Labor and Employment Update - Spring 2006

STEPS EMPLOYERS CAN TAKE TO PROTECT THEIR BUSINESS FROM UNFAIR COMPETITION BY FORMER EMPLOYEES

There are numerous steps employers can take to protect themselves from many of the adverse effects of a key salesperson, engineer, representative or executive leaving the company. However, it takes planning. Employers can protect their confidential information, processes, etc. with physical and electronic security systems, as well as agreements that address non-competition, non-solicitation of customers, non-solicitation of employees (i.e. anti-raiding/anti-piracy), non-disclosure and confidentiality.

Clearly, contractual safeguards should be an important part of any asset protection program; but they must be combined with other measures, including physical and electronic security. Sometimes employers overlook the most obvious precautions, such as locked drawers, password protected networks, use of confidential labels, and guarded facilities. Of course, the level of protection needed will depend on the type of information being protected. These practices also emphasize to employees and others that the information is confidential and can help persuade a judge that a company’s confidential information warrants protection. To be effective, the locks on drawers must be used and network passwords must be kept confidential and should not be obvious (such as having a users name and password be the same).

Employers should also have clear and well-publicized policies regarding confidential information. These policies should inform employees as to what types of information must be kept confidential and what the consequences may be (i.e., discipline or termination) for failing to keep the information confidential. As with other policies, periodic training, monitoring and consistent enforcement will determine the effectiveness of any confidentiality policy.

Non-competition agreements (also called restrictive covenants) are another way to protect you from former employees. Properly drafted restrictive covenants are material to an employer’s ability to protect customers, goodwill, and trade secrets. One size certainly does not fit all, however, when it comes to restrictive covenants. Employers who try to bind employees by overly broad and/or poorly drafted restrictive covenants may find that the non-competition agreement is entirely unenforceable or does not provide the protection needed. To be enforceable, a restrictive covenant must (1) be supported by consideration (i.e. must compensate the employee for agreeing to the terms of the non-compete); (2) be reasonably necessary to protect the legitimate interests of the employer; (3) be reasonable in both geographic and temporal scope; and (4) not place an undue hardship on the employee.

Even without a non-competition agreement, the law protects “trade secrets.” Generally a “trade secret” is something that derives economic value from not being generally known and not readily ascertainable by proper means and is subject to efforts that are reasonable under the circumstances to maintain its secrecy. Basically, a trade secret must (1) be a secret and (2) have competitive value to the owner. If the information is readily ascertainable, it is not a trade secret. Further, if the information is generally known or ascertained within the employer’s field, even if the general public does not know it, it will not qualify as a trade secret. An employer who neglects to take reasonable steps to protect information, such as restricting access to it, may find it is not a protected trade secret.

Employers should periodically review the steps they are taking to protect their businesses from unfair competition by former employees. Make sure you are taking all the appropriate steps, including the physical or technological (such as locked cabinets and password protected networks) and the documentation (policies and individual agreements). Once employees are gone, it may very well be too late.

AVOIDING CONFLICTS OF INTERESTS CREATED BY INTERNAL INVESTIGATIONS

Allegations of fraud, harassment or other misconduct, and the internal investigations that follow, have become commonplace in today’s corporate marketplace. Yet, many legal practitioners continue to struggle to avoid potential conflicts of interest between representing the organization and representing its constituents (e.g., officers, managers, supervisors or other employees).

The rules of ethics in most states make it axiomatic that a lawyer represents the organization and not its individual constituents. However, it is often cost effective for the organization to allow one attorney or firm to represent both parties. Such joint representation is perfectly acceptable in situations where the interests of the organization and the employee are in accord.

However, many organizations and practitioners fail to conduct a proper analysis of the legal interests created in the context of an internal investigation. For example, in Salvatore v. Kumar, a New York court held that an employee who was fired based upon information revealed during an internal investigation may sue the law firm that was hired by the company to represent her during the course of the internal investigation.

Irene Salvatore was a former vice president in the accounting department of Computer Associates, a New York-based software company. In or around April of 2004, Salvatore was questioned as part of an internal investigation into allegations of fraud and improper accounting practices. Shortly after the interview, Salvatore was fired.

Thereafter, Salvatore filed a lawsuit against Kaye Scholer, a 512-lawyer firm based in Manhattan, based upon an alleged conflict of interest between Kaye Scholer’s representation of Computer Associates and their representation of Salvatore. In the suit, Salvatore claims that Kaye Scholer failed to advise her of options besides cooperating with the internal investigation. Additionally, Salvatore claims that Kay Scholer worked with upper management at Computer Associates to identify lower-level employees to blame for the accounting fraud.

On April 18, 2006, Judge Elizabeth Hazlitt Emerson ruled that Salvatore had properly averred a legal malpractice claim against Kaye Scholer and denied Kaye Scholer’s motion to dismiss the Complaint. The case is still pending in the New York court.

The following is a list of important practice guidelines that can be used to avoid a similar potential conflict of interest:

1. When hiring outside counsel to represent both the organization and the employee, demand an engagement letter that defines what will happen if a conflict between the two “clients” were to arise;
2. Require counsel to meet separately with each party to conduct a detailed study of the facts underlying the claims;
3. Explore irregularities, if any, in the facts presented by each party to determine if a conflict of interest is likely to arise later in the litigation;
4. Identify an exit strategy or desired result for each “client”;
5. Inquire about any claims or disputes the employee may have against the employer, whether related or unrelated to this issue; and
6. Remember that personal, social and human relationships often develop within an organization and may interfere with a proper conflicts or interests analysis.

DOL ISSUES GUIDANCE ON PRACTICE OF MAKING PAYROLL DEDUCTIONS FOR LOST/DAMAGED LAPTOPS/CELL PHONES

On March 10, 2006, the Department of Labor issued an opinion letter addressing the effect of making payroll deductions (even on an occasional or one-time basis) on an employee’s “exempt” status under the Fair Labor Standards Act (“FLSA”).

The DOL’s letter was written in response to a company that had inquired whether it was permissible to impose “fines” on its exempt employees for lost/damaged company equipment (including company-issued laptops and cell phones). In particular, the company asked if it could deduct the amounts necessary to cover the cost of replacement/repair for the equipment from the exempt employees’ pay without endangering the employees’ “exempt” status. Alternatively, the company asked if it would be permissible to require the exempt employees to pay for the costs of replacing/repairing the equipment on an “out of pocket” basis.

The DOL reviewed the “salary basis” test under 29 CFR § 541.602, which provides that “subject to the exceptions provided in [section 541.602(b)], an exempt employee must receive the full salary for any week in which the employee performs any work.” Noting that none of the exceptions set forth in § 541.602(b) permit deductions from salary to be made to cover the cost of damaged/lost equipment, the DOL stated that the company’s policy would violate the “salary basis” rule and would render any employees subject to the policy “non-exempt” under the FLSA. Moreover, the DOL appeared to indicate, as a general proposition, that any type of deduction from salary – unless specifically permitted under § 541.602(b) – would defeat the “salary basis” test because the employee’s “salary” would not be “guaranteed” or “free and clear,” as is required under the regulations; “[i]t is [the Wage and Hour Division’s] long-standing position that an exempt employee must actually receive the full predetermined salary amount for any week in which the employee performs any work unless one of the specific regulatory exceptions is met.”

This is not the first time the DOL has issued guidance regarding the practice of making occasional or one-time deductions from exempt employees’ pay and its effect on exemption status under the FLSA. On February 20, 2001, the DOL issued an opinion letter addressing the relatively common practice of requiring employees to pay back sign-on bonuses and/or relocation bonuses in the event the employee does not remain with the company for some specified period of time. The 2001 inquiry came from a pharmaceutical employer that offered internship “loans” and relocation benefits to employees, with the understanding that such loans/benefits would need to be repaid by the employee in the event he/she did not stay with the company for a pre-determined period of time (one to two years). The company asked the DOL if it would be permissible to deduct amounts necessary to cover the repayment of these loans/benefits from the employees’ final pay. The DOL declared that deductions for recoupment of these payments would not be permitted under the “salary basis” test. Moreover, the DOL made clear its position that the policy in question would not only risk the exempt status of employees who had actually experienced the deductions; rather, because the entire class of pharmacists was “subject to” the deductions, the DOL stated that none of the pharmacists would qualify for exempt status in any week during which the policy was in effect.

In its most recent guidance, the DOL appears to have gone even further – not only disallowing deductions from pay – but suggesting that a company that requires an exempt employee to make a payment for the cost of lost/damaged equipment on an “out of pocket” basis also would violate the “salary basis” test, under the theory that the amounts being repaid would be coming from the employees’ previously paid salary.

In light of the above, it is advisable for employers to review their current policies and practices with respect to payroll deductions and/or the imposition of fines for lost/damaged equipment in order to determine the extent to which such policies or practices are applicable to otherwise “exempt” employees.

The Labor and Employment Group represents and counsels employers in all aspects of the employment relationship, including EEO litigation, union avoidance, negotiations, arbitrations, executive compensation, corporate transactions, and non-competition/non-solicitation agreements, as well as compliance with federal and state laws such as the Family and Medical Leave Act, the Americans with Disabilities Act, the Health Insurance Portability and Accountability Act, the Fair Labor Standards Act and the Occupational Safety and Health Act. This document is published for the purpose of informing clients and friends of Klehr Harrison about developments in the areas of labor, employment and benefits, and should not be construed as providing legal advice on any specific matter. For more information about this publication or Klehr Harrison, contact Charles A. Ercole, Chair of the Labor and Employment Group, at (215) 569-4282 or visit the firm’s Web site at www.klehr.com