Are Non-Compete Agreements Enforceable?

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The enforceability of non-compete agreements varies by state.  In a few states, an over-broad or burdensome non-competition agreement will be held to be unenforceable.  In other states, including Ohio, courts will rewrite non-competition agreements so as to scale back overly-broad provisions, while still protecting what the court believes to be the employer’s legitimate business interests.  Courts generally permit a non-competition agreement between a business and a former business owner to be of longer duration, cover broader territories and be more restrictive, than a similar agreement between the business and an employee.  For example, a non-competition agreement might only be enforced by a court against an employee for 12-18 months in a 25 mile radius of the business, while the court might enforce the non-competition agreement for 5 years or more anywhere in the United States if such restriction was necessary to protect the legitimate interests of the business from a former business owner. 

A good non-competition agreement should accurately describe the term, the restricted territory and the types of activities that would be considered competitive.  But a better non-competition agreement should also prohibit solicitation of customers, vendors, employees and others who have a business relationship with the business.  And the best non-competition agreement will also include a provision prohibiting use or disclosure of confidential or proprietary information.

A well-drafted non-competition agreement should provide that the business is entitled to use all equitable and legal remedies necessary to enforce the agreement, and that the business can collect attorney fees and other costs necessary to enforce the agreement.  In many situations it also makes sense for the non-competition agreement to include a liquidated damages clause which provides for monetary damages to be paid to the business if the former owner or employee uses or discloses confidential information, solicits a client or employee or otherwise violates the non-competition agreement.  Please call or email me if you would like to talk about non-competition agreements or need help in enforcing such an agreement.   Jsenney@pselaw.com or 937-223-1130.

AND ONE MORE THING.  Many small businesses share confidential information with their employees.  This confidential information can include client names, addresses and other client contact information, business methods, business practices and know-how.  This confidential information can be the life blood of the business.  Yet business owners often fail to adequately safeguard this information.  While state law provides some protection for “trade secrets”, such protection is limited and difficult to enforce.  Confidential information should be protected by a properly drafted and executed non-competition and/or non-disclosure agreement.  Call or email me if you would like to talk about protecting your confidential information at Jsenney@pselaw.com or 937-223-1130.

How Do I Get Employees Acting Like Owners Without Giving Them Stock?

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Employee incentive plans can be established to reward management employees based on increases in stock value without actually giving employees stock.  These plans are generally set-up as non-qualified deferred compensation arrangements and are often called stock appreciation right (“SAR”) plans or phantom stock plans.

Under the typical SAR or phantom stock plan, one or more key employee is awarded an SAR.  Under the SAR, a stock value baseline is established (normally fair market value on the date the award is issued), and the employee is given the right to receive cash (not stock) at some time in the future if the stock value has increased over the baseline.  The employee holds only a right to receive cash in the future if the stock value has increased.  The employee does not own the stock itself.  Hence the name “phantom stock.”  But the employee is rewarded if there is improvement in the value of the employer’s stock.  So the employee has every incentive to work hard, and go above and beyond the call of duty, to make the employer more profitable and successful.

Where employees are in a position to affect only part of the employer’s operations, some employer’s like to determine and measure the employee’s incentive compensation based on those specific factors the employee directly affects.  For example, a VP of Sales might receive an incentive award based only on increases in sales.  Or a controller or treasurer might receive an incentive award based on decreases in expenses or improvement in profit margins.

SAR and other employee incentive plans covering only key employees may be subject to ERISA, but generally are exempt.  If I can help you set up an employee incentive plan for your key management employees, let me know.  Jsenney@pselaw.com or 937-223-1130.

AND ONE MORE THING.    HB 153 was signed into law and contains language eliminating the Ohio Estate Tax for decedents dying on or after January 1, 2013.  Under the new law, the Ohio Estate Tax will still apply to decedents dying before January 1, 2013.   While we can't control date of death, we can advise you on certain strategies to reduce or eliminate federal and state estate tax.  Give us a call or email at Jsenney@pselaw.com or 937-223-1130.

Can I Pay Employees with Stock?

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The point of paying employees anything is to give them an incentive to show up for work and give you their best effort.  There are many different forms of compensation.  Employee compensation often includes basic salary, bonus, health insurance coverage, fringe benefits and retirement plan contributions.  All are important.  But if you really want to get your employees thinking like business owners, you may want to consider letting them acquire an ownership stake.

One way to do this is to give your most valuable employees a stock option.  When an employer gives an employee a stock option, the option agreement should state the number of shares subject to the option, the option price per share, the period of time during which the option may be exercised, applicable transfer restrictions and any other appropriate provisions or restrictions.
    
Stock options generally come in two basic forms.  One type of stock option is called an Incentive Stock Option (“ISO”).  The other type of stock option is referred to as a Non-Qualified Stock Option (“NQSO”).  An ISO is entitled to special treatment under federal and state tax law and must comply with the requirements of such law.   One of the federal income tax requirements of an ISO is that the option price must be equal to 100% of fair market value at the time the option is granted.  For federal and state income tax purposes, the employee does not recognize any compensation income, and the employer gets no compensation deduction, either at the time the ISO is granted or at the time the option is exercised.  Rather the employee recognizes a capital gain (or loss) at such time as the stock received upon option exercise is sold.
    
A NQSO is treated differently than an ISO for federal and state income tax purposes.  The employee recognizes compensation income, and the employer gets a compensation deduction, at the time the option is exercised.  The amount of the compensation income recognized by the employee (and the amount of deduction taken by the employer) is equal to the excess of the value of the stock on the date of exercise over the exercise price.  When the stock acquired upon option exercise is sold, the employee will have a capital gain (or loss).
    
More about stock options, restricted stock awards, phantom stock and other employee compensation and incentive arrangements will be found in a future blog post.  If I can help you set up an incentive or non-qualified stock option plan for your management employees, let me know.  Jsenney@pselaw.com or 937-223-1130

AND ONE MORE THING.    Have you ever heard of a DISC?  Does your business have significant foreign sales or income?  Does your business sell to other companies that export the final product?  You can reduce the federal income tax rate on such income significantly by setting up a DISC.  Give me a call or email me and ask me how at Jsenney@pselaw.com or 937-223-1130.

Should I Treat my Workers like Employees or Contractors?

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When workers are treated like employees, the employer is required to withhold federal, state and local income tax from the employee’s paycheck and pay such income tax withholdings to the appropriate government agency.  Furthermore, when workers are treated as employees, the employer is required to withhold and pay-over the employee-portion of the social security tax (6.2% on wages up to the wage base limit) and the medicare tax (1.45% on wages without limit), and to pay the employer-portion of the social security tax (also 6.2%) and the medicare tax (also 1.45%). 

     When workers are treated as independent contractors, the employer is not required to withhold income tax or payroll tax from the workers paycheck, and is not required to pay the employer-portion of social security or medicare tax.  Rather, the worker is treated as self-employed, and is personally liable to make quarterly estimated payments of income tax and self-employment tax.  Self-employment tax is the functional equivalent of the employer and employee payroll taxes.  Self-employment tax is assessed at the rate of 15.3% on wages up to the wage base limit, then 2.9% on all wages over the wage base limit. 

     When workers are treated like employees, the employer bears half of the payroll tax burden, and has the responsibility to withhold and pay income and payroll taxes to the government.  When workers are treated as independent contractors, the worker bears all of the payroll tax burden, and the employer is not required to withhold or pay-over any tax withholdings.  When workers are treated as contractors, the workers generally do not qualify to participate in group health insurance, retirement plans and other fringe benefit programs established for employees.  For these reasons, employers may see a financial advantage in characterizing workers as contractors rather than employees.

     The IRS looks at worker classification issues closely on audit.  The IRS applies a 20-factor test to determine whether workers should properly be classified as employees or contractors.  Although the IRS test refers to 20 factors, the IRS test really boils down to 2 main issues.  First, does the employer control the manner and methods by which the worker does his or her job?  That is, does the employer control the worker to the extent that the employer tells the worker how, where and when to do the job?  

     Second, does the worker have a risk of loss on the job?  A contractor has to run a business and pay bills.  The cost of labor and supplies on a job may exceed the amount the contractor collects on the job.  On the other hand, employees are paid a set wage by the hour, day, week or other period, and employee expenditures are often reimbursed.  So employees do not generally have a real risk of loss.

     If the IRS determines that an employee has been misclassified as a contractor, the IRS will generally look to the employer to make-up both the employer and the employee portion of income and payroll taxes.  If the employer is insolvent and cannot pay such taxes, the IRS will go after any responsible party.  For this purpose, a responsible party is any person who had the apparent power and authority (ie, a corporate officer) to make decisions concerning which creditors were paid. 

     Misclassification of workers can be a very expensive mistake.  The employer may need to pay income and payroll tax, penalties and interest, and may need to make additional contributions to employee retirement, health insurance and other fringe benefit arrangements.   There are some defenses and safe-havens available when the IRS questions worker classification.  But it is better to assess your situation now, and either correct your classification or prepare your defense strategy, before the IRS raises the issue.  If you want to discuss worker classification issues, please give me a call.   Jsenney@pselaw.com or 937-223-1130.

     AND ONE MORE THING.  How long has it been since you had a Legal Audit?  The Business attorneys at PS&E would like to meet with you and do a free legal audit of your company.  As part of the legal audit, we will work through a checklist with you and identify areas where you may be at risk.  If you would like to schedule a free Legal Audit with one of the PS&E attorneys, please send me an email or give me a call.  Jsenney@pselaw.com or 937-223-1130.

Do I Need my Employees to Sign a Non-Compete?

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Whether it is a necessity depends on a lot on what they do and who they know.  But it is not a bad idea to have all your employees sign a non-competition, non-solicitation and non-disclosure agreement as part of the terms of their employment.  Employees often learn confidential and proprietary information about you and your business.  If such information gets into the hands of the wrong people, your business may be injured or destroyed.

A well-drafted agreement will prevent your employees from competing with your business, soliciting your customers or employees, and using or disclosing your confidential information.  If your employee violates or threatens to violate the terms of the agreement, you can send a cease and desist letter, and then sue for breach if he or she does not comply.  If you have to sue, the court can issue a temporary restraining order, permanent injunction and other legal and equitable relief including monetary damages and attorney fees.
If your employee is using or disclosing your confidential information as an employee, partner or owner of another business, you should notify the other business that the employee is subject to a non-compete agreement.  If the other business continues to employee or be associated with the employee, you can sue the other business for tortious interference with contractual obligations.

In the absence of a non-compete agreement, you may be able to find some protection for your confidential information under the Ohio Trade Secrets Act.  But such protection is not perfect and only applies if you can prove your confidential information constitutes a protected trade secret.  More about protected trade secrets in a future blog.  B In any event, it is easier and less expensive in the long run to simply have all your employees sign a non-compete, non-solicitation and non-disclosure agreement when you hire them.
    
If you want some help with drafting a none-compete agreement, give me a call or send me an email.  Jsenney@pselaw.com or 937-223-1130.
    
AND ONE MORE THING.  Have you ever heard of Use tax?  Use tax is the compliment to sales tax.   You are obligated to pay use tax in Ohio if you buy something out of state and then bring it into Ohio to be used or consumed in Ohio.  The state of Ohio is stepping up its enforcement efforts against businesses.  The Ohio tax commissioner estimates that hundreds of thousands of Ohio businesses may owe use tax.  The Ohio Tax Department has an amnesty program beginning October 1, 2011 and ending May 1, 2013.  Businesses that enter the program will have to pay use tax back to January 1, 2009, but will not have to pay interest or penalty.   If you want to know more about use tax or the amnesty program, please give me a call.  Jsenney@pselaw.com or 937-223-1130.