Non-Compete Agreements have long been a source of dispute (and a lucrative source of income for many attorneys) when a departing employee or seller allegedly violates an agreement not to compete with the employer or buyer. In this document, Al Diamond reviews these agreements and the responsibilities and prohibitions that they define.
The primary question from an employer/employee standpoint is, “Does the employer ever have the right to prohibit an employee from either taking accounts or from competing in other ways after that employee has departed the agency that has paid the employee for their efforts in the creation, relationship building, and/or servicing an account that represents a part of the asset base of the employer agency?”
In the sale of an agency or book of business by one person or entity to another, the primary question is, “Does the seller have the right to either regain or sell insurance to accounts that they have sold to the buyer, or does the seller have the right to reverse any part of the non-competition part of the sale agreement to which the seller agreed in the transaction with the buyer?”
We at Agency Consulting Group, Inc. aren’t attorneys. However, we act as expert witnesses on Insurance Agency norms, practices, and disputes and have often been asked our opinion on industry standards for non-compete agreements and their validity or applicability under a variety of conditions. Our opinions are well grounded in industry practices and in common sense.
THE BASICS
First, non-compete terminology that prohibits a person from engaging in their chosen profession in their home area (the area with which they are familiar and a known entity) is generally unreasonable. Courts throughout the nation have agreed that neither an employment agreement nor a sale agreement in the insurance industry can prohibit someone from continuing to make a living once they leave a company’s employment or they sell an agency or book of business. For this reason, geographic restrictions are difficult, if not impossible, to enforce.
However, the relationships created, information gathered, and confidential data accessed while the person is an employee of a company or agency can be subject to confidentiality and non-competition agreements — as long as these agreements have a reasonable length. After all, the employee collected the data, established the relationships, and administered the account of the clients under the direction of, and while being compensated for those duties, by the employer agency.
If you’re hired as a carpenter and asked to purchase lumber, use it to create a building, and then make sure that the building remains in sound condition over time, you would have no right to take down the wall and take back the lumber once you left the contractor’s employment. Your employer paid for the materials and for your skills and efforts to create the building. Similarly, if a producer is paid to solicit clients, develop a relationship, and maintain this relationship on behalf of the insurance agency, neither should they have the right to re-solicit the client after leaving the agency.
COMMON OBJECTIONS
Departed producers raise two common objections to their prohibition from soliciting former employer’s accounts: (1) The customer has the right to go to whatever agent they choose; and 2) The customer’s relationship is with the producer, not with the agency — the agency would probably lose the customer anyway.
The answer to the first question is straightforward: If you have a reasonable, time-sensitive non-compete clause active at the time of a producer’s departure from an agency, this does not prohibit the client from using whichever agent they desire. However, it does prohibit the former employee (who was a participant in the agreement) from accepting the client during the period agreed upon by the producer in the non-compete agreement. Although customers certainly are free to choose, a producer may not be (by contract terms). No agent has ever been “required” to accept a customer — even if the customer desires the services of the agent.
The answer to the second objection is the reason for the insertion of a “reasonable time-sensitive” non-compete period. The agency originally hired the employee to solicit, service, or administer the insurance programs for its clients. It presumably paid the employee to accomplish these tasks with the assumption that the customer base grew the asset value of the agency. If the employee is no longer employed by the agency it’s the agency’s responsibility to replace them with another employee who will maintain and/or cement the relationship of the client with the agency.
For a period of time, the information created and known about a client becomes part of the confidential information that comprises the intellectual property of the agency. The period of time during which this information is current is the “reasonable” period for the duration of the non-compete agreements. Because most insurance accounts renew annually, information becomes stale over a period of time and must be updated to ensure that it remains current.
In most cases, enough information about a customer changes within two renewal periods to make the data known by the former employee “stale,” requiring the employee to regain this data through personal efforts, rather than using confidential information known to the former employee while employed by the agency.
Thus, the duration of a reasonable non-compete can be anywhere from two years (two full terms of renewal) to three years (including partial policy terms after the employee’s termination and two subsequent renewal terms). An employee operating with a valid non-compete agreement must give the employer enough time to re-establish relationships with the client with another employee. Once this period is completed, the employer and the former employee are considered on a relatively “level playing field” and competition again becomes fair. Information to which the employee was privy during their employment has become stale enough that they must garner their own information about the client. Enough time has elapsed to permit the employer to replace the employee in their relationship with the client, making competition fair between the former employee (now soliciting the client as just another agent) and the current agent.
RUSTLING ACCOUNTS
The answer to the question, “Does the seller have the right to either regain or sell to accounts that they have sold to the buyer, or does the seller have the right to reverse any part of the non-competition part of the sale agreement to which the seller agreed in the transaction with the buyer?” also requires a common sense answer.
In the Old West, they had a name for someone who would sell cattle to someone else, then come back and take back the cattle that he sold — a rustler — and they hung rustlers.
What’s the difference between the Old West rustler and an agent who would sell their asset, primarily a book of business comprised of a group of clients who were expected to continue to renew and be serviced by the acquirer, and then take back these clients — either soliciting them on purpose or claiming that the client just wandered back seeking his old agent? A rustler who claimed that the cows just wandered back home of their own volition would still be a rustler if they return the property that they just sold.
A MORAL OBLIGATION
A sale of clients from one agent to another creates a moral (if not legal within the terms of the agreement) obligation on the seller to help the buyer in the transition of clients. After all, the established value of the intangible asset was based on the seller’s and buyer’s expectation that a revenue stream of customer renewals would continue. Often, the purchase of an agency or book of business involves the seller spending time to smooth the transition in order to assure the buyer that they’re receiving the value of the asset that they bought.
This moral obligation does not imply that clients can’t leave the buyer for any reason. It remains the buyer’s responsibility to cement relationships with their acquired clients. If clients decide to leave, they may do so at any time. However, regardless of the buyer’s treatment of the clients and their subsequent decision to move to a new agent, their decision does not negate the prohibition against the seller accepting these clients back during the term of the non-compete agreement.
NON-PIRACY AGREEMENTS
Non-Compete Agreements protect the employer or buyer from employees or sellers soliciting accounts over which they had some control through production, service, or any other form of client/agency relationship. In acquiring an agency or book of business, the agreement affects all business involved in the sale. A second agreement might be needed to prohibit former employees from taking any other account of the agency for which they might have had access to confidential information (regardless of their involvement with the client). This agreement, usually called a Non-Piracy Agreement, imposes the same restrictions for the same reasons as the Non-Compete Agreement.
KEEP IT CLEAR!
Protecting an agency or buyer from unfair business practices or competition by a former employee or a seller who had access to confidential information and/or was paid to create the relationship for the agency is fair to both the employee or to the seller. They have the right to sell any insurance product to anyone they desire — except to those clients that they either sold to the buyer or for whom they had access to information to which they would not have been privy had they not worked for the agency.
The problems that arise with most agreements of this type are due to unreasonable or vague terms. In an agency/employee dispute, the court tends to favor the individual on questionable issues. In a buy/sell dispute, the court looks at the reasonable course of events unless the agreement has been written so that it gives an express advantage to one or the other.
Clean up any non-compete language to make the intent of the agreement both reasonable and clear. Never execute an agency sales agreement without having your own attorney review its terms!
However, don’t listen to the naysayers who will adamantly (and incorrectly) state that non-compete agreements don’t work for the insurance industry. If an employee or seller were able to compete legitimately on every piece of business in their former book, most agencies would be relatively worthless, instead of continuing to grow in value. Look at the ongoing sales of agencies! Who would pay these kinds of prices for business that has no relative assurance of continuing to provide a continuing revenue stream?