Companies operating in the insurance industry (like many firms) place a high value on client relationships and goodwill. They often require employees to enter into legally restrictive employment contracts to protect the company's client base and goodwill and to reduce labor turnover. The purpose of this article is to provide an overview of risks and potential economic damages associated with breaches of noncompetition and nonsolicitation agreements.
In connection with most, if not all, acquisitions of insurance businesses, such as insurance brokers and agencies, the acquiring business seeks to protect the target business's goodwill and customer relationships by institutionalizing those relationships using various tools, which often include postemployment covenants not to compete or solicit the business's clients for some period of time.
The enforcement of noncompetition and nonsolicitation agreements varies by state and depends on the facts of each case. This article is not intended to address the complex legal aspects of noncompetition and nonsolicitation agreements; rather, it will provide an overview of these agreements, risks to consider in connection with acquisitions of businesses involving existing or new noncompetition and nonsolicitation agreements, and hiring individuals with existing noncompetition and nonsolicitation agreements. I also address at a very high level the types of economic damages commonly associated with breaches of noncompetition and nonsolicitation agreements in disputes.1
Noncompetition and Nonsolicitation Agreements in General
The specifics of noncompetition and nonsolicitation agreements vary greatly across firms and states, but they share a common purpose: protecting firms' customer relationships and goodwill, which is typically accomplished by restricting the ability of an employee who leaves to compete against their former employer for some specified period of time, often in a specified geographic area. This restriction may prevent the departed employee, for a period of time, from (1) accepting employment at a firm that provides competing services and/or (2) working for the previous employer's clients. Nonsolicitation agreements can prohibit an individual from soliciting his former employer's employees, or from soliciting its clients, thereby protecting the previous employer's client relationships, goodwill, and employees.
Firms with sophisticated technical information and business practices have a strong interest in using noncompetition and nonsolicitation agreements in conjunction with nondisclosure agreements to protect trade secrets and confidential information. Similarly, companies that rely on strong relationships with repeat customers, such as insurance brokers and agencies, often require employees to sign noncompetition agreements to curtail employee and client attrition and protect the company's goodwill. Such agreements are intended to allow the company that incurs the loss of an employee an opportunity to transition the client relationships to others within the firm over some period of time, thereby reducing the effect of the departed employee competing for, or soliciting, the former employer's relationships upon expiration of the noncompetition and nonsolicitation agreement.
Risks of Noncompetition and Nonsolicitation Agreements
Acquirers and operators of businesses should consider the risks associated with noncompetition and nonsolicitation agreements, acquiring businesses with existing noncompetition and nonsolicitation agreements, and hiring individuals with existing noncompetition and nonsolicitation agreements. For example, in an acquisition of a business, a dispute could arise as to whether such agreement provisions apply or transfer to the new owner. Another example is when an employee or employees leave an employer and solicits other employees or clients in (alleged) violation of his or her agreement not to compete or solicit. This can occur in the normal course of operations or, sometimes, subsequent to an acquisition. To the extent that such conduct occurs, the former employer will oftentimes, inside or outside of litigation, attempt to enforce the requirements of the noncompetition and nonsolicitation agreements.
For instance, in a recent noncompetition lawsuit between two Florida-based insurance brokers, Brown & Brown, Inc., charged that eight of its employees were hired by AssuredPartners, Inc., in violation of their employment agreements that restricted the employees from working for another company in the insurance business for 2 years after their termination. Despite the restrictive covenants in place, the transferring employees solicited Brown & Brown customers. The parties settled for $20 million.2
Economic Damages Associated with Breaches
While the most commonly granted form of relief for breach of noncompetition and nonsolicitation agreements is an injunction against competition or solicitation, some parties may also be entitled to monetary damages. Most commonly, a defendant ex-employee does not have the ability to pay a significant judgment. However, in certain circumstances (such as the case between Brown & Brown, Inc., and AssuredPartners, Inc.), the new employer may be liable for the violation of the covenant (if, for example, it has aided, in some fashion, the breaches).3 Economic damages resulting from breach of noncompetition and nonsolicitation agreements take a number of forms, including (but not limited to) lost profits, unjust enrichment, and liquidated damages.4
Lost profits can be defined in many ways and are generally calculated as the net present value of the difference between what the injured party would have realized but for the accused party's actions versus the injured party's actual profits. Common approaches to calculate the profits that would have been earned but for the alleged wrongful conduct include the following.
Before-and-after approach—comparing the performance of the injured party before and after the alleged harmful acts
Forecast approach—using sales forecasts of expected performance for the business or industry to evaluate the probable effects of the harmful acts
Yardstick approach—comparing the harmed business of the injured party to comparable but unharmed businesses, clients, or locations to assess "but for" results
Market share approach—comparing the injured party's market share during the period prior to the harm to that of the injured party afterward
Unjust enrichment is a measure of the accused party's profits that were earned due to the wrongful act (such as breaching a noncompetition and nonsolicitation agreement). Unjust enrichment attempts to make infringement unprofitable by forcing the accused party to disgorge their unlawful gain, as opposed to directly compensating the previous employer based on their harm.
Some noncompetition and nonsolicitation agreements explicitly define how to calculate damages associated with a breach. These are commonly known as liquidated damages. Liquidated damages may be found enforceable so long as (1) the amount is reasonably commensurate with the harm caused by the act, (2) it is difficult to prove losses otherwise, and (3) it is inconvenient or infeasible to otherwise obtain an adequate remedy.
Noncompetition and nonsolicitation agreements are commonly used in the insurance industry to protect the company's client base and goodwill and to reduce labor turnover. Companies that are contemplating implementing noncompetition and nonsolicitation agreements or that need to clarify the carryover of such agreement obligations in a merger or acquisition may benefit from specialized legal advice to understand best practices in their state. Breaches of noncompetition and nonsolicitation agreements can have a significant negative economic impact on employers and acquirers, resulting in lost business and enterprise value.
If readers are interested in learning more about the technical aspects associated with assessing the economic damages relating to breaches of noncompetition and nonsolicitation agreements or the value associated with noncompetition and nonsolicitation agreements, email me, and, if there is enough interest, I will write further on this topic.
1 This article is not comprehensive and does not fully address the many complex issues that may be involved in measuring such economic damages.
3 As stated earlier, this article is not intended to present all of the complex legal aspects of these types of matters. I am not an attorney and write this from the perspective of a financial and valuation expert that has been hired in a consulting and testifying capacity on dozens of occasions in a wide variety of industries, including the insurance industry.
4 For a more detailed description of the technical issues, see James Hitchner, Financial Valuation: Applications and Models, 4th edition (Wiley, 2017), Chapter 26; or Roman L. Weil, et al., Litigation Services Handbook: The Role of the Financial Expert, 5th edition (Wiley, 2012), p. 4–16.
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