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For this week’s Draw the Law, you all chose Non-Compete Agreements.  This is definitely a topic of interest among employers and lawyers alike.  In addition, small business owners should remember I talked about non-competes in the context of buying a business.

What is a Non-Compete Agreement?

Before getting to what a non-compete agreement, you have to realize as our economy has grown and changed over the years, we now are in a knowledge economy.  Therefore, it is imperative for companies to not only protect their traditional intellectual properties, but the knowhow that gives them a competitive edge.   Through laws and agreements, like the Hawaii Trade Secrets Act and non-competes, companies have sought to enforce their proprietary rights against others.

A non-compete agreement tries to prohibit or limit the degree in which an employee can compete with their former employer.

Problems with Non-Competes

I tell this to many clients who come to me for drafting agreements, “I can put whatever you want in the agreement, but at the end of the day it matters if the court will enforce it.”  So it is the case with  non-competes, many employers want to make it impossible for their former employee to basically work.  This is not going to fly with a court because as a society, we value trade and the ability to make a livelihood for yourself.  Thus, courts will closely scrutinize these agreements because by their inherent nature they restrict trade.

The Law’s Balancing Act

The calculus the court usually enters when trying to decide whether to enforce or strike out the non-compete agreement is as follows:

A vs. B + C, where

(A) is the company’s interests at risk (trade secret, proprietary information, investment in the employee) VS. (B)is the employee’s ability to make a living + (C) is the“public good” (access to goods and services).

Therefore, a court will ignore a company’s non-compete with an employee if the risk is minimal to the company and enforcement would leave the employee unable to earn a living and harm the public.

The Factors

Specifically, a court looks to the following factors when make determinations on the aforementioned balancing equation:

  1. duration of the restriction (is it for six months or till the end of time?)
  2. geographic restriction (is it a part of a district on an island or is it the whole state?)
  3. the scope of the restriction (is it a specific level of job or is it the whole industry?)

What those Factors Mean When Creating a Non-Compete

Therefore, the tricky part of drafting a non-compete is to make sure you do not draft something so broad it prohibits an employee from working on this planet, in the same industry, for as long as he or she lives.  That is overbroad and a court would definitely not enforce it.

On the other hand, if you make the non-compete so small in its restriction (i.e. you can’t work in this building, for a day, as a payroll manager, and the person has HR operational skills learned at your company) then there is no point in creating the agreement because your former employee will just take all the knowledge and experience you invested in them and work for your competitor.

Final Words

Thus you are left with creating a non-compete agreement somewhere in between those extremes.  It always is best to have an attorney work with you on this matter.  Let them see how your business works and what is of value, but also how the employee you want to sign the non-compete will operate within the company.  It will help them craft an agreement that zeroes in on protecting the valuable knowledge, but allowing the former employee to make a living without using that stuff against you should they ever leave.

Finally, a brief word on independent contractors (IC) and the use of non-compete provisions, as stated in the other Draw the Law post on ICs, the issue of control comes up.  If you think about it, a non-compete is controlling the behavior of the IC.  Therefore, too much control (restrictions) on the IC may make them an employee in the IRS’s viewpoint.

Consider using a non-disclosure agreement instead to protect sensitive information when dealing with ICs.

As always if you like this post or any of my other series please “Subscribe” to this blawg to receive e-mail updates.  In addition, follow me on Twitter and “Like” me on Facebook.  If you need to contact me directly, please e-mail me at Ryankhew@hawaiiesquire.com.

*Disclaimer:  This post discusses general legal issues, but does not constitute legal advice in any respect.  No reader should act or refrain from acting based on information contained herein without seeking the advice of counsel in the relevant jurisdiction.  Ryan K. Hew, Attorney At Law, LLLC expressly disclaims all liability in respect to any actions taken or not taken based on the contents of this post.

In my previous post I discussed raising capital through governmental loans and programs.  Today’s Draw the Law topic is about deciding to buy a business or its assets and franchise agreements.

Say you come to the realization that you don’t mind owning a business that someone else has built up.  The culture, the image, the stuff walls and tiles – all of it looks great!  You probably would then explore buying the business or if it is a part of a chain entering into a franchise agreement.

Buying a Business: Why Start from Scratch?

Exchanging Information: Getting to Know Each Other

Let’s say you want to buy the mom and pop store that makes shave ice down the road.  The first thing you will always need, and it remains true of all business transactions, is information.   The information you will need is your credit worthiness, financials, and the like – why?  Because the seller of the business wants to know if you can afford the business and in exchange you will ask for the books from the shave ice store.  Just because the business is always crowded with tourists does not necessarily make it the moneymaker you are expecting.  You want to know if they own the space they are in or leasing, is all the equipment paid up or are there liens on them, what are the terms of the current employees’ contracts, etc . . .  The only way you as the buyer of the business know it is worth it for you is to see if you are getting what you bargained for, and that means you will need to prove to the seller that you can pay them the price you will settle on.

Buy the Business or the Assets?

Do you want the body or the guts?  That is one of the most basic questions you want to know.  Do you just want the stuff that makes up the business, which includes equipment, facilities, and intangible property like trademarks?  Or has the business been successful over the years because of the contracts it has in place (as it is the business entity that signed all those agreements)?

You will have to decide which is more beneficial.  Just buying the assets is like removing the hermit crab from its shell; you leave behind the corporate entity and anything attached to it similar to how an anemone is left on the shell when the crab moves.  Similarly, any contracts, lawsuits, and such liabilities are left with the corporation.

The Process: Start to Close

In general, the process is a lot of review, negotiating, and the finalizing of details.  Are the sellers telling you everything?  Can you get a look at the records and books?  How will you pay for the business?  If it is in monthly installments how will they accept payment?  Operationally, how will the transfer work out?  Like the transfer of accounts, titles, etc. . . .  Finally, when all that is reduced to writing you can sign the contract.  Of course, this does not happen overnight and you will probably need to work with a group of experts, such as a business broker, an accountant, your banker, an attorney, and the seller’s people to get this to all happen.

Non-compete Agreement and Warranties

Non-competes and warranties are things you will agree to before the deal is completed, but care about what happens after the business is in your hands.  The business you just bought or its assets are not worth much if the seller goes and starts the same exact business.   Therefore, you get assurances from the seller that they will not be your competition by placing a non-compete clause in the sales agreement or draft a completely separate document.  Either way, there are some restrictions on how much you can limit or prevent the seller from starting a similar business. Oft times, a buyer will actually retain the seller on as an employee or consultant to ease the transition, and thus is another way to prevent competition from the former business owner.

A warranty gives you, the buyer a right to go after the seller if an undisclosed liability comes up after the transaction is complete.  Let’s say you buy the shave ice store, but the former owners forgot to tell you that some of their customers had gotten stomachaches from food poisoning.  Those customers then sue you, as you have become the new owner of the business.  If you had a proper warranty clause you would be able to go after the former owners for what the customers are suing you for.

Franchising: What Comes with the Name?

When you buy a franchise you are buying a business.  Generally, it is a business with brand recognition and with that recognition comes all the inner workings of that brand from its trademark to its secret recipes you get it all.  It even includes how the storefront will look.  Typically, especially if it is one of the national brands, you will be paying a lot of money, and why not?  You would be paying for a brand name that has a proven track record (but like any business, you should realize that does not always mean success).

Pros

  • Experience – the franchisor (the entity you are buying the franchise from) will help you with all their experience and knowledge get started.  If you are new, this is definitely something that will help you get up to speed.
  • Advertising – you are now apart of the franchises chain of distribution, therefore it is in their interest to coordinate marketing and advertising with you.  National sales campaign?  You will probably be sent all the material and have it all set-up for you.
  • Established – all the time spent creating a name and image has paid off for the company, and you are paying a fee or royalties so you can use that name and everything associated with it.
  • Lower operational costs – because you are getting all your products and supplies from the franchisor it is usually at a reduced cost and therefore, it is less costly for you to operate than if you had to buy all that stuff on your own.

Cons

  • Lost of control – the strength of a brand name and image comes from consistency.  When you enter a famous fast food chain in another state or even country you expect the same products and services you would expect locally.  To accomplish this feat, the franchisor restricts what you can do with the storefront.
  • Favoring the Franchisor – the franchisor is in the business of making money, naturally, the agreement they are going to have you sign favors them.  Some factors that favor them are the following:
    • Royalty fees – usually, paid on monthly gross sales and not profit, therefore you pay even if you aren’t making money
    • Restriction on transfer – you may not be able to sell the franchise and it may only be back to the franchisor
    • Termination at their discretion – the franchisor may end the agreement when they feel you are not cooperating leaving you high and dry
    • Competition – the franchisor can sell as many franchises as they wish, which includes your neighbor who also wants to buy into the franchise
    • Trapped – you might be forced to only buy supplies and products from the franchisor and be unable to go to outside supplies
    • Paperwork – the franchise wants to see you are making the most of your relationship with them, and thus would like to see reports from you, on a monthly, even weekly basis.

Just as a heads up the next several draw the posts will concern itself selecting a location for your business and the people involved with your business (employees, vendors, and customers).  Don’t forget if you enjoy this series or any of the other series on my blawg feel free to subscribe in the right-hand corner of this page to receive e-mail updates on posts.  If you are on Facebook be sure to “Like” “Ryan K. Hew” to get updates there as well.

See you on the next draw!

*Disclaimer:  This post discusses general legal issues, but does not constitute legal advice in any respect.   No reader should act or refrain from acting based on information contained herein without seeking the advice of counsel in the relevant jurisdiction.   Ryan K. Hew, Attorney At Law, LLLC expressly disclaims all liability in respect to any actions taken or not taken based on the contents of this post.