I am returning to my long neglected blog and starting a series about legal issues encountered in forming a new business.

I will start with a post about concerns the founder of a new business should have before leaving his or her job and continue posts through one about the financing of the new business. I will place emphasis on formation of a technology driven start up.

What then are the issues the new company’s founder must consider prior to quitting his or her job?

  1. The founder, no doubt, had to sign or became subject to a number of agreements with his or her current employer. These agreements may be contained in a single contract, separate contracts or in an “employee handbook.”  Wherever contained, they must be carefully reviewed.
  2. Non Disclosure Agreements—NDAs. The founder probably signed a non disclosure agreement with the employer.  Such agreements generally prohibit the use or disclosure of the employer’s confidential information.  The founder must be careful not to have even the appearance of appropriating confidential information because, if in fact there is evidence of misappropriation, litigation by the employer can move to quickly shut down the new enterprise.  NDAs take various forms.  In certain agreements, making a determination as to what, in fact, is confidential information may be difficult.
  3. Misappropriation of Trade Secrets. Wholly apart from the foregoing agreements, the employer may get injunctive relief and/or damages for “misappropriation of trade secrets.”   To prevail, the employer must show that there is in fact a trade secret, that the employer took reasonable steps to preserve it and that the employee used improper means in breach of a confidential relationship to get and/or use the trade secret.  In addition, there may be criminal prosecution for the misappropriation of trade secrets.
  4. Non-Competition Agreements. Many employment agreements contain non-competition agreements. Non-competition agreements are currentlyenforceable if they are necessary to protect the “legitimate business interests” of the employer and if they are reasonable in geographic scope and in time of enforcement.  Courts have held that non-competition agreements that were designed simply to protect the employer from ordinary competition did not serve the aforesaid “legitimate business purpose,” and are thus unenforceable.  I say these agreements are now “currently enforceable” because there is pending legislation to drastically curtail the effect of non competition agreements.  Attempts, however, by the Massachusetts legislature to limit the scope of non competition agreements[1]have met with no success (see my posts of August 2, 2016, June 15, 2015, September 14, 2013 and December 14, 2011, which discuss the merits of some of those proposals). In the event the founder is subject to a non competition agreement, he or she must carefully analyze the agreement to determine whether the founder and the new business are subject to its prohibitions and, if so, whether the employer can enforce the agreement.
  5. Non Solicitation Agreements. The founder may also be subject to agreements preventing solicitation of customers, vendors or employees, etc. of the employer.  Care must be taken to avoid running afoul of these agreements when staffing or ramping up a new business.
  6. Assignment of Invention Agreements. Many employment agreements contain a provision requiring assignment to the employer of know how and inventions.  Some of these agreements may even provide that employees must disclose futureinventions developed for a certain time after termination of employment.  Any know how, invention or process, etc. to be used in the new business should be carefully examined by an IP lawyer to determine whether such an agreement will be breached.  This will be crucial to the success of future funding of the business because ownership and protection of the new company’s intellectual property will be carefully scrutinized by any funding source.
  7. Prohibition of Outside Activities Agreements.Certain agreements prohibit work on outside business activities during business hours, or prohibit outside activities, period.   If it is determined that such an agreement is effective, the founder must find a way to deal with this prohibition.  Even if no such agreement exists, the founder should be careful.  Work should be undertaken on a new business while in the employ of another only after seeking the advice of an attorney.
  8. Other Restrictive Agreements. Employers are creative when attempting to protect confidential information and trade secrets and, of course, when attempting to stifle competition.   The types of devices are limitless and an employer’s otherwise innocuous clause or agreement may give rise to serious consequences in the new enterprise.  Care and thoroughness pay off here.
  9. Many employment agreements require return of the employer’s property. Prior to the founder’s exit he or she should carefully examine files, plans, equipment, hard drives and other retention devices for the employer’s property.  Even an inadvertent retention, if discovered (and it will be!), may result to the founder’s detriment in a law suit by the former employer.
  10. Finally, on exit from the employer, the exit or severance documents should be carefully looked at to make sure that the employer did not add additional agreements that might affect the founder’s new business. A severance payment, for example, may be linked to a non competition or non solicitation agreement.  Prior to leaving, the founder of the new business should also attempt to maximize his or her benefits, such as vacation time, sick time, stock options and the like.

Plan carefully your exit.

 

[1]          The current bill couples the limitation on the scope of non competition agreements with the Uniform Trade Secrets Act.

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In Baker v. Wilmer Cutler Pickering Hale and Dorr LLP,[1] the Massachusetts Appeals Court held that an attorney for a limited liability company owed a fiduciary duty to its minority members. I believe it’s clear that this ruling would apply to corporations and its shareholders

In Schaefer v. Cohen, Rosenthal, Price, Mirkin, Jennings & Berg, P. C[2]. the Supreme Judicial Court, in dictum, stated that there could be a duty of corporate counsel to the minority shareholders.   The Court stated:

[T]here is logic in the proposition that, even though counsel for a closely held corporation does not by virtue of that relationship alone have an attorney-client relationship with the individual shareholders, counsel nevertheless owes each shareholder a fiduciary duty . . . Just as an attorney for a partnership owes a fiduciary duty to each partner, it is fairly arguable that an attorney for a close corporation owes a fiduciary duty to the individual shareholders.

In Baker, the Appeals Court adopted this rationale and stated whether such a fiduciary relationship to, in the case of individual members of a limited liability company, exists, is “largely a question of fact.” Reversing the granting of a motion to dismiss, the Appeals Court found that when the majority members secretly retained the attorneys to represent the company, then the attorneys worked to assist the majority to extinguish rights of the minority, a claim against the attorneys could exist. The Court held that the complaint stated a claim for the attorneys’ breach of fiduciary duty, as well as a claim for aiding and abetting such breach, conspiracy and violation of M. G. L. c. 93A.

As a practical matter this case may prove troubling for lawyers who represent close corporations and who assist in action at the request of the controlling person or group. While the facts in that case are more than somewhat extreme and the case was positioned upon a motion to dismiss, until some flesh is put on the bones of this case, the lawyer acts at his or her peril. The ruling is salutary, however, and a real benefit to improving corporate governance.

I represent primarily close corporations. I tell its shareholders that I represent the company and that when I believe that a shareholder has an interest adverse to another, I explicitly note the conflict and suggest that the adversely affected shareholder obtain counsel.   This has always been good practice and the Baker decision will only cause me to put the foregoing in writing.   I will also be more insistent on requesting potentially adversely affected shareholders to retain separate counsel.

[1]           91 Mass. App. Ct. 835 (2017).

[2]           405 Mass. 506, 541 N. E. 2d 997 (1989).

Mass. Gen. Laws c. 149, §148 provides that a discharged employee must be paid “in full” his or her wages on the date of discharge. That section also provides that the term “wages” includes “any holiday or vacation payments due an employee under an oral or written agreement.” Thus an employer must pay for accrued vacation time on the date of discharge, along with all other wages earned to that date.  So, if you do not have a clear policy as to how vacation accrues, how much vacation pay do you give an employee on that date? What if you have no defined policy—you merely tell the employee he or she has, say, two weeks vacation?

In the event of no defined policy (which is usually the result of an oversight), I have always counseled the practice of giving the entire year’s vacation time (less any time taken) pay on discharge.   A client of mine wanted a detailed memo about discharge policy and, while researching the subject, I came across the following advisory.   The Massachusetts Attorney General’s Advisory 99/1 Vacation Policies states:

             “Employers can protect themselves by adopting clear and unambiguous vacation                    policies . . .A policy that provides for employees to earn a given amount of vacation “a year, “ “per year” . . . is not clear. Where an employer’s policy is ambiguous, the actual time earned by the employee will be pro-rated according to the time period . . . in which the employee actually works. For example, if an employee is to receive twelve vacation days “in a year,” and the employee voluntarily or involuntarily terminates his or her employment after ten months, the employee would be entitled to ten vacation days or one day per month worked. Discharge prior to one year without pro rata payment constitutes failure to pay wages earned under Section 148.” (emphasis mine)

            Does the above mean that vacation pay may be apportioned if no policy is stated? One employment lawyer with whom I spoke and a person at the Attorney General’s office suggested that the pro ration in the AG’s Vacation Policy above only applied if the employer’s policy was ambiguous.   There is a difference between an ambiguous policy and no stated policy. The thinking was that “no accrual policy” was not ambiguous—it was clear; the entire vacation time accrues at the beginning of the year.

If you want to pro rate vacation pay on discharge, make your vacation policy known (post it or include it in a manual or in a hiring letter) and clear.

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To the Editors:

I have been a subscriber of The New York Times off and on for 50 years; a reader for longer.   Though The Times was editorially leftish, I particularly appreciated its independent journalism.   Sadly, those days have passed and the opinion pages appear on page one and the editorial and op ed. pages literally scream with political favoritism for Mrs. Clinton. As a supporter of Sen. Sanders I wrote, a couple of months ago, regarding an article appearing on page 1 but which I believed belonged on the editorial or op-ed page. The “news” article supported Mrs. Clinton and misrepresented Sen. Sanders’s positions. I was disappointed in the paper and made my feelings known (my letter was not printed).

As a progressive, I cannot support Mr. Trump. Recently, The Times, in both of its news and op ed. pieces has taken to misquoting Mr. Trump, in an apparent effort to favor Mrs. Clinton. I find this offensive. One would hope that a well-informed citizenry could make up its mind as to Mr. Trump’s or Mrs. Clinton’s qualifications without a “push” from what purports to be the newspaper of record.

The Times has reached a new low; it had been my paper of record but is no longer. Perhaps in the days of on line journalism, it can’t afford first-rate reporters or editors (or for that matter, in its on line versions, spell and grammar checkers).

I’m disappointed.

Please cancel my subscription.

Respectfully,

Edmund Polubinski, Jr.

Boston, Massachusetts

The Massachusetts legislature ended its session without taking action on competing bills limiting non competition agreements in the House and Senate.   This is probably a good thing because the discussion regarding the bills has not been substantive. The venture capital industry supporting a limitation and the business community opposing the limitation have both resorted to specious arguments.   I discuss the pros and cons of eliminating or limiting non competes in my posts of June 25, 2015 and September 14, 2013 below.

I have had very few clients involved in family businesses, which businesses have succeeded to the second generation.  Some of my clients have been children who have been “frozen out” of the business by their siblings, sometimes to the dismay of the founder.  Sometimes the second generation hasn’t a clue to how the business is run.

The owners of a successful business should begin at least 10 years before they plan to turn over the reins, to implement a realistic plan for succession.  By realistic I do not mean including, in future management, the child still in kindergarten or believing, that the child who is successful educator, will suddenly see the light, and join the business.  It may be that the best course is sale of the business, insuring a safe retirement and perhaps a cash gift to the second generation.

There are some interesting stories at Lifting the Second-Generation Curse.  You can find a link to that article which appeared in The New York Times at my Twitter account @EdPolubinski

Crowdfunding was authorized by the JOBS Act enacted on April 5, 2012. The SEC adopted regulations implementing the crowdfunding portions of the Act on October 30, 2015, and those regulations became effective on May 16, 2016. The release adopting the regulations was 685 pages long but the rules adopted are not all that complicated. The following is a brief and general discussion of those regulations.

Crowdfunding will be of use to issuers who want to raise smaller amounts of capital (up to $1 Million in any 12 month period).

An individual’s investment in any 12 month period in all crowdfunding issuers is limited to:

(i) The greater of $2,000 or 5 % of the lesser of the investor’s annual income or net worth if either the investor’s annual income or net worth is less than $100,000; or

(ii) 10 % of the lesser of the investor’s annual income or net worth, not to exceed an amount sold of $100,000, if both the investor’s annual income and net worth are equal to or more than $100,000.

During any 12 month period, the aggregate amount of securities sold to an investor through all crowdfunding offerings may not exceed $100,000.

Certain companies are excluded from participating in in raising funds by crowdfunding,

Generally, securities purchased in a crowdfunding offer may not be resold for a period of one year.

The issuer must make disclosure about the business, use of proceeds, etc. similar to that which an issuer must make under Regulation D.   This is something that the company should not try at home; this disclosure is difficult and precise work. Disclosures of this sort have followed a pattern and it would be wise to follow that pattern.   The disclosures are an “insurance policy.”

The standard for financial statements depends upon the amount of the offering.

There are filing requirements and ongoing reporting requirements. Advertising is restricted.

Finally, the crowdfunding must be conducted exclusively through an SEC registered intermediary—either a SEC registered broker—dealer or a “portal.”   If you call, I can give you the names of several “portals.”