Employment Law & Employee Benefits

How Contracts Can Protect a Firm's Human Capital

The use of employment agreements for selected employees has become more important than ever

January 2004

By Michael R. Callahan*
for New Hampshire Business Review

nhbr

It seems but a short time ago that for many American workers their first employer was also their last. Driven by a variety of factors, it has been reported that today’s workers change employers about every three years.

In that earlier era, the ownership of required machinery and equipment guaranteed employee loyalty because without it the capacity of workers to produce materials of similar value was profoundly limited. Today, the skills, knowledge and experience of employees are often among the most valuable assets of any business. Today’s business owners do not own those assets. In fact, wages might be viewed as rental payments for the lease of what are now employee controlled assets.

Even though employers may have invested significant sums that have enabled their employees to acquire valuable skill sets, and even though employers have provided unfettered access to their customers, pricing schedules and trade secrets, it may be the case that those leased assets may soon be employed by their competitors. Such a hiring not only disables the first employer, it allows the competitor to acquire an accelerated learning curve at no risk and little cost.

This reality makes the use of employment agreements for selected employees more important than ever. Non-disclosure agreements not only forbid the use of key information, they may prevent employment with competitors in those circumstances where the use of such information will be inevitable.

Covenants not to compete may be used to prevent employment with competitors for a period of time, in a geographic area or with key present and even future customers.

While these devices provide a reasonable means for an employer to protect a hard-earned niche in the marketplace, a word of caution is in order. Our judicial system has a declared disdain for those devices which limit or restrain trade. Barring potential workers from selected portions of the marketplace and employers from hiring whomever they may choose, plainly restrains trade.

There also is a judicially declared goal to assure the freedom of all of us to contract in whatever manner we may choose. The obvious dissonance sounded by the clash of these two core values has resulted in a more unpredictable pattern of enforcement for these agreements.

Enforcement questions

In a quest for rational consistency, courts have understandably sought to avoid the abandonment of either value. In simple terms, they have grudgingly conceded a willingness to enforce the agreements, thereby maintaining some allegiance to the freedom of contract, while subjecting such contracts to a more rigorous scrutiny. This careful review has been employed to limit their impact on free trade.

Courts have declared some of these contracts unenforceable because of findings of duress in their execution or lack of consideration. They have denied enforcement when their reach was deemed unreasonable, i.e., the time was too long or the marketplace too wide.

Contracts also have been denied enforcement because of their detrimental impact on third parties. In California, non-competition covenants are essentially void except in very limited circumstances.

While there may be a multitude of ways to nullify the useful effects of these agreements, they are still regularly enforced. But one size does not fit all. Some courts have even reasoned that the widespread use of form contracts is cause enough to deny their enforcement.

Those contracts that thoughtfully address articulated needs are far more likely to succeed. Such contracts bar employees for a rationally based time period from the employer’s core market. They are most successful when they seek to protect the retention of existing and probable future customers.

For many businesses, the wholesale resignations of two or three key employees is a brutal, disabling event. The employment agreement is a useful means to assure recovery time, before the competitor is able to gain traction in the existing customer base. Its mere existence may persuade some employees that the hurdle is not worth jumping. At the very least, it diminishes the attractiveness of one’s employees to competitors. Actions against the raiders themselves for interference with advantageous contractual relationships provide an additional, useful deterrent.

Much has been written about the importance of a nurturing and caring workplace. It is all true, and such efforts should not be minimized. It also may be worthwhile to remember these words from Franklin D. Roosevelt: “If you treat people right, they will treat you right – 90 percent of the time.”

The allure for existing employees to create their own new businesses and the use of attractive inducements by existing competitors continues to threaten many businesses. Given the increasingly transitory nature of the work force, well-drafted employment contracts are even more valuable today. For some, they may mean the difference between life and death.

* Michael R. Callahan is admitted in New Hampshire.

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