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Norton Law Corporation Non-Compete Agreements for Independent Contractors

Independent Contractors and Non-Competes Never Mix

A shorter week equals a shorter post. That means it’s the perfect time to talk about an issue that comes up a fair amount. Can I get my independent contractors to sign a non-compete agreement? If you haven’t read the title, get ready for a surprise: NO. That’s right, you never want to have your independent contractors sign a non-compete agreement. I’ll explain why in a little bit, but first some backstory.

Employers love hiring contractors over employees for a ton of reasons. No benefits. No healthcare. No wage laws. No vacations. You don’t have to deal with those bureaucrats and their rules getting the the way of your business. In fact, most employers would love to hire only independent contractors. Too bad that’s just about impossible given the differences between employees and independent contractors. But that’s a story for another blog post.

Many employers, to avoid the extra costs of employees, misclassify employees as contractors. And that’s, for those of you who haven’t read my other post comparing employees and independent contractors, is a big no no. Misclassification just leads to a lot of fines and lawsuits and other nasty situations down the road, so don’t do it. And more and more governmental agencies are starting to take notice—much to the chagrin of the employers.

But here’s the thing. Somewhere along the way, employers felt their contractors were sharing trade secrets. After all, they were working for the competition, often at the same time. And truth be told, you should hope they are, since that may tip the scales to the independent contractor side over the employee side. Employers did not see this as a good thing, and so they asked their independent contractors to sign non-competes. As I stated in the intro, this is bad—very bad. Why?

Because non-compete agreements are documents only signed by employees—NEVER by independent contractors.

It all comes down to the question of who is a true independent contractor? One who checks all the contractor boxes in the employee versus independent contractor test. One who works for others while they’re working for you. And if you make that contractor sign a non-compete agreement, then guess what, they now only work for you—like an employee. But what’s so bad about that? Well, they’re supposed to be working for a variety of companies in the same industry in which they have expertise. After all, I assume that’s why you hired that independent contractor. You wanted someone with unique knowledge of the industry. And how did they get that knowledge? Probably by working for some of your competitors.

So what is a savvy business owner to do when she wants to hire an independent contractor? Well, as you’ve just learned, never have them sign a non-compete agreement. Instead, make sure they sign a confidentiality agreement (aka a non-disclosure agreement). An independent contractor agreement that lays out exactly what they’re to do and how much they’re paid for it is also great. Follow those up with an invention assignment agreement and you’re all set. After all, you don’t want their hard work (which you paid for) to wind up as their property. Those three documents are usually enough to keep employers out of trouble. As long as they stay out of their contractors way.

And for those who are hiring an independent contractor for mission critical activities? Double-check that you actually want an independent contractor and not an employee. If that’s the case, then slap that non-compete agreement in front of your contractor and tell them to sign it. Well, maybe don’t slap it in front of them, but you get the picture.

One final note. If you’re hiring someone and you want them to be classified as an independent contractor, take a look at our other blog post on the subject. 7 Tests to Determine if that Independent Contractor You’ve Hired is Actually an Employee. And if you need help drafting any of the necessary documents for your business (like employment or contractor agreements), feel free to contact me.

A few notes: Somehow this has become the most popular post on my website, which has led to a number of questions. Allow me to address some of the most common.

  1. Is the de facto rule that independent contractor agreements should never have a noncompete clause, no way no how, lest it automatically render the agreement invalid or something like that? No. There are some reasons to include one, but on the whole including a noncompete clause in an independent contractor agreement can lead to that independent contractor being classified as an employee. It is simply one of many factors to be looked at when trying to determine if an independent contractor is actually an employee in disguise. Furthermore, this post—like all of the posts on my website—is merely legal conjecture. It is not necessarily the black letter of the law nor should it be considered applicable to your unique situation. If you have a legal issue related to independent contractors and employees, contact an employment attorney.
  2. Does this post apply to me in my state/country in my unique situation? I can’t tell you that. Being a California lawyer, I can only talk about issues based on a California perspective (with the exception of my trademark and copyright law posts, which in certain circumstances are designed to cover the Federal laws dealing with trademarks and copyrights). So if you are in another state or country, you will need to look to that state or country’s own laws regarding the issue of whether a person is an independent contractor or an employee. As for whether I can answer you regarding your personal situation, that depends on the facts at hand and whether you are located in California.
  3. Does the presence of a noncompete agreement in an independent contractor agreement automatically render that agreement unenforceable or automatically mean that person is an employee rather than an independent contractor? No. Again, the presence or lack of a noncompete in an independent contractor agreement is just one of many factors to consider when tasked with trying to determine whether a person is an employee or an independent contractor.
  4. Is there ever a good time to put a noncompete agreement in an independent contractor agreement? Sure. If the independent contractor you’re hiring is doing something very similar to what kind of business you’re running before you hire her as an independent contractor and plans to continue doing the same after she’s finished her tasks with you, then you may want to have a noncompete in there. But just be aware that you may find that person should probably have been classified as an employee given their similar skill set to what you’re doing as well as the presence of the noncompete.
  5. Will you help me litigate my case on the issue of independent contractors and employees? No. Sorry. I have no interest in litigating. My practice is almost entirely business transactional (I draft contracts and other business documents as well as file and prosecute trademark and copyright applications) except for the rare trademark or copyright case that requires court action. Moreover, I am certainly not an employment attorney, and there are plenty of good attorneys out there who only handle employment law issues.
Norton Law Corporation Presents a Post About the Business Documents Your Company, LLC, or Corporation Needs

7 Documents You Need to Keep Your Business Legally Sound

I’m always a little surprised when savvy business owners come to me to make sure their business is operating legally, only to find they’re missing a number of key documents. To be perfectly honest, a lot of the documents only matter if you’re in the process of expanding your business, going to sell your business, looking to take on investors, or you’re going to register your company’s securities with the SEC. But, that being said, if you want to save yourself a lot of headaches (and a lot of money having attorneys fix things that are horribly, horribly broken) before you take those steps towards growth and expansion, and if you want to protect you and your family’s interests in the most comprehensive way possible, it’s always a good idea to make sure your business’s documents are in order sooner rather than later. Without further ado, the documents you’ll need:

  1. Articles or Incorporation / Certificate of Incorporation / Articles of Organization: These documents have many names depending on where they’re being filed and what they’re being filed for, but they all have pretty much the same purpose—to let the Secretary of State (or the equivalent Division of Corporations) know your business is registered as a corporation or a limited liability company (LLC).

    If you’re incorporating your business in California, for example, you’ll need to draft and file the articles of incorporation. There’s a form, but if you hire a half-decent business attorney, they’ll draft you articles that actually apply directly to your business rather than shoehorning you into what the state’s template provides.

    The Certificate of Incorporation is the document you’ll need if you want to incorporate your business in Delaware. It’s very similar to what you might file here in California, with a few tweaks (and a different name). If you’re not sure whether you want to incorporate in Delaware or your home state (not necessarily California), I wrote a nice article on that a few months ago: Why Your Home State May Be the Best Place to Incorporate Your New Business.

    As for the Articles of Organization, that’s the document you’ll file in California to organize your business as an LLC. Of course, there’s also a form for that—and you generally have to use it.

  2. Bylaws / Operating Agreement: As with the documents above, these two documents have different names, but essentially do exactly the same thing. They help you determine the ground rules for how your business is run. Bylaws are used by a corporation (no matter what kind: C-Corp, S-Corp, B-Corp, etc.) to specify such issues as how large the board will be, where the initial office will be located, what powers the officers and directors have, how shares may be transferred, and how shareholders and directors can vote.

    Now, if you’re the sole shareholder of your own private corporation, you’re probably thinking why in the world would I want to spend a few hundred dollars on a document like this when what I say goes. And that’s a fair question, but here’s a fair answer: in some states, you have to submit your bylaws to the Secretary of State/Division of Corporations/Whatever they’re called in your state at the time time you register your corporation. Even if that’s not the case, some banks will want to see your bylaws before you open an account, the professional licensing organization of your state may want to see them if you’re running a professional corporation, investors will definitely want to see them before they send any money your way, and the buyer will want to see the bylaws when it comes time to sell your business.

    Oh, and if you’re passing your corporation on to your kids when you die, the bylaws can help them easily make the transition from your ownership to that of your kids without too many struggles (provided it’s drafted properly). And best of all, if you’re a sole shareholder of your company and you want to protect your family from liability if your company is ever sued, a set of bylaws can go a long way in proving your company is it’s own entity and not just your alter ego.

    For the purpose of this post, an operating agreement is practically the same as the bylaws, except they’re used for LLCs.

  3. Minutes from Meetings: You’re holding regular shareholder/director/member meetings, right? Right? Well, don’t feel too bad if you’re not. There’s a ton of small businesses out there where regular meetings means once every five years. But while you may not think that the minutes from your regular shareholder meetings are that important, in truth, they really can be.

    Here’s the thing. Imagine your business is going along smoothly when all of a sudden someone sues you for some screw up of one of your employees. Maybe they hit someone with the company car while they were en route to the job site. That person has a valid case and sues your company and you. Normally, if the company has caused some kind of wrong, all of the liability rests on them, but there’s a theory in the law called piercing the corporate veil which basically means that if the plaintiff (the person who’s suing you) can show that your company is no more than just your alter ego, they can go after your assets too to satisfy their judgment debt if they win. And here you thought forming a corporation or an LLC totally insulated you from liability.

    But how can you protect yourself from such an attack? Holding regular meetings and keeping records of them. It doesn’t matter if they’re shareholder meetings, board meetings, or member meetings (if you’re operating an LLC), just make sure you have them and make sure they’re properly documented.

  4. Trademark Registration Certificate: Strictly speaking, this isn’t required, but you should really get one. Seriously, you’ll save a lot of money down the road, especially if there’s already someone else using your trademark and you don’t know about it.

    No matter what kind of business you own, your brand is your most valuable asset. I’ve said it before, and I’ll say it again until I’m blue in the face.

    I don’t care if you’re a cruise ship operator with vessels that cost tens or hundreds of millions of dollars—your brand may be just that valuable. After all, when someone is looking for a cruise ship, they’re not going to trust a company they’ve never heard of, they want the Disney cruise experience or the Carnival cruise experience—not the “some guys we’ve never heard of with a huge boat” experience. So spend the money now and trademark your business’s name (and it’s logo too if the logo is really nifty and a part of your brand’s image).

  5. Employment Documents: Planning to hire someone (or a few someones)? You’re going to need employment contracts, an employee handbook, and independent contractor agreements at least. And you’d better make sure you know the difference between an employee and an independent contractor, because if you misclassify someone as a contractor who’s actually an employee, you’re going to be in a world of hurt. And at the very least, make sure you know whether your employees are classified as exempt or non-exempt.

  6. Distributor / Vendor / Service Contracts: From E-Commerce sites to plumbers, everyone needs basic contracts to help them run their business. Whether you’re distributing someone else’s goods or selling your own goods or services, it’s always a good idea to have your agreements properly documented—and that means in writing. Oral agreements, while technically enforceable in court, are always an uphill battle, so put your contracts in writing.

  7. Non-Disclosure Agreements (NDAs): Sharing your business information with others can be a good idea, but having them steal that information for their own uses later can be disastrous. That’s where NDAs come into play, when you’re showing off some aspect of your business to a third party (including your employees and independent contractors), you want to make sure they’re not going to divulge the information they’ve gleaned to another, or worse, use that information to further their own business interests. Just make sure you don’t give one of these to a potential investor (from a legitimate investment firm or VC) or you’ll look like a real novice in the startup and small business world.

After all of that, you’re probably thinking there can’t possibly be any more documents that may come into play during the life of your business—but there are. Copyright licenses, trademark licenses, commercial leases, industrial leases, equipment leases, retail leases, franchise agreements, term sheets, share purchase agreements, merger and acquisition documents, and the list goes on. As you can see, this was by no means meant to be an exhaustive list of what kinds of documents you need for your business, but it should give you a better understanding as to why hiring a business attorney sooner rather than later can save you a lot of headaches down the road. These documents aren’t going to write themselves, and only an attorney (or a very, very, very skilled businessperson) should undertake drafting, revising, and negotiating them.

7 Tests to Determine if that Independent Contractor You’ve Hired is Actually an Employee

Now that’s a long title.

But you’re not here for the title. You’re here for the content.

It happens to even the most careful of employers. You think you have hired an independent contractor only to find out later on that the person you hired should have been classified as an employee. You did your research. You read the California statute for independent contractors. The language is simple, right? “Any person who renders service for a specified recompense for a specified result, under the control of his principal as to the result of his work only and not as to the means by which such result is accomplished.” California Labor Code §3353. You figured that just meant a person who performs work independently and isn’t subject to your company’s rules. Or, to make matters worse, you thought that meant anyone who is not exclusively your employee but can work for other employers at the same time. However, while you may think this misclassification between independent contractor and employee is just an honest mistake, the difference can have a huge impact on your business—and your finances. After all, one simple misclassification can mean that you may owe back workers compensation, taxes, benefits, and unemployment insurance.

So what’s the point here?

Don’t misclassify your employees as independent contractors—or you will greatly regret it later on.

But what is an employer to do? Well, the best thing you can do is hire an attorney who can help you with employer protection, or someone similar. Before you contact that lawyer, though, there are a few questions you should ask about the employment relationship to help you see if you really have hired an independent contractor or if you’ve actually just hired a new employee.

  • Is the person performing the services engaged in a distinct occupation or business?
  • In the person’s occupation or business, considering factors such as the locality, is the kind of work usually done under the direction or supervision of the principal or is the work usually done by a specialist without supervision?
  • How much skill is required for the person’s occupation?
  • Does the person supply their own tools, instrumentalities, and place of work, or are the tools, instrumentalities, and place of work supplied by you?
  • How long will the services be performed?
  • Is the type of work you’re hiring the person for of the same type of work your business regularly does?
  • Do you believe you are creating an employer-employee relationship? Does the person you’re hiring believe they are entering into an employer-employee relationship?

The foregoing questions come from S.G. Borello & Son, Inc. v. Dept. of Industrial Relations (1989) 48 Cal.3d 341, 351, and the following should not be construed as legal advice in any way. I am providing you a very generalized look at California law on the topic. Also keep in mind that the Federal tests for an independent contractor relationship are different.

Image Courtesy: Victor1558