Counsel representing businesses, their owners, or executives regularly earn their legal fees by resolving problems that arise from poor business practices. Those practices often evolved from temporary “fixes” to resolve emergencies or decisions that were never evaluated before they became the standards. Start-up or newly-successful companies often fail to allocate any portion of their budgets toward professional advice to advance their sophistication level in the marketplace. The adage of “if it ain’t broke, don’t fix it” is a poor defense to sophisticated opponents. Rather than using internet resources, forms from friends, or waiting until emergencies require action, awareness of legal pitfalls and standardization of practices with counsel review will help companies both succeed and defend against claims. Here are three areas prone to legal risk that should be regularly examined:
1. CONTRACTS: Contracts cover everything that a company does, from forming the entity itself (e.g., the Articles of Incorporation or Organization, Bylaws, and Operating Agreements govern how the company will be operated and how the owners will buy/sell their interests), to employing top-level personnel, protecting intellectual property, buying/selling/leasing/licensing property or services, or partnering with others to conduct business. These disputes come in all shapes and sizes, including:
(a) NO CONTRACTS where companies fail to have contracts in place so that disputes require interpreting years of practices (evidenced by varied communications) among a patchwork of persons. It is difficult to enforce “rules” based on little or changing precedent in a course of dealings by the parties, especially when a contingency arises for the first time that spawns disagreement. Always, the best practice is for counsel to prepare a contract for the company to meet its business goals and best protect against legal risk in anticipation of various scenarios between the parties.
(b) POOR CONTRACTS where companies rely upon the contracts or forms of the other parties with whom they deal, usually at their peril because the forms were either created with terms in favor of the drafter in the first place or fail to protect the non-drafting company’s interests; the pitfalls go unnoticed until a dispute arises which is often too late. Also, owners or executives sometimes try to save money by using forms from friends or the internet, often not knowing what some legal terms mean or lacking the education to know what terms are missing until they get burned by their own drafting errors. One easy example: is there a provision for attorney’s fees to be paid at all, typically by the losing party, if a dispute requires legal intervention? The American rule as to the payment of fees is that each party pays its own fees unless the contract or applicable law provides otherwise. (Conversely, the “English rule” is that the loser pays the winner’s attorney’s fees.) While counsel can educate on the best type of fee provision for a contract at hand, companies are often surprised to learn that they may have a solid legal claim but will be responsible for fees in order to recover the damages they have suffered, perhaps costing more than the value of the claim itself. Another easy example: if the parties are in different states, which state’s laws control disputes under the contract (and has counsel compared the different state laws to select the best scenario for your needs)? Many thousands of dollars are spent by parties on both sides of litigation of a contract dispute if this provision is missing, as well as fighting over proper venue for the lawsuit itself when there is no venue provision.
(c) INCOMPLETE OR STALE CONTRACTS where the practices of the parties have evolved beyond the terms of their contracts or effectively changed those terms, often piecemeal through verbal agreements or a maze of various writings over years of conducting business. If a dispute arises, counsel cannot evaluate only the contract itself, but must knit together the years of writings, electronic communications, and a client’s one-sided understanding of verbal agreements. If a legal demand fails to persuade an opponent to resolve a dispute (or the stakes too high to invite reason), costly litigation may be unavoidable in these circumstances. Companies are better served by regularly reviewing their contracts to make sure they comply with their practices and intentions.
(d) MISUNDERSTOOD OR UNINTENDED CONTRACTS where one or both parties to a contract did not understand terms or relied upon orally-expressed intentions which were in fact different than the terms in the contract. In a perfect world, everyone obtains sound legal advice before signing any contract, but that is not the world in which we live. Still, the sooner such a review can take place, the earlier that amendments can be made that don’t harm the parties’ relationship; parties typically have good intentions when entering into a contract and will be amenable to making adjustments for their mutual, long-term benefit.
To prevent these legal pitfalls, a company should aim toward its own counsel reviewing its contract needs, standardizing its commonly-used agreements for its best interests, and regularly evaluating those contracts to ensure they align with the company’s goals and the parties’ practices.
2. FAILURE TO PROTECT ASSETS: Assets include people (employees, vendors, suppliers, customers), the company itself, intellectual property, and real and personal property. Sometimes failure to protect assets is a waiver of legal rights, and waiver can mean dilution of the value of the property until it is worthless. In this area, insurance agents are (almost) as much your friend as your counsel:
(a) COMPANY ACTIONS can be protected by various insurance policies to cover general liability when its owners/managers are negligent in actions taken (or failure to act, known as omissions). In addition to coverage for commercial general liability (CGL) or liability umbrella coverage as applicable, insurance coverage is available for identified risk scenarios (errors & omissions coverage, E&O) and for acts of identified persons (directors and officers coverage, D&O). These insurance avenues are worth consideration and may be equally valuable to the obvious insurance coverage needed to insure real estate, leased premises, and company inventory, equipment, vehicles and other assets.
(b) INTELLECTUAL PROPERTY can also be protected by insurance coverage to some extent, but also (or mostly) requires appropriate legal protection and policies/practices to qualify as intellectual property or maintain that status. While patent and trademark protection are excluded from this article, companies regularly possess (but do not understand how to protect and maintain) trade secrets. To protect them in most states, companies must identify their trade secrets in policies or memoranda to those who have access to them and prohibit those persons from using or disclosing the trade secrets outside of working for the company; they must also limit access/distribution of those secrets as much as possible with various policies and regularly-employed practices, such as computer access/usage/download rules and the right to search any containers (thumb drives, devices, backpacks, purses, bags, boxes) coming in/out of the premises. Companies must also be diligent about where its secrets are contained and how to exercise control over them (such as on cellular phones or devices and social media accounts like LinkedIn or Facebook). Better, heightened protection of trade secrets includes the use of non-disclosure, non-competition, and/or non-circumvention contracts or policies that are personally signed by all who have access to the sensitive information (which access level should be limited according to function). Protection of intellectual property is an area where relying on forms from friends or the internet can be harmful, as Indiana case law is clear that there is no “one size fits all” and that restrictive provisions must be tailored to match a company’s protectable interests, yet not be overbroad or overreaching, in order for a court to uphold their protections. If the company’s lifeblood is the ownership or development of one or more secrets that competitors cannot readily ascertain, good contracts and policies and practices require retaining specific legal expertise in this area. If a company fails to adequately protect its trade secrets by law, they can become lost (and free to others) forever. Here, an ounce of prevention (in hiring good counsel) is truly worth a pound of cure.
(c) PEOPLE are important to a company’s success and some merit greater protection than others. Not only may “key man” insurance coverage be needed to protect a company against a loss sustained due to a key person’s untimely death or disability, but companies must work hard to retain key people. Retention measures include employment contracts for defined terms and benefits that may include bonus plans for attaining goals, profit sharing, and stock options. To avoid losing valued employees to competitors, employment agreements should also include non-compete and non-solicitation provisions. Contracts with vendors, suppliers, and customers can also contain non-solicitation and non-circumvention provisions to protect against their raiding of company employees, customers, or contractors. Core vendors or suppliers might also be retained if the company can provide them exclusive rights or areas tied to a contract for a term with similar restrictions.
(d) ANTI-FRAUD PROTECTION may be hard to contemplate, yet fraud committed by trusted employees or agents costs companies many thousands of dollars each and every year. Excluded from this article are data security protection measures best left to IT consultants to protect against hackers who can steal a company’s data, social media, accounts, and identity. But there are every day opportunities to be the victim of common theft that companies must be sure to impose checks and balances at every level, including:
* financial (don’t have the same person write checks, make deposits, approve invoices, and receive/reconcile the bank statements),
* accounting (regularly or randomly use outside accountants and give them more than one level of communication to ensure steps are not missed when an embezzler is delaying or doctoring information; also regularly or randomly seek reviews or audits rather than compilations or mere tax return preparation),
* data (regularly but randomly monitor all authorized user email communications, downloads, and printing activity – as policies must address and allow – to make sure company data is protected from unauthorized use or disclosure),
* human resources (regularly and randomly monitor all payroll and other checks payable to employees to make sure they align with what the company believes they are being paid and commensurate with their peers).
To continue to protect company assets at the highest level, companies are best served by having their insurance coverage and legal needs reviewed every three years (and more often when in times of expansions or cutbacks).
3. EMPLOYMENT PRACTICES include hiring employees and their pay, treatment, and departure. It’s no wonder that this is a common legal pitfall for companies even if all employees are honest and good-intentioned. Here are some words of advice to help avoid legal risk in this area:
(a) COMPENSATION is regularly a trouble area for companies. Some companies unwittingly pay employees in ways prohibited by wage laws and face large penalties when caught, like putting people on salary who don’t meet the legal exemptions to be paid on a salary. Companies also fail to recognize the importance of signed/certified records for time worked by each employee, and/or make improper deductions/calculations of wages. Failure to put bonus or paid-time-off policies in writing, or to practice them consistently with those writings, are other high-penalty hits to the company budget when they must be rectified. For example, bonuses intended as discretionary may be imposed automatically, or leave may be on calendar years rather than rolling years, if distributed policies don’t demonstrate otherwise. Companies must make sure they understand the wage laws applicable to the job functions of their various employees and utilize written pay policies or agreements for bonus, leave, and unique pay situations.
(b) POLICIES are often missing or piecemeal, failing to “grow” with the company’s workforce. This is understandable when many companies do not employ human resource managers until they have accumulated an unmanageable number of employees. Though not automatically true, the inadequate policies are an indicator of a company’s (likely unknowing) failure to comply with applicable equal employment, anti-discrimination, disability/leave, and other laws that apply to their employees (who are to be informed of those rights) when they apply to the company’s workforce as early in Indiana as when the sixth employee is hired by the company. More problems arise when companies fail to be consistent in applying their policies, resulting in practices different from the policies (or even applicable law). Inconsistent application of policies creates risk when handling matters with employees who enjoy a protected status under the law but are treated differently than everyone else subject to those policies.
(c) MISMANAGEMENT of employees is a common occurrence that exposes companies to claims by employees even if they ultimately lack merit. Let employees know the expectations about their job performance, attendance, ethics/honesty, and set a culture acknowledging the importance of each member of the team to foster respect and support in the workplace. The Golden Rule is a great place to start, and from the top down. Employees are going to make mistakes, but counsel them and let them improve because they are an investment worth the effort. Companies that don’t train, mentor, and inspire their employees will suffer a revolving door of disgruntled employees who never graduate to the “A-team” needed for the company’s ultimate success. Disgruntled workers spread ill will inside and outside, they pursue claims, and they can be harmful and even devious – don’t give them a reason to be anything but loyal and proud of being part of the company’s A-team. Good policies, consistent practices, fair treatment, and honesty will help companies avoid being mired down by emergency issues created by unhappy employees and also help to maintain a high level of morale within the company to retain a strong workforce.
(d) HANDLING EMPLOYEE EXITS is a dirty job that only the most-sophisticated HR Managers handle well. This means that most companies receive poor grades in this area, even when it involves the voluntary resignation of a long-term employee. First, no matter who is departing and how, protect the company assets by making sure computer access is stopped, keys and property are returned, and emails/phone messages are redirected so they are not lost. Of primary importance is protection of IP rights, so also check the exiting employee’s recent computer activities, particularly items emailed out, downloaded, or printed in the prior 60-90 day period. Second, make sure the employee understands all post-employment obligations (especially including trade secret protection and compliance with any restrictive covenants like non-competition agreements), providing copies of applicable policies or agreements to them on their last day at the office to avoid any denial or misunderstanding about them. If they are subject to restrictions, the company can rightfully ask them about their new employer and duties, etc.; if they refuse to cooperate, that is a red flag that counsel should investigate or pursue a possible breach of those restrictive duties, including possibly notifying the new employer of those duties. Third, make sure the transition for their absence is planned by researching active matters well before their last day of employment; even if a discharge, the company will not want pending leads or sales to be ignored. Fourth, be sure to pay all wages/bonuses due them according to law and applicable policies; failure to do so may cause the company to be liable for interest, penalties, and attorney’s fees. Fifth, if the company pays a penny more in compensation than is due the employee (which it should consider offering a severance if there are possible claims that the employee may pursue), make sure the company receives a legally-compliant release from the departing employee. Counsel involvement is critical here, as releases can be void and thus worthless if they don’t comply with applicable laws. Finally, if any post-employment restrictions apply to the exiting employee, plan to monitor their activities early and then monthly until the restrictions have expired so that any compliance issues may be promptly addressed and the company’s interests remain protected. If not, waiver in pursuing a breach could negatively affect the ability to enforce those restrictions against subsequently-departing employees, or even render those restrictions unenforceable as to everyone.
When in doubt, companies can more precisely navigate these employment matters with guidance of counsel to help avoid claims that can sometimes be costly to pursue or defend. Most companies and their employees would prefer resolution over litigation, so find an attorney who will meet the company’s needs sooner rather than later.
Author Kathleen Hart serves as outside general counsel and litigator for privately-held businesses and/or their owners/executives. She may be reached at 317-636-8000 or email@example.com. Opinions are solely those of the author.
© Riley Bennett Egloff LLP
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