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Covenant Not to Compete vs Non Piracy Clause

By August 18, 2020July 7th, 2021Agency Management Moments

Iroquois’ in-house counsel Janine Fodor is back in the studio with the Trusted Advisor Podcast to review the main differences between a covenant not to compete and a non-piracy clause, and outline the reasons one may be more enforceable.  She will also discuss the importance of understanding what contracts potential new employee might have in place. 

A legal scale balancing covenant not to compete and non piracy clauses

Edwin K. Morris (4s):
Welcome to the trusted advisor podcast brought to you by Iroquois group. Iroquois is your trusted advisor in all things insurance. I am Edwin K. Morris. Please welcome back in the studio Janine Fodor. She is the Iroquois group’s in-house counsel. Previously, Janine was a partner at the Wagner and Hart law firm and moved to the Iroquois group full time in 2013. Janine is currently teaching her first law class at St. Bonaventure university called law and policies, focusing on cybersecurity. Please note that this podcast is for general informational purposes only.

Edwin K. Morris (44s):
It is not intended to be legal advice and should not be relied upon as legal advice. How does an organization protect itself in the idea of a employee moving on?

Janine Fodor (54s):
Well, one very common thing for insurance agencies to do is to write into their employment agreement with producers or other employees who are outselling, covenants not to compete or non piracy clauses in their contracts of employment.

Edwin K. Morris (1m 12s):
Are those two different things?

Janine Fodor (1m 14s):
Those are two different things. So a standard covenant not to compete would say in the contract that the employee will not engage in the business of insurance within a certain radius of the insurance office, maybe 50 miles or 75 miles for a definitive amount of time, maybe three years or four years. Whereas a non piracy clause is more narrow. And what it says is that the employee can engage in the business of insurance anywhere they, he or she wants to, but can’t take the customers that they serviced when they were working with their original employer, which is really what’s most critically important to an insurance agency.

Janine Fodor (1m 59s):
It’s those customer relationships where the value resides

Edwin K. Morris (2m 3s):
In this technological-laden world, does that radius geography thing even still make sense?

Janine Fodor (2m 10s):
You know, not so much it’s, especially, it depends a great deal on where exactly you are. It might mean more in, in certain areas of the country than others, but one problem that employers, as a general matter have with covenants not to compete, is that the courts and any other enforcing mechanism like an arbitration, arbitrator or mediator, they’re very reluctant to enforce covenants not to compete because they prevent the employee who leaves their initial employer from making a living. So if you write in a very, either lengthy or geographically broad covenant not to compete, like you can’t compete anywhere in the state of Virginia, you can’t compete anywhere in the United States.

Janine Fodor (2m 55s):
It’s very, very unlikely that a court will enforce that broad a covenant. So you’re always playing this balancing game. You want a covenant that’s broad enough and long enough to be effective, but not so overly broad or overly long that it’s likely to be just thrown out by a court, which is why a non piracy provision will often work better for a retail agency, because then you’re protecting your customer base. And you’re not preventing a person from going out and engaging in their business, but just with new customers with, with a different group of people, they’re not taking your customers, but they’re able to make a living

Edwin K. Morris (3m 33s):
The non-piracy clause is like really just setting the things up to where it can be enforced. You can say these, these folks were here with us before.

Janine Fodor (3m 41s):
Yeah, exactly. It’s a lot easier to enforce a non piracy and in part, because it clearly is the heart of the original employer’s business. And secondly, because it doesn’t prevent a person from going out into the marketplace and making a living of, but they just can’t take the customers.

Edwin K. Morris (3m 59s):
You can’t harvest the relationships.

Janine Fodor (4m 2s):
Exactly. Yes. Yes.

Edwin K. Morris (4m 5s):
I don’t hear the word covenant in too many other frameworks. So I had to look it up. Cause the only connotation I had had something to do with Salem. So covenant for definitional purposes, Merriam Webster defines it as a, usually a formal solemn and binding agreement. So is insurance really the only place you hear this non-compete terminology of covenant?

Janine Fodor (4m 30s):
No. I would, I would define a covenant as a promise. You know, that’s probably the most basic definition. And I think these promises not to compete occur in many industries where the primary product is an intangible intellectual property product. Because if, if you have in your head or if you can take with you, without you don’t have, you’re building something in order to go and start to compete directly with your former employer, you have to bring with you a lot of tangible pieces of equipment with respect to insurance or software development and other things. It might be pretty easy to take what’s necessary to build up a competitive business.

Edwin K. Morris (5m 11s):
So how does an organization protect itself in the hiring process to even know something like that even exists with a current hire? Yeah.

Janine Fodor (5m 20s):
That’s another really important point that it’s, they’re so relatively common that if you are an agency who’s going to be the new employer and you’re looking at, to hire a producer or somebody who has worked in the insurance business previously, especially if they tell you they’re bringing a book of business with them, you want to be really careful that they don’t have in place this kind of non piracy provision or non-compete that would actually prevent them from taking what they think they might, and they may in good faith think they can take it, but if you look closely at their agreement, they can’t take it.

Edwin K. Morris (5m 52s):
So the due diligence is on the new hiring organization to figure that out. I’m presuming this not public knowledge. So I can’t go down to the courthouse and see if this is on record.

Janine Fodor (6m 2s):
Yes. I, it’s very, very important to have that conversation with the prospective employee to ask them whether they’re under a covenant and secondly, to if they’re willing to, and usually these agreements are confidential, but to share the actual agreement to so that you can see that the terms. And then sometimes you might ask the employee to warrant in the new employment agreement that they are not bound by a covenant not to compete so that you’re getting at least their word

Edwin K. Morris (6m 31s):
How likely would it be for the new organization to contact the old organization, just to see what they say?

Janine Fodor (6m 36s):
Yeah. You know, that’s a tough call because sometimes the employee hasn’t even told his former employer that he’s leaving. So you’re, you might be in a bit of a bind and you want to be careful because even if you’re not party to that agreement, so then the new employer didn’t sign the covenant not to compete, but if you hire somebody knowing that they’re bound by a covenant and just disregard it, then you, the lawyer. Yeah. You could, you could be sued for interfering with that contractual relationship between the employee and his former employer. So I think the best way to handle it is just to really ask, to do your due diligence with the prospect and if possible, to request a copy of the agreement that he or she has with the former employer.

Janine Fodor (7m 21s):
And, and if you can see that, then you can sort of check for yourself,

Edwin K. Morris (7m 26s):
Those binding agreements, the non piracy and the non-compete it’s up to the new employer to do, like you say, do that due diligence to know what they’re getting into with this new employee and to make sure there is no restrictions period. But if there is, how do they proceed?

Janine Fodor (7m 44s):
Well, I think that any business person who finds themselves with a legal conundrum like that, so they’ve now hired somebody and they find out that they had restrictions for an and again, these things aren’t unambiguous. The employee might not be deceiving the new employer, it’s just that they can be a difference in opinion about how to interpret these covenants. I think the best advice is to try to negotiate a solution with the former employer. So that might mean buying out a book of business. It might mean agreeing that new employee is not going to pirate accounts that they had with their old employer for at least a certain amount of time, 18 months or two years.

Janine Fodor (8m 26s):
So before you would jump into any kind of adversarial situation, you know, sue or counter-sue or seek arbitration, I think trying to sit down in a room and work it out is, makes the most economic sense, because you might have to pay a little bit more for your employee because you have to buy out their accounts or you might lose some of what you thought the employee was going to bring with him and her, but you’re saving yourself both the time and the cost of litigation, which is an exceedingly disruptive thing for a small business to be involved in.

Edwin K. Morris (9m 4s):
I’m just curious in the world of insurance, is this infraction covered? So say the new agency hires someone and then whoops, something like this crosses wires they were unaware of, or didn’t have the exact knowledge of.

Janine Fodor (9m 20s):
It, it doesn’t, it doesn’t squarely fall under errors and omissions because it doesn’t have to do with the extent of coverage for an insurer. It would be hard to have a claim like that covered maybe under a D&O policy or possibly under an employment practice policy. The problem is there’s almost always an intentional conduct exclusion. So if the employee is not telling you the truth, then not telling the truth is not something that insurance companies typically cover. So you don’t want to hire somebody who’s not telling you the truth. It’s better to know the truth and to deal with it by negotiating with the former employer, then either not to ask or to sort of take somebody at their word that you’re not entirely trusting.

Janine Fodor (10m 8s):
If you can do some genuine due diligence, ask them more pressing questions, ask to see the agreement. Then at least you’re going to get a more complete answer and, and your new employer, isn’t going to be negligent. You know, you can’t really be responsible when somebody outright doesn’t tell you the truth, but that’s probably not somebody you want to hire.

Edwin K. Morris (10m 27s):
The last thing I’ll ask, is there anything that’s different state by state region by region that is a tar pit for this type of thing that either happens really well there, or it does not happen very well at all.

Janine Fodor (10m 40s):
Yeah. Well, I am not familiar with every state’s laws, but I know this is an area where there is quite a bit of diversity in terms of state laws, that some States are very employee friendly, meaning they’re quite hostile to the idea of covenants not to compete. They feel like they should support an open marketplace that unless you have a very narrowly construed covenant not to compete with it, short term, short geographic area, or a very narrowly construed to former customers, it’s not going to be enforced. Other States are a little more generous. So I would definitely, if you’re writing a covenant not to compete and you’re hiring somebody who you think can really compete with you, it’s worth talking to council in your state because it’s an area where state law does differ in terms of their, just their tolerance of those covenants and how, and how broadly you can write and have them be enforced by the state courts.

Edwin K. Morris (11m 36s):
Well, I think this has been an extremely informative topic. It’s going to fit the bill for a lot of folks that are not clear on this. I’m sure it’s one of those things that you don’t deal with all the time. Thank you very much for your time today.

Janine Fodor (11m 48s):
You’re welcome. Have a great day.

Edwin K. Morris (11m 52s):
Thanks for listening to this edition of the trusted advisor podcast brought to you by Iroquois group. Iroquois, your trusted advisor for all things insurance, and remember get out of the office and sell. this program was recorded live at the Cohen multimedia studio on the grounds of Chautauqua institution. I am Edwin K. Morris, and I invite you to join me for the next edition of the trusted advisor podcast.

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