Covenant Not-to-Compete in Massachusetts

Massachusetts court has long limited an employer’s right to restrict a former employee from competing against the employer. Court only enforces such a restriction if employer can show “legitimate business interest” to protect itself from unfair competition by the former employee. Employer’s legitimate business interest has to be balanced against employee’s right and freedom to obtain employment in order to make a living.

An employer’s “legitimate business interest” falls into three general categories: (1) trade secrets; (2) confidential business information; and (3) goodwill. It shall be noted that free from ordinary business competition in the industry is not itself a legitimate business interest. I see the covenant more often with high level staff or senior executives rather than regular or lower level employees.

In addition to protect reasonable and legitimate business purpose, the not-to-compete term also needs to be reasonable in scope, time and geographic scope. The reasonableness is defined by case law. A lot of factors are used to assess the situation, such as, nature and financial position of the employer, employee’s job description, employee’s ability and need to make a livelihood.

Employer shall also enter into such a covenant with the employee at the outset of their relationship. It could become problematic when employer rushes to strike such a deal with the employee at the time of employee’s departure.

Protection of Proprietary Information for Early Stage Businesses

The protection of intellectual property is essential to the success of a business focused on development and marketing of a new technology. The protective approach shall be broad instead of narrow. It may include the use of Non-Disclosure Agreement (NDA) or Confidentiality Agreement, specifically tailored employment or third party service contract, Noncompetition Covenant, ,filing of a Provisional Patent or a trademark.

NDA may be a standalone agreement or a confidentiality clause may be built into a service contract. It is a fairly common practice for a technology start-up to forbid the disclosure of its proprietary technology by another party who needs access to this technology to design systems, platforms or products for the start-up. The goal is not only prohibiting the disclosure, but also clarifying who owns the intellectual property of what specific component. It is the best interest for most businesses to require the service provider to release the ownership of intellectual property right of any work provided. This shall be made clear in the contract.

The company shall require the primary sales representative or software developer to sign a Noncompetition Agreement. That individual could be either an employee or contractor. The extent of the non-competition as to the geographic regions, time and scope shall be reasonable and for legitimate business purpose. Legitimate business purpose is construed as protect trade secret, confidential information and goodwill. If the engagement is with another business, not an individual, the non-competition prohibition could be difficult to impose depends on the circumstances.

Basic Structure of a Business Corporation

Every week, I’ve encountered questions and confusions from many soon-to-be entrepreneurs, and sometimes even entrepreneurs who are running real companies, about power struggles among board of directors, officers and shareholders.

In general, board of directors exercise all the corporation powers except those reserved to the shareholders by statutes, articles of organization or bylaws. It means, business affairs of the corporation shall be managed under the direction of the board. Note the word “direction”. Board does not engage in day to day operation of the corporation, but only “directs”. The board members are elected by the shareholders. The number shall be fixed by the shareholders at the annual meeting. In Massachusetts, the number shall be at least one. If the corporation has more than one shareholder, the number of directors shall not be less than three.

The most basic structure of the officer team has a President, a Treasurer and a Clerk. President is in charge of the daily operation of the business. One would imagine a President has pretty broad authorities, but amazingly, his power is very limited and in most instances only has the authority to enter into routine transactions, unless he is also a Chief Executive Officer (CEO). Treasurer receives and disburses corporate funds. Clerk, also referred as Secretary, takes minutes of board and shareholder meetings and maintains corporate records and seal. All the officers are elected and removed by the board and fulfill their duties at the direction of the board. The scope of their authority shall be enumerated in the bylaws.

Shareholders are the owners of the corporation. They have the right to elect and remove board members, which is a right sometimes shared with the board itself. Shareholders have the right to inspect and copy corporate records. Corporate records include articles of organization, bylaws, resolutions adopted by the board, minutes of shareholder meetings, records of actions taken by shareholders without meetings, financial statements, corporate communications to shareholders, and names and addresses of directors and officers.

The biggest source of contention is who has the right to do what, and what quorum and how many votes are needed to elect or remove a board member or officer, and to determine a corporate action or transaction. Well drafted articles of organization and bylaws shall address all these issues in accordance with the statutes, thus to minimize the likelihood of future disputes.

Wage and Hour Exemption in Mass

By Mass law, employers have to pay employees overtime pay, with some exceptions. Exemptions applies only to highly skilled employees who have achieved a level of proficiency in the theoretical and practical application of a body of highly specialized knowledge, such as, computer and system analysis, programming, and software engineering. It is usually a fact specific task to define what types of jobs within this parameter has "achieved certain level of proficiency", mostly those employees who do not need close supervision and can work independently.

To avoid overtime claims in software industry and emerging businesses that may be able to take advantage of a special minimum wage and overtime exemption for workers in these areas. The employees must be salaried or hourly, with a regular rate of a minimum wage set by the law, and must have a primary duty consisting of either or any combination of:

Application of system analysis techniques and procedures.

Design, development, documentation, analysis, creation, testing, or modification of computer systems or programs; or

Design, documentation, testing, creation, or modification of computer programs related to machine operating systems.

Can Wrongful Termination Claim be based on Voluntary Quit?

My phone rang early afternoon on Tuesday. A lady asked if I have a few minutes to listen to her story and determine if she has a valid wrongful termination claim. It turned out that she quit instead of being discharged by her employer. At the first glance, it doesn't seem to fit in the parameters of a "wrongful termination". However, it is noted that her decision to quit may have been a "constructive discharge" because her salary would be reduced to half and position would change from a manager supervising thirty plus people to one of those she oversaw.

Constructive discharge is a type of termination that is "quit" on surface but "discharge" in nature. It usually occurs when employer makes significant changes of employee's job responsibilities, demotes employee to a much lower position, or cut her compensation to a point of intolerance based on unlawful grounds, such as, race, religion, color, disability, nationality, age, etc. Under these circumstances, nobody would have been able to continue the job because of the humiliation and indignity she would suffer as a result of it, voluntary quit is but the only choice she has.

Interestingly, early next Morning, she called back telling me that her employer offered her job back last night. The ending was not too bad. I gave her something to take away - when you encounter a situation like this, don't quit on spot, calm down and give yourself just a few hours to think it through and perhaps consult with an attorney before making a wise decision.

Can My Company Sponsor My Own H-1B?

The tough job market makes increasingly difficult for foreign students to secure post graduate employment from companies who are willing to sponsor work visas. Many entrepreneurial minded students ask me how likely their labor certificates are to be approved by Department of Labor (DOL) if they have some “ownership” in the companies that sponsor their work visas. Will they be considered as “investors” or “employees” for the visa purpose?

“Investor” usually includes anyone that has a capital interest in the company. A sole shareholder of a corporation or limited partnership rarely works. A Corporation is a more suitable type of business for that purpose on behalf of employee/owners. For instance, a Board of Directors that has the power to remove executives allows the DOL to be convinced that a position may be available to U.S. workers. There is no magical percentage of ownership that would guarantee a successful labor certification.

There also has to be a bona fide job opportunity. The corporation cannot be set up as a scheme or sham for foreign entrepreneur to procure a labor certification. In addition, the foreign employee/owner’s skills cannot be so integral to the company’s operations that the company would cease to exist but for the employee/owner’s participation. Furthermore, the foreign employee/owner’s degree of control over the business is also a factor. Basically, if his ownership interest and control over the management of the company is too great, it is suspected that a bona fide job offer cannot exist for a U.S. worker. The Labor Certificate will probably fail.

These are the typical questions about the foreign employee/owner that need to be addressed:

1. Is he in the position to control hiring decisions regarding the job for which certification is sought?

2. Does he have an ownership interest in the company?

3. Is he involved in the management of the company?

4. Is he on the Board of Directors of the company?

5. Is he one of a small number of employees?

6. Are his services so indispensable to the employer that the business would likely cease to exist without him?

When to Form a Business

I have been asked by many entrepreneurs about the timing to incorporate their businesses. Some are hesitant to do so at an earlier time for a number of reasons, primarily, the cost associated with the formation, uncertainties about the market prospect and how equity and profit can be split among co-founders, and conflict of interest with existing or former employers. There are many good reasons that a company shall be formed sooner than later. I encourage entrepreneurs to balance the advantages and disadvantages.

Advantages to form a company are:

Ability to contract/Limited liability – Founders may want to establish relationships with third parties in order to plan the business. These third parties could be strategic partners, advisors, employees and etc. Some founders enter into these contracts before the company is formed, this arrangement is not ideal, because any potential liabilities arising from the contract may be founders’ personal liabilities. Once a company is formed, a corporate shield is established, and founders could not be held personally liable in conducting the normal business in most circumstances.

Tax advantage – The earlier the company is formed the sooner stock can be issued and sooner the capital period begins to run. For income tax purposes, when stocks that have been held for more than one year are sold, they will be taxed at a preferential rate than those have been held for less than one year.

Cheap stock issues – If you wait until receiving strong indications from potential investors to form a business, there may be bigger tax liabilities for founders. The difference between what founders pay for their stocks and fair market value of stock at the time of purchase (as determined by reference to what investors are willing to pay) may be characterized as income, possibly resulting in significant tax liabilities to founders.