In a December 2014 post, I presented an overview of what items should be included by an employer in a covenant not to compete in order to make it enforceable with respect to the employer’s employees and when that covenant should be implemented by the employer.  This post highlighted a Superior Court of Pennsylvania case being followed by many Pennsylvania attorneys, including my colleague, John Gotaskie.  I supplemented that post with another piece in February of this year which examined the issues being considered by the Pennsylvania Supreme Court on appeal of this case.  While this case is still on appeal, the original ruling held that a covenant not to compete is not enforceable against a former employee who went to work for a competitor due to the fact that the covenant was not supported by additional consideration given by the employer.

Another one of my colleagues, Alex Radus, recently provided another cautionary tale concerning covenants not to compete.  In a June 2015 post, Alex highlighted a Nebraska Supreme Court case which held that a franchisor’s overly broad covenant not to compete would not be enforced against a former franchisee.  One of the two reasons the court gave for not enforcing this overly broad covenant was that the State of Nebraska has a long-standing rule which provides that if a portion of a covenant not to compete is legally unenforceable, then the entire covenant will be unenforceable.  Unlike most other states that allow their courts to rewrite or “blue pencil” an otherwise illegal covenant not to compete in order to make it enforceable, Nebraska courts are not permitted to rewrite the overly broad portions of a covenant not to compete.

Alex concludes his piece by noting that franchisors and their lawyers should ensure that their covenants not to compete are enforceable from the outset under local law, especially in states that do not allow their courts to “blue pencil” these covenants.  Of course, this advice is equally applicable to employers as it is to franchisors.  However, his piece led me to place myself in the shoes of many of my clients who will likely have the following two questions:  What is my local law with respect to covenants not to compete and how do I find out if my state will allow courts to rewrite covenants that are deemed to be overly broad and unenforceable?  For those looking for answers to these questions, Fox Rothschild provides an outstanding resource.

National Survey on Restrictive CovenantsThe National Survey on Restrictive Covenants prepared by colleagues in my firm’s Labor and Employment and Securities Industry practice groups gives a state-by-state overview as to the enforceability of covenants not to compete (as well as covenants not to solicit, covenants not to hire and confidentiality covenants) and whether the so-called “blue pencil doctrine” is allowed to be used by that state’s courts.  As is the case with most laws, the answers provided in this survey are not always cut and dry and will undoubtedly continue to evolve over time, so please be sure to consult your lawyer with respect to particular questions.  In the meantime, feel free to familiarize yourself with your state’s requirements and find out whether your state will permit courts to scale back an otherwise unenforceable covenant not to compete.

 

Copyright: vipdesignusa / 123RF Stock Photo
Copyright: vipdesignusa / 123RF Stock Photo

The US Citizenship and Immigration Service (USCIS) announced today that it has reached the congressionally mandated H-1B cap for fiscal year (FY) 2016. The agency began accepting petitions from employers on April 1.

For more details, I invite you to read yet another excellent blog post by my colleague Catherine Wadhwani in Pittsburgh, writing for our Immigration View blog. In it, she provides a concise rundown on the latest from USCIS. And if you’d like to read more on the intersection between immigration and emerging companies, the Immigration View blog offers a Startup Companies category with relevant posts.

Copyright: vipdesignusa / 123RF Stock Photo
Copyright: vipdesignusa / 123RF Stock Photo

The US Citizenship and Immigration Service (USCIS) has just issued a press release containing useful information for companies looking to hire a talented foreign professional worker who requires H-1B sponsorship. Emerging companies often face this challenge, so mark your calendars for April 1, 2015. That’s when USCIS will begin accepting petitions subject to the fiscal year 2016 H-1B visa cap.

For more details, I invite you to read another excellent blog post by my colleague Catherine Wadhwani in Pittsburgh, writing for our Immigration View blog. In it, she provides a concise rundown on the latest from USCIS.

Back in December of last year, I wrote a piece about a relatively recent Superior Court of Pennsylvania case which held that a covenant not to compete is not enforceable against a key salesperson who left his employer to work for a competitor.  The primary reasoning behind the Court’s decision was that the underlying agreement was not signed at the outset of the salesperson’s employment with his employer and the employer did not provide him with any additional benefits or consideration at the time he signed the agreement.  As the foundation for my piece, I referenced a May 2014 article authored by my colleague John Gotaskie which summarized the key findings in the case.  I also noted that during the week prior to my piece being published, the Pennsylvania Supreme Court agreed to hear an appeal of the Superior Court’s decision and that the final outcome of the case remains open.

Lucky for us, John continues to stay on top of this case and summarizes the key issues to be heard on appeal in another piece he published last week.  The focus of the appeal will be to determine whether Pennsylvania’s Uniform Written Obligations Act allows the enforcement of a restrictive covenant against an employee even without his or her employer providing additional consideration.  In other words, will the Supreme Court allow the mere fact that an employee knowingly signs and intends to be legally bound by a restrictive covenant agreement serve as a substitute for the seemingly well-established requirement that an employer must either have its employees sign this type of agreement at the outset of their employment or provide them with some specific and additional consideration (for example, cash and/or a job promotion) at the time of signing?

While I doubt that the Supreme Court will answer this question with a blanket “yes”, I can’t be sure.  More importantly, as John notes, the factors to be considered by the Supreme Court may suggest that they have doubts about the basis for the Superior Court’s original decision.

Please be sure to check back to see how this case unfolds, but for now the lesson remains the same.  Be prepared to pay your employees unless you have them sign a restrictive covenant agreement at the outset of their employment.

Aside from the obvious (for example, lack of capital, lack of operating history, etc.), one of the most pronounced challenges facing startup and emerging companies is their dependence on one or a few key individuals, whether employees or founders.  This is such a common theme for early stage companies that it is almost universally disclosed to potential investors as a “risk factor” in private placement memoranda or similar documentation used when raising capital.  Smart business owners and investors who understand this risk often seek to protect the company’s interests by requiring that these key individuals enter into covenants not to compete with the company, usually through the form of restrictive covenant agreements. 

Covenants not to compete generally contain three components: (1) a time restriction (i.e., the period of time after employment during which the individual is prohibited from competing against the company); (2) a scope of business restriction (i.e., the type of business or industry within which the individual cannot be engaged); and (3) a geographic restriction (i.e., the locations in which the individual cannot be engaged in a competing activity).  While the laws governing these covenants vary greatly from state to state, most courts will hold that they are enforceable so long as they are intended to protect the legitimate business interests of the company and they are reasonable with respect to time, scope of business and geography.  In other words, they can’t be too long, the type of business or industry cannot be too far-reaching and the area cannot be too large.

However, no matter how reasonable the terms of a covenant not to compete may be, it will almost certainly never be enforced by any court in any state unless the company can show that the covenant not to compete was entered into at the beginning of the individual’s employment with the company or the company provided the individual with some additional and specific consideration such as an increase in salary, a cash bonus or a job promotion.  This “timing” factor was highlighted in an excellent piece authored by John Gotaskie, an attorney in our Pittsburgh office, earlier this year.

John’s piece summarizes a recent Superior Court of Pennsylvania case which held that a covenant not to compete entered into by a key salesperson who left his employer to work for a competitor is not enforceable since the underlying agreement was not signed at the outset of his employment and the employer did not provide him with any additional benefits or consideration at the time he signed the agreement.  You can also listen to John’s podcast on this topic here. Note that last week the Pennsylvania Supreme Court agreed to hear an appeal of this decision, so the final outcome remains open.

Regardless of the outcome, the lesson is fairly straightforward for business owners and their investors.  If your state’s laws allow non-competes for employees, protect your interests and tie up your key employees with covenants not to compete at the outset of their employment.  If you don’t, be prepared to pay, whether it is at the time you ask them to sign as an existing employee or in court when you are trying to enforce the covenant because a former employee that used to be a vital team member is now competing against you.

Copyright: vipdesignusa / 123RF Stock Photo
Copyright: vipdesignusa / 123RF Stock Photo

Although startups can offer unique opportunities for potential employees, emerging companies often face great competition in the hiring process.  Your company may be benefiting from the services of a talented foreign professional worker who requires H-1B sponsorship, or perhaps you’ve identified a foreign professional you’d like to hire.

Because cap-subject H-1B petitions are extremely time-sensitive, it’s best to be prepared.  As a start, I invite you to read an excellent blog post by my colleague Catherine Wadhwani in Pittsburgh, writing for our Immigration View blog. In it, she discusses the upcoming “H-1B cap season.”

If you’re about to form a start-up, you may be trying to decide between forming a corporation or an LLC.  Although many considerations go into this determination, important factors for you to consider are your proposed funding and hiring plans.

Funding Plan

If you’re expecting to raise $1 million or more in your first round of financing, then you will likely be seeking venture capital.  Venture capital firms, which are typically limited partnerships, generally prefer to invest in a C-corporation rather than an LLC.  A venture capital firm will often shy away from investing in an LLC (i) to avoid the profits and losses of the LLC (and the tax implications related thereto) being attributable to the individual partners of the venture capital firm, as an LLC is a “pass through” entity for tax purposes (see Business Week Article)[1], (ii) so that a venture capital firm’s otherwise tax-exempt partners (e.g., pension funds, charities, endowments) are not subject to unrelated business income tax (UBIT) (see 26 U.S.C. § 511 et. seq.)[2], and (iii) due to a venture capital firm’s general familiarity with investing in C-corporations.

However, if your start-up does not need outside capital, or is able to raise capital from individuals or from investors who prefer or are comfortable with flow-through tax treatment, an LLC may be appropriate.

Hiring Plan

If you intend to hire individuals who are to be incentivized by the issuance of stock options or restricted stock, you should form your start-up as a corporation.  A corporation may generally set up an incentive stock option and restricted stock plan in a cost-efficient manner and incentive stock options and restricted stock may be issued by the corporation to its employees in a tax-efficient manner.  Just as importantly, most employees are familiar and comfortable with both stock options and restricted stock.

On the other hand, stock option plans for LLCs are not permitted by IRS rules.  Instead, LLCs may adopt phantom equity or profits interest plans.  Although employees are less familiar with these types of plans and such plans can be less cost-efficient to put in place and less tax-efficient with respect to the employee recipients of phantom equity or profits interests, these types of plans are viable alternatives if there are other compelling reasons to form your start-up as an LLC.