Category: Contracts

Social Media & Emerging Employer Issues: Are You Protected?

McBrayer NEW logo 1-10-13

On June 13, 2013, Business First of Louisville and McBrayer hosted the second annual Social Media Seminar. The seminar’s precedent, Social Media: Strategy and Implementation, was offered in 2012 and was hugely successful. This year’s proved to be no different. Presented by Amy D. Cubbage and Cynthia L. Effinger, the seminar focused on emerging social media issues for employers. If you missed it, you missed out! But don’t worry, a seminar recap is below and for a copy of the PowerPoint slides click here.

McBrayer: If a business has been designated an entity that must comply with HIPAA, what is the risk of employees using social media?

Cubbage: Employers are generally liable for the acts of their employees which are inconsistent with HIPAA data privacy and security rules. As employees’ use of social networking sites increase, so does the possibility of a privacy or security breach. An employee may be violating HIPAA laws simply by posting something about their workday that is seemingly innocent. For instance, a nurse’s Facebook status that says, “Long day, been dealing with a cranky old man just admitted into the ER” could be considered a HIPAA violation and expose an employer to sanctions and fines.

 

McBrayer: Should businesses avoid using social media so that they will not become the target of social media defamation?

Effinger: In this day and age it is hard, if not impossible, for a business to be successful without some use of social media. There is always the risk that someone will make negative comments about an individual or a business online, especially when anonymity is an option. Employers need to know the difference between negativity and true defamation. Negative comments or reviews are allowed, perhaps even encouraged, on some websites. If a statement is truly defamatory, however, then a business should make efforts to have the commentary reported and removed. The first step should always be to ask the internet service provider for a retraction of the comment, but legal action may sometimes be required.

 

McBrayer: When does a negative statement cross the line and become defamation?

Effinger: It is not always easy to tell. First, a statement must be false. If it is true, no matter how damaging, it is not defamation. The same goes for personal opinions. Second, the statement must cause some kind of injury to an individual or business, such as by negatively impacting a business’s sales, to be defamation.

 

McBrayer: Can employers ever prevent employees from “speaking” on social media?

Effinger: Employers should always have social media policies in place that employees read, sign, and abide by. While it is never really possible to prevent employees from saying what they wish on social media sites, some of their speech may not be protected by the First Amendment’s freedom of speech clause.

 

McBrayer: What constitutes “speech” on the internet? Is “liking” a group on Facebook speech? How about posting a YouTube video?

Effinger: This is a problem that courts and governmental employment agencies, like the National Labor Relations Board, are just starting to encounter. There is no bright-line rule for what constitutes “speech,” but it is safe to say that anything an employee does online that is somehow communicated to others (even “liking” a group or posting a video) qualifies.

 

McBrayer: Since a private employer is not bound by the First Amendment, can they terminate employees for social media actions with no repercussions?

Effinger: No! In fact, it could be argued that private employees are afforded more protection for what they say online than public employees. While a private employer has no constitutional duty to allow free speech, the employer is subject to state and federal laws that may prevent them from disciplining an employee’s conduct. As a general rule, private employees have the right to communicate in a “concerted manner” with respect to “terms and conditions” of their employment. Such communication is protected regardless of whether it occurs around the water cooler or, let’s say, on Twitter.

 

McBrayer: It seems like the best policy would be for employers to prohibit employees from discussing the company in any negative manner. Is this acceptable?

Effinger: It is crucial for companies to have social media policies and procedures, but crafting them appropriately can be tricky. There have been several instances where the National Labor Relations Board has reviewed a company’s policy and found its overly broad restrictions or blanket prohibitions illegal. Even giant corporations like General Motors and Target have come under scrutiny for their social media policies and been urged to rewrite them so employees are given more leeway.

 

McBrayer: Is social media a company asset?

Cubbage: Yes! Take a moment to consider all of the “followers”, “fans”, or “connections” that your business may have through its social media accounts. These accounts provide a way to constantly interact with and engage clients and customers. Courts have recently dealt with cases where a company has filed suit after a rogue employee stole a business account in some manner, for instance by refusing to turn over an account password. Accounts are “assets,” even if not tangible property.

 

McBrayer: What is the best way for an employer to protect their social media accounts?

Cubbage: Social media accounts should first be addressed in a company’s operating agreement. Who gets the accounts in the event the company splits? There are additional steps every employer should take, such as including a provision in social media policies that all accounts are property of the business. Also, there should always be more than one person with account information, but never more than a few. Treat social media passwords like any other confidential business information – they should only be distributed on a “need to know” basis.

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What’s New Out There? A Trade and Business Regulatory Update

Sheppard Mullin 2012Proposed DoD Rule: Detection and Avoidance of Counterfeit Electronic Parts (DFARS Case 2012-D-005)

On May 16, 2013, the Department of Defense (“DoD”) issued a proposed rule that would amend the Defense Federal Acquisition Regulation Supplement (“DFARS”) relating to the detection and avoidance of counterfeit parts, in partial implementation of the National Defense Authorization Act (“NDAA”) for Fiscal Year (“FY”) 2012 (Pub. L. 112-81) and the NDAA for FY 2013 (Pub. L. 112-239). 78 Fed. Reg. 28780 (May 16, 2013). The proposed rule would impose new obligations for detecting and protecting against the inclusion of counterfeit parts in their products. Public comments in response to the proposed amendment are due by July 15, 2013.

The proposed rule, titled Detection and Avoidance of Counterfeit Electronic Parts (DFARS Case 2012-D-005), partially implements Section 818 of the NDAA for FY 2012 requiring the issuance of regulations addressing the responsibility of contractors (a) to detect and avoid the use or inclusion of counterfeit – or suspect counterfeit – electronic parts, (b) to use trusted suppliers, and (c) to report counterfeit and suspect counterfeit electronic parts. Pub. L. 112-81,§ 818(c). Section 818(c) also requires DoD to revise the DFARS to make unallowable the costs of re-work or other actions necessary to deal with the use or suspected use of counterfeit electronic parts. Id. The new rule also proposes the following in order to implement the requirements defined in Section 818.

  • Definitions: Adds definitions to DFARS 202.101 for the terms “counterfeit part,” “electronic part,” “legally authorized source,” and “suspect counterfeit part.”
  • Cost Principles and Procedures: Adds DFARS section 231.205-71, which would apply to contractors covered by the Cost Accounting Standards (“CAS”) who supply electronic parts, and would make unallowable the costs of counterfeit or suspect counterfeit electronic parts and the costs of rework or corrective action that may be required to remedy the use or inclusion of such parts. This section provides a narrow exception where (1) the contractor has an operational system to detect and avoid counterfeit parts that has been reviewed and approved by DoD pursuant to DFARS 244.303; (2) the counterfeit or suspect counterfeit electronic parts are government furnished property defined in FAR 45.101; and (3) the covered contractor provides timely notice to the Government.
  • Avoidance and Detection System: Requires contractors to establish and maintain an acceptable counterfeit avoidance detection system that addresses, at a minimum, the following areas: training personnel; inspection and testing; processes to abolish counterfeit parts proliferation; traceability of parts to suppliers; use and qualification of trusted suppliers; reporting and quarantining counterfeit and suspect counterfeit parts; systems to detect and avoid counterfeit electronic parts; and the flow down of avoidance and detection requirements to subcontractors.

Potential Impacts on Contractors and Subcontractors

Although the rule is designed constructively to combat the problem of counterfeit parts in the military supply chain, it imposes additional obligations and related liabilities on contractors and subcontractors alike.

  • The proposed rule shifts the burden of protecting against counterfeit electronic parts to contractors, thus increasing contractor costs and potential contractor liability in this area.
  • Under the proposed rule, contractors would need to take steps to establish avoidance and detection systems in order to monitor for and protect against potential counterfeit electronic parts, also increasing the financial and temporal impact on contractors.
  • Avoidance and detection system requirements will need to be flowed down to subcontractors, increasing subcontractors’ responsibility – and thus liability – for counterfeit parts.
  • The proposed rule would also make unallowable the costs incurred to remove and replace counterfeit parts, which could have a significant financial impact on contractors – even under cost type contracts.
  • As it currently stands, the narrow exception regarding the allowability of such costs applies only where the contractor meets all three requirements of the exception, which likely would be a rare occurrence.

Interim SBA Rule: Expansion of WOSB Program, RIN 3245-AG55

On May 7, 2013, the Small Business Administration (“SBA”) issued an interim final rule implementing Section 1697 of the NDAA for FY 2013, removing the statutory dollar amount for contracts set aside for Women-Owned Small Business (“WOSB”) under the Women-Owned Small Business Program. 78 Fed. Reg. 26504 (May 7, 2013). Comments are due by June 6, 2013.

The new rule would amend SBA 127.503 to permit Contracting Officers (“COs”) to set aside contracts for WOSBs and Economically Disadvantaged WOSBs (“EDWOSBs”) at any dollar amount if there is a reasonable expectation of competition among WOSBs as follows: (1) in industries where WOSBs are underrepresented, the CO may set aside the procurement where two or more EDWOSBs will submit offers for the contract and the CO finds that the contract will be awarded at a fair and reasonable price; or (2) in industries where WOSBs are substantially underrepresented, the CO may set aside the procurement if two or more WOSBs will submit offers for the contract, and the CO finds that the contract will be awarded at a fair and reasonable price.

The new rule would amend SBA 127.503 to permit Contracting Officers (“COs”) to set aside contracts for WOSBs and Economically Disadvantaged WOSBs (“EDWOSBs”) at any dollar amount if there is a reasonable expectation of competition among WOSBs as follows: (1) in industries where WOSBs are underrepresented, the CO may set aside the procurement where two or more EDWOSBs will submit offers for the contract and the CO finds that the contract will be awarded at a fair and reasonable price; or (2) in industries where WOSBs are substantially underrepresented, the CO may set aside the procurement if two or more WOSBs will submit offers for the contract, and the CO finds that the contract will be awarded at a fair and reasonable price.

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Federal Contractors: The Federal Acquisition Regulation (FAR) E-Verify Clause Revisited – Critical Steps a Contractor Can Take To Foster E-Verify Compliance

Sheppard Mullin 2012

“Yes, we use E-Verify.” “Of course, our company is in compliance, we did an I-9 audit a few years ago – isn’t that the same as E-Verify?” “I know this is not an issue, because I remember being told we addressed all I-9 and E-Verify issues.” “No, the General Counsel’s office doesn’t handle immigration issues.”

You get the picture. Many companies simply do not take immigration compliance seriously. This failing usually does not come from a disinterest in compliance, but rather from a threshold failure to understand the intricacies involved in immigration issues or the potential exposure that could result from noncompliance. Only when faced with government investigations, public scrutiny, or other negative impacts on the business do the right people in the right places start to pay attention. When they learn that federal contractors can be suspended or debarred for failing to adhere to immigration and E-Verify related issues that attention is heightened.

It has been almost three years since the Federal Acquisition Regulation (FAR) E-Verify clause (FAR 52.222-54) for federal contractors went into effect in September of 2009. E-Verify is a free, internet-based system that electronically verifies the work eligibility of new employees by comparing the Form I-9 related information employees submit with the records of theSocial Security Administration (SSA) and the Department of Homeland Security (DHS). Close to 450,000 employers are now enrolled in E-Verify. While the Government does not charge contractors to use the program, companies should be cognizant of the operational costs associated with E-Verify, including costs connected to training, monitoring, and verifying compliance with the System. In the case of federal contractors, E-Verify must be used to verify all new employees as well as existing employees assigned to a contract. However, there is also an option available to verify an entire existing workforce upon receipt of a qualifying federal contract.

Not every federal contract, however, will be subject to the FAR E-Verify requirements. FAR 52.222-54 exempts federal contracts that include only commercially available off-the-shelf (COTS) items (or minor modifications to a COTS item) and related services; contracts of less than the simplified acquisition threshold (currently $150,000); contracts that have a duration of less than 120 days; and contracts where all work is performed outside the United States. As defined in FAR 2.101, a COTS item is: (i) a commercial item, (ii) that is sold in substantial quantities in the commercial marketplace, and (iii) that is offered to the Government without modification as the product is available in the commercial marketplace. There are other employee-related exemptions that federal contractors should be familiar with, including employees hired before November 7, 1986, employees with specific security clearances, and employees that have previously been processed through E-Verify by the federal contractor.

Compliance is Non-Negotiable

To date, the Government has been fairly lackadaisical in its review of compliance in the E-Verify arena. Accordingly, it is not surprising that E-Verify compliance may not fall very high on a federal contractor’s list of legal concerns. However, with a comprehensive immigration reform package, that includes a mandatory E-Verify provision and new laws percolating in the States, contractors should reconsider their priorities. Increased enforcement is likely and a proactive review of current E-Verify related processes, including sub-contractor flow down, and other policies is recommended.

In fact, U.S. Citizenship and Immigration Services (USCIS), the agency that runs the E-Verify program, has beefed up its Monitoring & Compliance Branch’s activity to review to detect, deter, and reduce misuse, abuse, and fraud. And who can blame it? The agency clearly wants to be in a position to provide detailed E-Verify data and good-looking numbers to Congress as the immigration debate heats up in Washington, DC. Fortunately for USCIS, ample funding has been designated for the program. As a result, participants have benefited not only from an extraordinary increase in E-Verify resources and training aides, but also from immensely improved technology used in the system.

It is no surprise that along with the increased funding comes increased monitoring of usage. In fact, USCIS site visits and desk reviews appear to have escalated. A number of companies recently have received calls informing them they are not in compliance with E-Verify procedures. The calls are friendly and are sometimes coupled with an “offer of assistance” in the form of a USCIS visit. By the way, it is an offer you cannot refuse without being viewed as uncooperative – not a good thing for a Government contractor.

Such visits and calls from the USCIS’ Monitoring & Compliance Branch are to be taken very seriously. Accordingly, federal contractors not only should review and revise, but truly understand, the processes they have in place for E-Verify as well as the entire Form I-9 process. Such processes also should be tested periodically for accuracy and efficacy. Federal contractors should want to know whether their E-Verify policies actually are working in the field the way they are written on the paper. Nothing a company is doing should be a surprise to the general counsel’s office, and nothing in the E-Verify reports should read like a foreign language to the individuals charged with overseeing the system.

History is Cyclical

The pace of E-Verify implementation picked up incredibly in June of 2010 when the GSA announced a mass modification of all Federal Supply Schedule (FSS) contracts that mandated the incorporation of E-Verify. Federal contractors continued to do their best to comply promptly, but oversights and omissions were inevitable.

Almost three years later, things are quieter on the E-Verify front, but the obligations and risks remain. While Immigration and Customs Enforcement(ICE) certainly reviews E-Verify matters, we have seen few if any reviews of federal contractor programs. But this soon will change. DHS likely will refocus and retool its worksite with a particular focus on E-Verify and other types of immigration compliance if the system is made mandatory for all U.S. employers. After all, USCIS no longer will have to sell its system. Everyone will buy it; there is no one else to buy it from, and there will be no choice but to buy it. It will be just a matter of when one buys. Government contractors, as the first purchasers of E-Verify, should expect to be among the first non-compliance “examples” when the time comes.

The Realities of E-Verify for Federal Contractors

There is no doubt that E-Verify is a best practice. However, it is not a replacement for background checks and other post-employment screenings and safeguards monitoring the system. In fact, the E-Verify system is still very much prone to identity theft, and must internally be monitored for misuse and overall compliance. While the Government agrees that E-Verify usage creates a “rebuttable presumption” that a company has not knowingly hired an unauthorized alien, there still can be problems. In fact, employers may face civil and criminal liability if, based upon the totality of the circumstances, it can be established that they knowingly hired or continued to employ unauthorized workers. Remember, a federal contractor’s participation in E-Verify does not provide a safe harbor from worksite enforcement. The Department of Justice’s Office of Special Counsel (OSC) also takes E-Verify violations very seriously and continues to open investigations involving abuse of the system. Unlike its sister agencies OSC has taken a keen interest in reviewing E-Verify related matters. Most notably, many of the OSC’s investigations do not involve malice in intent but rather accidental misuse of the system.

Best Practices for Federal Contractor’s

While not an all-inclusive list, federal contractors would be well served by considering the following proactive steps:

  1. Provide bi-annual training to anyone who is a user in the system. As E-Verify ramps up its site visits and desk reviews, compliance is more important than ever. Ensure your I-9 compliance is also in shape, as the I-9 data feeds into the E-Verify system.
  2. Verify your company has a viable policy established to flow down the E-Verify requirement to your sub-contractors, vendors. E-Verify usage is a “flow down” requirement; prime contractors are required to take steps to ensure that subcontractors for services or construction of more than $3,000 also implement the rules. Regardless of the size of your company, verify this process and take the extra step of seeing how it works in practice.
  3. Create a sub-contractor verification system. While the scope of a prime contractor’s “flow down” responsibilities to subcontractors and identifying which subcontracts are subject to E-Verify were not clearly defined in the FAR regulation, many believe merely having a copy of the “E-Verify Enrollment Page” of the subcontractor will not be enough when things go wrong.
  4. Carefully review the E-Verify exemptions. Limited exemptions for COTS contracts, contracts where work is performed outside of the United States, and for employees with specific active security clearances exist but are often harder to segregate and rely on then general usage of E-Verify. Consistency is key in deciding when to use E-Verify.
  5. Review overall immigration and visa compliance. In today’s world, it is simply not acceptable for employers, particularly large ones, to rely on an “off-the-shelf” compliance approach. Policies, electronic I-9 and E-Verify systems all must be vetted and monitored. Audits that review overall immigration compliance programs should address E-Verify compliance risk factors. Moreover, an independently audited immigration compliance program, preserves attorney client privilege and could protect employers from debarment or involuntary suspension from the E-Verify program. Specifically such a review should include the company’s Form I-9s, visa processes and E-Verify reports.
  6. Review E-Verify Usage. Do not assume everything is working the way it is supposed to. Someone needs to roll up their sleeves, and get dirty; ensure all users are closing case correctly and ensure all users know how to process Tentative Non-Confirmation notices. Reviewing E-Verify reports should be an ongoing, frequently completed task for someone in the organization. If you use an electronic I-9 system, it is even more important that you review the status of cases as well as historical data as often as possible. E-Verify only works well if a company first understands the importance of Form I-9 compliance.
  7. Review your Memorandum of Understanding (MOU) with the USCIS. The E-Verify program requires companies to agree to certain conditions upon enrolling in the system via the MOU. Do not take these responsibilities lightly. Ensure the specifics of the E-Verify agreement are accurate and up to date. For example, does the company still have two hiring sites? Is the company no longer performing E-Verify from the centralized location noted in the MOU? Almost three years after the FAR E-Verify clause went into effect, we still run across government contractors that are not enrolled in the E-Verify program or not correctly enrolled. We also routinely run across large prime contractors that have not adequately implemented their E-Verify program and flow-down procedures.
  8. Consider the impact of E-Verify as it pertains to any Union presence the company may have. A careful review of the National Labor Relations Board (NLRB) claim that use of E-Verify should be bargained is something to be carefully reviewed by federal contractors and their affiliates.
  9. Ensure you track employees assigned to contracts if your entire workforce was not E-verified at the onset. It is critical to have someone charged with knowledge of which employees are assigned to a contract within the meaning of the regulations and a system in place to E-Verify any legacy employees that have not previously undergone verification.
  10. Review E-Verify in the context of your current corporate structure or in terms of a merger, acquisition or other restructuring. A careful assessment of a federal contractor E-Verify related responsibilities and the associated timelines involved during any restructuring must be carefully considered. It is also important to analyze which affiliated entities are considered under government contract for purposes of the E-Verify clause. An affiliate or subsidiary with a different EIN may not necessarily be subject to the E-Verify provisions.

Debarments and Other Penalties

Federal contractors will continue to be responsible for E-Verify compliance for the foreseeable future. The consequences of a failure to use the E-Verify program leading to the loss of current and future federal contracts should not be downplayed. Federal contractor compliance with the E-Verify MOU is a performance requirement under the terms of the federal contact. As such, termination of the contract for failure to perform is one potential consequence of noncompliance with the MOU. Suspension or debarment, of course, also may be a potential consequence where the violation suggests the contractor is not responsible. Indeed, the E-Verify program’s suspension and debarment enforcement activities are being ramped up. DHS already ranks high on the agency list for debarment numbers, leading with a significant number of non-procurement FAR debarments. In FY12, ICE alone debarred 142 businesses and 234 individuals. Federal contractors need to take this enforcement activity seriously as it likely will increase in the face of mandatory E-Verify.

In short, now is the time for companies proactively to review internal polices, perform the necessary risk assessments, conduct the Form I-9 exposure as well as anti-discrimination audits, and then take ownership of any changes or improvements that need to be made.

China Enacts New Employment Law Affecting Employers Who Do Not Directly Employ Their Workers

Sheppard Mullin 2012

China has a new employment law. This new law significantly impacts an employer who does not directly employ its own workers, but instead uses agencies such as FESCO or third party staffing companies, also known as labor dispatching agencies. At the end of 2012, the Standing Committee of the National People’s Congress adopted the Decision on the Revision of the Labor Contract Law of the People’s Republic of China (“Amendment”). The Amendment will take effect July 1st of this year. The intent of the Amendment is to offer better protection to workers employed by labor dispatching agencies.

Labor dispatching is a common method of employment where a worker enters into an employment contract with a labor dispatch agency and is then dispatched to work in another company – commonly referred to as the “host company”. This type of employment arrangement has proved problematic because many of the dispatched workers are not paid wages commensurate with their work as compared to their direct hire, permanent employee counterparts. Additionally, the dispatched workers’ health and safety rights are not well protected. The Amendment tackles this problem by requiring employers to hire the majority of their workforce directly and by strictly controlling the number of dispatched laborers. Moreover, the Amendment clearly states that all employers shall stick to the principle of “equal pay for equal work”.

The four main revisions introduced by the Amendment can be found by clicking here:

MAIN SECTION:

Heightened Standards

First, the standards for establishing a Labor Dispatch Agency are heightened. Specifically, a labor dispatch agency is now required to:

a. have a minimum registered capital of no less than RMB 2,000,000 (previously only RMB 500,000);

b. operate from a permanent business premise with facilities that are suitable to conduct its business;

c. have internal dispatch rules that are compliant with the relevant laws and administrative regulations;

d. satisfy other conditions as prescribed by laws and administrative regulations; and

e. apply for an administrative license and obtain approval from the relevant labor authorities.

All labor dispatch agencies established after July 1, 2013, will need to meet these new local labor law requirements before they can start the company registration process. Existing agencies that are already licensed have until July 1, 2014, to meet all local labor law requirements before renewing their business registration.

Equal Pay for Equal Work

Second, one of the most problematic areas of the former dispatch model was the inequitable pay between dispatch workers and their similarly situated, direct hire counterparts. The Amendment adds the principle of “equal pay for equal work” such that dispatch agencies must provide the same remuneration standards for dispatched employees as is provided to the direct hire employees who hold similar positions.

Clarification of Acceptable Outsourcing

Third, the Amendment clarifies that labor dispatch arrangements should only be implemented for temporary, ancillary or substitute positions. The Amendment clearly defines these categories as follows:

  • Temporary position: A position that will last no more than six months
  • Auxiliary position: A position that is not a part of the main or core business of the company
  • Substitute position: A position that must be temporarily filled because a permanent employee is away from work on leave or for other reasons

The Amendment further narrows the use of outsourcing by limiting the percentage of outsourced workers a company may have. The actual percentage shall be prescribed by the Labor Administration Department of the State Council. This percentage of dispatched workers does not apply to representative offices established by foreign companies in China. This is because representative offices are not allowed to hire Chinese employees directly, and instead must hire them through a labor dispatching agency.

Tougher Penalties

Fourth, the Amendment imposes tougher penalties. Specifically, for entities providing labor dispatch services without a license, the labor authorities may confiscate all illegal gains and impose a fine of no less than one time, but not more than five times, the illegal gains on such entities. Where there are no illegal gains, a fine of no more than RMB 50,000 may be imposed.

Employers and dispatching agencies violating the law, and failing to correct the violations within a certain time period, may be fined between RMB 5,000 and RMB 10,000 per dispatched worker. Additionally, labor dispatching agencies may get their business licenses revoked.

Conclusion

How aggressively the new law will be enforced remains to be seen, but companies should be prepared none the less. Companies that use labor dispatch agencies should ensure that their service provider has the proper license. Furthermore, any company with a high percentage of dispatched workers should evaluate their employment model and prepare for potentially transitioning their employment strategies in order to comply with the new Labor Contract Law. This may include direct hiring for some of the currently outsourced positions. Lastly, companies should evaluate their internal policies to ensure that they are sufficient for any changes – especially those involving headcount – that may be made.

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Non-Compete Agreements Aren’t for Everyone: The Necessity of Proving a “Legitimate Business Interest”

Womble Carlyle

It is a longstanding tenet of North Carolina law:  A company must have a legitimate business interest to justify using non-competes in its employment agreements.

Employers often focus on specific language describing the scope of their non-competes – should it be six months, one year or two years?  Should it be citywide, statewide, or is a larger territory reasonable?  And although the scope of a non-compete is critical, two recent North Carolina court decisions emphasize that you can’t use a non-compete in just any situation.  There must be a legitimate business interest which merits its use.

What qualifies as a legitimate business interest?

In Pinehurst Surgical Clinic, P.A. v. DiMichele, the NC Court of Appeals enforced an employment agreement prohibiting the defendant physician from practicing medicine in competition with the plaintiff surgical clinic for two years within a 35-mile radius of its Pinehurst facility.

In reversing the trial court’s finding of no irreparable harm, and remanding the case with instructions to grant the PI, the Court focused on several key findings which demonstrated the employer had strong, legitimate and protectable business interests to justify the use of non-competes:

  • In its more than 60 years of existence, the clinic had invested many resources “cultivating relationships with patients, employees, and various entities in the region in which it does business.”
  • The clinic annually spent significant sums “to develop and maintain a loyal patient base and goodwill in the community.”
  • The clinic provided the physician with “extensive confidential information regarding all aspects of plaintiff’s medical practice and business affairs.”
  • The clinic also provided the physician with an extensive patient base and the support necessary to maintain a successful medical practice, reputation and goodwill in the community.

In contrast – and reaching a different result – in Phelps Staffing, LLC v. C.T. Phelps, Inc., the Court of Appeals found that a staffing company failed to establish a legitimate business interest supporting its use of non-competes.   A number of factors undermined the staffing company’s case:

  • The employees at issue were “general laborers”;
  • The employees did not have access to trade secrets or proprietary information; and
  • The staffing company admitted that the primary purpose of the non-compete was to prevent competition from other temporary staffing companies.

The Court had little trouble affirming the trial court’s finding that the non-compete was “merely an attempt to stifle lawful competition between businesses and that it unfairly hinders the ability of plaintiff’s former employees to earn a living.”

These North Carolina cases are in sync with the national trend.  For example, in Gastroenterology Consultants of the North Shore v. Mick S. Meiselman, an Illinois appellate court invalidated a physician’s non-compete because the former employer failed to show a legitimate protectable interest.  The evidence showed that the doctor had been practicing in the relevant territory for about 10 years before his employment with the practice, the practice did not introduce the doctor to his patients or his physician-referral sources, the practice did not advertise, promote or market the doctor’s practice, and the doctor maintained his own office and telephone number.  The practice merely provided some administrative support for the doctor.  As a result, the practice lacked a legitimate interest to justify the non-compete.

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Supreme Court Hears Oral Arguments Regarding Limits on Class Arbitration Waivers in Federal Cases

Womble Carlyle

Recently, the United States Supreme Court heard oral argument in American Express Co. v. Italian Colors Restaurant, a case that will have a substantial impact on the enforceability of arbitration agreements that contain class action waivers.  Italian Colors picks up where the Supreme Court left off in AT&T Mobility, LLC v. Concepción when a sharply divided Supreme Court held that a state law purporting to invalidate class action waivers in arbitration agreements was preempted by the Federal Arbitration Act.

Here, the Supreme Court is confronting the question of whether, as the Second Circuit Court of Appeals put it, the “federal substantive law of arbitrability” can invalidate class action waivers in arbitration agreements when the underlying claims are based on federal law.  The Second Circuit Court of Appeals determined that federal law requiredthe invalidation of the class action waiver because the cost of litigation compared to the relatively minimal amount of potential damages would effectively prohibit plaintiffs from pursuing their federal claims.  Concepción did not compel a different result, according to the Second Circuit, because in that case there was no showing that ”the practical effect of the enforcement would be to preclude [the plaintiff class’s] ability to vindicate their statutory rights.”

The Supreme Court’s decision in this case will have a substantial impact on the viability of class action waivers contained in arbitration clauses.  If the Second Circuit’s ruling is upheld, it will provide plaintiffs with a way around the limitations of Concepción if they are able to show that litigating a matter on an individual basis would be prohibitively expensive.  A decision reversing the Second Circuit would give business owners a greater ability to avoid complex and expensive class action litigation through carefully worded arbitration agreements.

The Supreme Court is expected to decide the case before the end of June 2013.

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Three Provisions You Cannot Operate Without In Your Operating Agreement

McBrayer NEW logo 1-10-13

Deciding on the entity form to use for your business depends on a number of factors, but for many entrepreneurs, an LLC is the best fit. An LLC is a hybrid entity as it provides liability protection similar to a corporation and favorable income tax treatment similar to a partnership. If you are starting or currently operating a business through an LLC, your most important organizational document is the agreement between you and your partners: the Operating Agreement. An operating agreement establishes the internal operations of the business in a way that suits the specific needs of the business owners. Once signed by the members of the LLC, it is an official binding contract.

Another benefit of using an LLC to operate your business is the flexibility LLC owners have to structure their operations and business relations with their partners. While the Kentucky Limited Liability Company Act contains default provisions for many of the organizational issues that may arise, members of an LLC may agree to operate under provisions other than the Act’s default provisions. No matter the nature of your business, your LLC should have an operating agreement that includes details such as voting rights and responsibilities, powers and duties of members and managers, allocation of profits and losses, and distribution of capital, whether the members agree to use the LLC Act’s default provisions or alternatives to the default language.

As an example of the flexibility of the Act, and also of the importance of carefully considering the effects of each section of your operating agreement, consider the following three provisions that will help your business run smoothly.

1. Transfer provisions.

An operating agreement typically contains some language about the circumstances under which a member may or must transfer his ownership interest in the LLC to another person or entity. Under the Act, a member may freely transfer membership interest to anyone. There are a number of provisions in the Act that tell us how the transferring member and the new owner are to be treated, one of which is that the new owner will not be a full member with the right to vote unless a majority of the other members vote to make the new owner a full member. If members are allowed to freely transfer their interests however, founding members may find themselves faced with new business partners they did not approve. Moreover, a member’s interest could be transferred involuntarily, such as by death, divorce, or bankruptcy. For these and other reasons, you and your business partners may decide on a transfer provision that would limit uncertainty in these situations. Terms in the operating agreement may require a majority of members to vote to allow a proposed transfer before it can occur, or give the company or the members a right of first refusal to purchase the membership interest subject to a proposed transfer. The members might agree to purchase life insurance policies to provide the funds to purchase the membership interest of a member at death. The operating agreement may also prohibit members from pledging (granting a lien on) membership interest. Putting restrictions on transferability gives members control over when, how, and why membership interests are transferable.

2. Deadlock provisions.

Management or member deadlock occurs when a company’s decision makers are evenly split on a matter and neither side will relent. It is a potentially fatal problem and, thus, should always be addressed within the operating agreement. Under the Act, the remedy for deadlock is judicial dissolution. A court “may dissolve a limited liability company in a proceeding by a member if it is established that it is not reasonably practicable to carry on the business of the limited liability company in conformity with the operating agreement.” Once the LLC is dissolved, it cannot carry on business, but must wind up and liquidate its business. There are, however, many strategies that can be put into your operating agreement to avoid this problem:

· The opposing member may be allowed to withdraw from the LLC.

· The operating agreement may require that a deadlock at the manager level be subject to a vote of the members.

· The members may agree to be bound by a coin flip.

· The members may be required to take the issue to binding arbitration.

· The members may incorporate a buy-sell provision that would require one member to provide a purchase price to the other member and then require that other member to purchase or sell the membership interest in the LLC at that purchase price such that the selling member ceases to be a member of the LLC.

With each of these strategies, the common feature is that the LLC is likely to continue as a functioning business after the deadlock is resolved.

3. Additional Capital Contributions.

A company operating agreement will usually state the amount of money or the value of property each member initially contributes to the company for operations, known as initial capital contributions. As an example, three people may decide to start a business and agree that each of them will give the company $3,000 so the company has $9,000 in start-up capital. Most operating agreements also have language about additional money from the members, known as additional capital contributions. Because the Act allows flexibility here as well, that language may state that members are not required to make additional capital contributions, or it may require additional capital contributions and allow for one member to make an additional capital contribution for another member that fails to make that contribution when due in exchange for a portion of that member’s membership interest. There are many possibilities. But frequently, when considering these possibilities, members fail to consider the effect of the additional capital contribution language on the limited liability feature of the LLC.

One important function of an LLC is that the members are not individually liable for the debts of the LLC if the LLC cannot pay its creditors. That protection from individual liability is not absolute, however. Among other things that may cause a court to ignore limited liability protection, including fraud, intentional misconduct, or the failure to maintain a real distinction between the LLC and its members, the additional capital contribution language can be read to require the members to pay LLC debt that the LLC cannot pay itself. The members may avoid this by affirmatively stating in the operating agreement that additional capital contributions are never required and the members have no personal liability for the debts of the LLC, but that may cause problems later if the LLC needs additional capital. The members may instead decide to have additional capital contribution language, but to have it drafted carefully so as to avoid unintentionally negating the limited liability protection generally afforded by the LLC. The important thing is to consider and plan for the potential needs of the LLC, and to do so in a way that doesn’t result in unintended consequences for the LLC or its members.

Every successful business encounters bumps in the roads. An operating agreement is a road map, a tool to navigate through the difficult obstacles.

© 2013 by McBrayer, McGinnis, Leslie & Kirkland, PLLC

Sequestration: Responding to Government Contract Delays and Changes

The National Law Review recently published an article regarding Sequestration written by Jonathan T. Cain of Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C.:

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Recent hardening of the rhetoric between Congressional Republicans and the White House is leading to growing acknowledgment that across-the-board reductions in federal agency budgets are likely to be imposed, at least temporarily, beginning March 1st. Government contractors serving nearly every federal agency can expect to be affected by delays, stop-work orders, and/or contract changes to postpone or reduce the government’s cost of contract performance.

Federal contracts give the government the right to impose schedule delays in contractor performance, direct work stoppages, and order changes in the delivery schedule, but the government does not have the right to impose the costs of those actions on contractors – provided the contractors take timely action to preserve their rights to compensation for those increased costs.

The clause most likely to be employed is the stop-work order. This clause is included in federal contracts for supplies, services, and R&D, and in both fixed-price and cost-reimbursement contracts. It permits the contracting officer to issue a written order to the contractor to stop all or any part of the contract work for up to 90 days. Within that 90-day period, or any additional extension of the 90-day period to which the contractor has agreed, the contracting officer must either revoke the stop-work order or terminate the contract for the government’s convenience. If the stop-work order is lifted, the contractor has 30 days after the end of the work stoppage to submit a written claim for increased costs. The contracting officer must allow all timely submitted, reasonable costs incurred by the contractor for the stoppage. If the agency terminates the contract for convenience, the contractor is entitled to recovery of all reasonable costs of termination plus profit on all work completed.

Fixed-price supply and service contracts for non-commercial items also will include a Government delay of work clause. Under this clause, the contractor is entitled to recover for increased costs resulting from delays or interruptions in the performance of the work caused by any overt act of the contracting officer or the failure of the contracting officer to take a contractually required action in a timely manner. Recovery of costs for government delay of work do not require a written order by the contracting officer. A delay caused, for example, by a decision of the customer agency to send government employees home on furlough may cause a contractor serving that agency to incur a costly delay. Such costs are recoverable under the delay of work clause. In the case of a delay of work, the contractor may only recover costs incurred within the 20 days before the contractor gives written notice of the cause of the delay to the contracting officer. If a contractor suffers a government-caused delay, it should immediately calendar its notice deadlines and file written notices to preserve its right to recover delay costs.

Contracts that are not for commercial items and services also will contain a changes clause that gives the government the unilateral right to change certain terms of the contract, including in the case of services, the time of performance. The contractor is entitled to an equitable adjustment to the contract price, schedule, or both to compensate for the change. Changes may occur as a result of an express contract modification or constructively as a result of other government actions. In either case, the contractor is entitled to an equitable adjustment to the contract for all changes, provided that it has given written notice to the contracting officer within 30 days after the change is imposed. If a contractor does experience an express or constructive change to the contract, it also must immediately begin to separately account for all its incurred, segregable costs that are allocable to the change. Failure to do so will make recovery of those costs more difficult, if not impossible.

Commercial item contracts for goods and services are not required to contain a delay or stop-work clause, though many do. The standard changes clause in a commercial item contract requires mutual agreement of the government and the contractor to any modification, though it is not uncommon for that clause to be replaced with a non-commercial changes clause. Each contract should be reviewed to determine the steps required of the contractor to preserve its right to recover for government delays and changes resulting from even a short period of sequestration.

©1994-2013 Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C.

Awuah v. Coverall: What If I Didn’t Know About The Mandatory Arbitration Provision In My Franchise Agreement?

The National Law Review recently featured an article by Matthew J. Kreutzer with Armstrong Teasdale titled, Awuah v. Coverall: What If I Didn’t Know About The Mandatory Arbitration Provision In My Franchise Agreement?:

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A new ruling by the United States Court of Appeals for the First Circuit in Awuah v. Coverall case, No. 12-1301, — F.3d — (1st Cir. Dec. 27, 2012), is yet the latest in a string of recent court decisions that confirm the strength and enforceability of arbitration clauses in franchise agreements.

The Awuah case first made waves two years ago when the United States District Court for the District of Massachusetts compared the franchise relationship between Coverall (a janitorial service franchisor) and its franchisees to a “modified Ponzi scheme.”  You can read more about that decision in my prior blog posts here and here.  This latest ruling deals with the enforceability of the arbitration clauses in a number of the subject franchise agreements.

The facts can be summarized as follows: a class of franchisees sued their franchisor, Coverall North America, which is a janitorial cleaning service. The franchisees assert several state-law claims against Coverall, including claims for breach of contract, misrepresentation, and deceptive and unfair business practices. In addition, the franchisees claim that Coverall misclassified them as independent contractors when they are, in fact, employees, and that Coverall failed to pay wages due to them.

Appellees, who are a subset of the overall class, challenge Coverall’s contention that appellees should be required to arbitrate the dispute based on arbitration clauses in the subject franchise agreements. Appellees became Coverall franchisees by signing Consent to Transfer Agreements, or Guaranties to Coverall Janitorial Franchise Agreements. These documents did not themselves contain arbitration clauses, but instead incorporated by reference the terms and provisions of the transferor’s franchise agreements, which did contain such clauses. None of the appellees allegedly received (or requested) copies of the franchise agreement signed by its respective transferor.

Appellees argued to the U.S. District Court for the District of Massachusetts that “it is black-letter law in the First Circuit that an individual may not be bound to an arbitration clause if he does not have notice of it,” citing cases brought under federal employment statutes. Appellees made the point that Coverall had not demonstrated that any of them were shown the transferor’s franchise agreement, or that they were shown the arbitration clause contained therein. The District Court agreed, determining that the appellees did not have to arbitrate their claims against Coverall because they did not have adequate notice of the arbitration clause in the franchise agreement. Coverall appealed.

The U.S. District Court for the First Circuit overturned the District Court’s ruling, finding that under governing Massachusetts law, “one who signs a written agreement is bound by its terms whether he reads and understands them or not.” The Court further found that Massachusetts does not impose any requirement that the parties be given special notice of an arbitration provision. In any event, the Court stated, any such requirement would be preempted by the Federal Arbitration Act, 9 U.S.C. § 1, et seq., which requires that agreements to arbitrate be treated in the same manner as other contracts.

This latest decision serves as a reminder for prospective franchisees to carefully review a proposed franchise agreement before signing.  For existing franchisees, it is a warning that mandatory arbitration clauses are not easily avoided.  For franchisors, the decision highlights the importance of ensuring that, when a franchisee transfer or assign their franchises, the new franchisees receive and sign a full copy of the franchise agreement that will be effective post-sale.

© Copyright 2013 Armstrong Teasdale LLP

Trade Secret Misappropriation: When An Insider Takes Your Trade Secrets With Them

Raymond Law Group LLC‘s Stephen G. Troiano recently had an article, Trade Secret Misappropriation: When An Insider Takes Your Trade Secrets With Them, featured in The National Law Review:

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While companies are often focused on outsider risks such as breach of their systems through a stolen laptop or hacking, often the biggest risk is from insiders themselves. Such problems of access management with existing employees, independent contractors and other persons are as much a threat to proprietary information as threats from outside sources.

In any industry dominated by two main players there will be intense competition for an advantage. Advanced Micro Devices and Nvida dominate the graphics card market. They put out competing models of graphics cards at similar price points. When played by the rules, such competition is beneficial for both the industry and consumers.

AMD has sued four former employees for allegedly taking “sensitive” documents when they left to work for Nvidia. In its complaint, filed in the 1st Circuit District Court of Massachusetts, AMD claims this is “an extraordinary case of trade secret transfer/misappropriation and strategic employee solicitation.” Allegedly, forensically recovered data show that when the AMD employees left in July of 2012 they transferred thousands of files to external hard drives that they then took with them. Advanced Micro Devices, Inc. v. Feldstein et al, No. 4:2013cv40007 (1st Cir. 2013).

On January 14, 2013 the District Court of Massachusetts granted AMD’s ex-parte temporary restraining order finding AMD would suffer immediate and irreparable injury if the Court did not issue the TRO. The TRO required the AMD employees to immediately provide their computers and storage devices for forensic evaluation and to refrain from using or disclosing any AMD confidential information.

The employees did not have a non-compete contract. Instead the complaint is centered on an allegation of misappropriation of trade secrets. While both AMD and Nvidia are extremely competitive in the consumer discrete gpu market involving PC gaming enthusiasts, there are rumors that AMD managed to secure their hardware to be placed in both forthcoming next-generation consoles, Sony PlayStation 4 and Microsoft Xbox 720. AMD’s TRO and ultimate goal of the suit may therefore be to preclude any of their proprietary technology from being used by its former employees to assist Nvidia in the future.

The law does protect companies and individuals such as AMD from having their trade secrets misappropriated. The AMD case has only recently been filed and therefore it is unclear what the response from the employees will be. What is clear is how fast AMD was able to move to deal with such a potential insider threat. Companies need to be aware of who has access to what data and for how long. Therefore, in the event of a breach, whether internal or external, companies can move quickly to isolate and identify the breach and take steps such as litigation to ensure their proprietary information is protected.

© 2013 by Raymond Law Group LLC