Buy-Sell Agreements and Non-Compete Covenants

By Ira Rosenblatt Guest Columnist Question: We customarily require executives in our company to buy a small amount of stock in our company. They are also asked to sign a buy-sell agreement which contains a covenant not to compete, among other provisions. When they leave, the buy-sell provision is triggered, and we buy back their stock in exchange for them agreeing not to compete. I have heard conflicting feedback regarding this approach. Does this practice produce an enforceable covenant not to compete? Answer: The short answer to your question is “no.” As its name suggests, non-compete agreements are designed to restrain individuals from engaging in their chosen lawful business, trade, or profession. As such, subject to very limited exceptions, such covenants are void under California law. The recognized statutory exception your policy presumably seeks to trigger is found in California Business & Professions Code Section 16601. That statute allows those shareholders who sell all of their ownership interests and good will in a company to agree not to compete with the buyer, subject to reasonable geographical and term limits. This exception grows out of a public policy described by one court as follows: ” it would be ‘unfair’ for the seller to engage in competition which diminishes the value of the asset (he or she) sold ” Monogram Industries, Inc.v. Sar Industries, Inc., (1976) 64 Cal.App. 3d. Based on the information in your question, however, it appears your policy does not fit within the Section 16601 limited statutory exception. First, the exception only applies to shareholders who own and sell a “substantial interest” in the company. What constitutes a “substantial interest” will vary from one company to the other, but it is critical that any sale constitutes a transfer of the company’s good will. Many published California cases find that non-compete provisions emanating from arrangements like yours are void. Often, courts note that the seller (here, your ex-employee) held an insignificant (as opposed to “substantial”) interest in the company. Or, perhaps, the selling shareholder really never owned any good will (as perhaps is the case with your arrangement as well, although it is not possible to know based on the limited information in your questions). Other courts label these arrangements “shams,” holding that employers cannot avoid anti-competitive laws by forcing their employees to buy insignificant amounts of stock which they must then resell upon termination. My suggestion is to either revise your policy to ensure that these employees are purchasing and selling substantial interests in your company and its good will (and that the sales price is reflective of that value), or discontinue the policy and search for ways to keep your employees from leaving in the first instance. Q: Our board of directors is considering making the vice president title available to more of our company’s key executives. We think it will have a positive impact on morale and will give them more credibility in their dealings. Are there any issues of which we should be mindful? A: I would caution you to evaluate the additional liability these vice presidents may create for the company. Unless a company’s bylaws or articles state otherwise, corporate officers serve at the pleasure of the board. When officers deal with third parties, the law states they act as agents for their company. As agents, officers can bind the company to commitments so long as the agent is acting (or perceived to be acting) within their scope of authority conferred by the board. Authority can be either actual or apparent. Actual authority is authority conferred, either expressly or impliedly, by a company’s bylaws, articles, or by action of the board. Apparent authority is that authority the company allows third parties to reasonably believe one possesses, even if they do not. My suggestion is that you and your fellow board members clearly define the authority you choose to confer on these “vice presidents” and that you do not hold these vice presidents out to the public (or more likely allow them to hold themselves out to the public) as having any more authority than that which the board conferred, lest you risk having them bind your company to unanticipated obligations. I would also ensure that you include them in your mandatory management sexual harassment training, assuming they are not already. Q: My bank requires that two corporate officers sign all loan documents. When I asked why, they explained that two officer signatures are required to bind a corporation. I had never heard that. Is that the case? A: No. Any one officer with either actual or apparent authority is capable of legally contracting on behalf of a corporation. Your bank’s policy is grounded in California Corporations Code Section 313. Under that section, so long as any note, mortgage, contract, and the like, is executed by the chairman of the board, the president or any vice president (sometimes referred to as the “operational” category), on the one hand, and the secretary, any assistant secretary, the chief financial officer or any assistant treasurer (sometimes referred to as the “financial” category), on the other hand, the corporation is precluded from later claiming that the individual(s) signing the document lacked the authority to execute the same. Where one individual holding two of the specified offices (one in each of the “operational” and “financial” categories) executes an instrument, Section 313 applies even though only one of his/her titles is reflected therein. See Snukal v. Flightways Mfg, Inc (2000) 23 Cal 4th, 754. The “purpose of this provision is to allow third parties to rely upon the assertive authority of various senior executive officers of the corporation concerning the execution of any instrument on behalf of the corporation.” See Legislative Committee Comments. Although two signatories are not required to contractually bind a corporation, if two officers as proscribed by Section 313 do execute a document, the other party can rest easier knowing that the law will preclude the corporation from later contending that the signing parties lacked authority to bind the corporation. Q: Is there any down side to purchasing EPL insurance? A: For the benefit of other readers, “EPL” is an acronym for Employers Practice Liability insurance. EPL insurance is designed to cover employment related claims (e.g., wrongful termination, retaliation, discrimination, harassment) not typically covered by other insurance policies. EPL policies have grown in popularity as employment-based claims continue to be in vogue among the plaintiff’s bar. The pros of such coverage are obvious. Since your question regards cons, consider the following. You yield control of the litigation to the insurance company and its counsel of choice. For example, your insurance carrier will not be as concerned as you regarding the negative precedent a settlement may or may not have on other employees. Moreover, many EPL policies have a quasi-consent clause which may leave the employer responsible for any and all losses sustained over and beyond any recommended settlement that you reject (e.g., if plaintiff’s counsel demands $25,000 and your insurance company asks for you to approve it, if you do not, your policy form might make you responsible for any verdict/settlement later realized over that amount); EPL policies also require employer cooperation, which might be an issue if plaintiff’s settlement demand asks for reinstatement if you are not open to that request.