs without getting sent to the back of the queue for green cards.  This newfound job mobility will give them higher, more competitive salaries and thus less likelihood of being abused as “cheap labor.”

• U.S. labor unions, Obama’s core supporters, have kept their mouths shut.  They probably will be happy to see higher wages for H1-B’s due to portability and no increase in the 65,000 H1-B cap.   They can’t complain about humanitarian waivers and parole for family unification under the DACA program.

• Governing without a legislature.  In the short term, Obama’s executive order to waive the application of the law on a wholesale basis is good for business (especially high-tech, e-business and startups).  As a political gesture, it is probably bad for the incoming Republican-controlled Congress and the constitutional balance of power.  Thus, it will unlikely be overturned legislatively until a new Congress in 2016.

Not only illegal aliens, but businesses of all sizes, universities, startups, venture capital, business angels, tech-based operations can rejoice.   Of course, the devil’s in the details.