Todd Stein

Friday, 20 December 2002 09:36

Incomplete noncompetes

Buying and selling a business in Pennsylvania just got more complicated.

A recent state Supreme Court ruling makes it harder for the new owners of a business to enforce employee noncompete agreements after an asset sale. The ruling could deflate a seller's asking price by releasing top employees from their noncompete pacts.

Without noncompete agreements in place, key employees, such as top sales executives, can jump ship after the company is sold and defect to a competitor, taking major accounts and the company's market value with them.

The decision, W. Lawrence Hess v. Gebhard & Co. Inc. & Eugene Hoaster Co., Inc., exposed a loophole in a salesperson's noncompete agreement.

Essentially, the pact was not enforceable because it was missing an assignability clause. The asset sale agreement required the selling business to assign its contracts, including employment agreements, to the buying business. The employment contract, however, was deemed by the court a personal contract between the salesman and his original employer. Absent the assignability clause, the salesman was free to look for a new job with local competitors.

What does this mean for small business owners? To start, make sure new noncompete agreements contain assignability clauses. Adding a clause later creates a big hurdle. In exchange for inserting the clause into an existing contract, the employer must supply the worker with "new consideration," possibly a pay raise, promotion or a payment of money.

What's more, the mere mention of assignability clauses can lead to sale rumors, employee turnover and deflation of company value, exactly the things the owners are trying to avoid. Management must be ready to deal with gossip, even if a sale is not in the works.

Because there is a cost associated with adding the clause, management should assess which employees are worth the expense. And there's another consideration: Would the courts uphold noncompete agreements if the sale were a stock sale, rather than an asset sale? In a stock transaction, the contract parties remain the same: the salesperson and his/her original company. In theory, the contract need not be assigned.

The theory, however, has not yet been tested in the Pennsylvania Supreme Court. Stanley M. Stein is a partner with Feldstein Grinberg Stein & McKee. He is a business litigator specializing in noncompete agreements and trade secrets. Reach him at or (412) 263-6111.

While most business owners are careful to maintain adequate coverage for theft, fires, floods and other natural disasters, too many overlook three critical areas of vulnerability.

Business interruption insurance reimburses for overhead expenses and loss of profits when a fire or other occurrence interferes with day-to-day operations. It’s separate from disaster coverage, which addresses physical damage. Be sure the policy protects against the failure of a primary vendor to provide materials or products you need to conduct business.

If your business encompasses more than one location, look into blanket coverage for property damage, business interruption and extra expenses. You can get rental insurance to reimburse landlords for rent owed during an interruption. It’s possible to buy an extended period of indemnity, which gives your company extra time to get back on its feet after the interruption ends.

The other problem with business interruption is that insurance can preserve your business until it’s ready to reopen, but by then, your customers will have found other suppliers. Prevent this by forming an agreement with a friendly competitor to produce each other’s product during an interruption. Customers won’t be left in a lurch and you’ll have customers to serve once it’s over.

General liability insurance coverage should include employee benefit liability and defense coverage, as well as stop-gap liability and defense coverage. The former protects you from damages caused by a paperwork mistake, such as failing to add a new employee into the benefits system by paying the employee’s medical expenses, as well as your legal expenses, if your company is found at fault.

The latter provides reimbursement of expenses if you’re found liable for an employee’s injury after asking the person to do something outside safety standards.

Disability insurance for your top salesperson, chief engineer or other key employee in case he or she is unable to work for an extended period due to a serious illness or accident outside work. Benefits go to the individual, so the company doesn’t have to continue the salary—freeing up money to temporarily fill the slot and keep your business running. Since you were not forced to fire the person, it’s more likely he or she will return when able.

And what disability protection do you have as owner of the business? Many companies, particularly those in periods of fast growth, rise and fall with the talents of the owner. If you faced a disabling injury, would your business—and your family—survive a long down period? Disability protection means you as the owner still receive an income stream, allowing the business to hire someone to fill your shoes until you can return to work.

Remember to specify “own-occupation” coverage—as opposed to “return-to-work”—when purchasing disability insurance, so the reimbursement remains in effect until the individual can’t return to the original job. Be sure to find a policy that is noncancelable by the insurer. Finally, lower cost group coverage can be purchased for employees as a group benefit.

Other coverages depend on particulars of your business—such as utility interruption coverage in case of a power outage or long distance phone service interruption. Are your executives covered during business-related foreign travel? If you operate out of an older facility that doesn’t meet today’s building codes, you might consider ordinance of law and increased cost of construction coverage to pay for rebuilding costs related to bringing your facility to compliance with local regulations.

For the best protection, obtain a complete audit of your property and casualty coverages from a professional risk manager.

Todd Stein is president of the Brunswick Cos.