Quirky Question #212, Montana Non-Competes

Quirky Question #212 – Montana Non-Competes

By:  Gabrielle With and Steve Bell

Quirky Question #212:

We are an accounting firm and recently fired an employee at will.  We have always understood that Montana law disfavors non-competition agreements, therefore, our employment agreement provides that if the accountant provides services to our clients within six months of leaving, he will pay us the profits from such an engagement which are stipulated to be 75% of gross revenues.   Since our former accountant is not completely prohibited from competing, isn’t this agreement enforceable? Read more

Quirky Question #198, Employee Handbooks and At Will Employment

Quirky Question # 198:

A friend just told me that we have to revise our Employee Handbook. He claims we no longer can say that our employees are employed “at will.” They are. Why can’t we say it?

Dorsey’s Analysis:

You ask a straightforward question. The response may be a bit more complicated than you suspect.

To ensure that everyone is operating with the same understanding, let me briefly explain the “at will” employment concept. The basic notion is that employees are employed “at the will of the employer.” Consequently, the employer reserves the right to terminate the employee’s relationship with the employer at any time, for any reason (a subject addressed further below). Read more

Closely Held Companies and Lifetime Employment, Quirky Question # 143

Quirky Question # 143:

I read with interest your analysis of QQ # 140, dealing with closely held corporations.  We are in a similar situation, though we have the sticky additional issue you referenced of the matter involving a family member.  This person claims she is entitled to “lifetime” employment.  Given that she’s only in her late 40s, that’s a daunting prospect.  Moreover, as her siblings will attest (if forced), she simply is not competent.  Does the company really have to employ her for the next several decades?

Dorsey’s Analysis:

As I referenced in Quirky Question # 140, issues involving employment in closely held corporations are especially difficult when the employee involved is an owner/shareholder.  Those problems are exacerbated when the person employed is a member of the family that owns the closely held company, and is an owner/shareholder herself.

As previously addressed, the rights and responsibilities of the employer and employee alike depend on the closely held corporation law of the state in question, the decisions of your state court on these types of issues, and the particular facts of your situation.  Given that many of these cases involve fundamental issues of equity, courts scrutinize the specific factual circumstances underlying the dispute.

For example, in a seminal Minnesota case, Pedro v. Pedro, 489 N.W.2d 798 (Mn. Ct. App. 1992), a dispute arose among three brothers, each one-third owners of the family’s luggage and leather products company.  All three brothers had worked for the company for most of their adult lives.  Each brother, as an equal shareholder, received the same benefits and compensation as the others, and had an equal vote in the company’s management.

The relationship among the brother deteriorated when Alfred Pedro discovered an “apparent discrepancy” of nearly $330,000 between the internal accounting records and the company’s checking account.  The dispute regarding the missing funds resulted in the two other brothers, Carl and Eugene, firing Alfred.  When Carl and Eugene fired Alfred, they discontinued his pay and benefits.  They also informed other employees that Alfred had had a nervous breakdown, which was not true.

The trial court found that Alfred was entitled to $766,582 as damages for his one-third ownership of the company, and another $58,260 in prejudgment interest on that award.  The court also awarded Alfred $563,417 on the ground that his brothers had breached their fiduciary duties to him, as well as an additional $68,690 in prejudgment interest on that part of the award.  In addition, the trial court found that Alfred had a contract of lifetime employment and that he had been wrongfully terminated; this finding resulted in an additional award of $256,740, plus $31,750 more in prejudgment interest.  The damages for lifetime employment constituted lost wages that Alfred would have received had he worked until age 72.  Finally, the court awarded the plaintiff his attorneys’ fees.

The appellate court began its analysis by emphasizing that the “relationship among shareholders in closely held corporations is analogous to that of partners.”  Id. at 801 (citations omitted)(“close corporation has been described as partnership in corporate guise”).  As ‘partners,’ the shareholders owed each other a fiduciary duty, a relationship that imposed upon them “the highest standards of integrity and good faith in their dealings with each other,” and the obligation to treat each other “openly, honestly and fairly.”  Id. (citations omitted).

The appellate court found that there was ample evidence to support the trial court’s finding of a breach of fiduciary duty.  The two defendant brothers had not paid Alfred the monies owed pursuant to the shareholders’ agreement, interfered with his execution of his job responsibilities, hired a private investigator to follow him when he was not in the office, threatened to fire him if he did not stop inquiring about the missing funds, fabricated reasons to justify his termination, and falsely represented to other employees that he had had a nervous breakdown.  The court found that this conduct did not comport with the defendants’ obligation to treat Alfred openly, honestly and fairly.

With respect to the trial court’s finding that the plaintiff was entitled to damages for “lifetime” employment (through age 72), again the appellate court affirmed.  The Court of Appeals found that “[t]he unique facts in the record support the trial court’s finding of an agreement to provide lifetime employment to respondent.”  Id. at 803.  The appellate court noted that Carl Pedro, Sr., had worked for the company until his death.  Eugene Pedro (one of the defendants) had worked for the company for more than 50 years and Carl Pedro, Jr. had worked for the company for over 34 years.  At the time of his discharge, Alfred already had worked for the company for 45 years.  Given this pattern of longevity, the Court of Appeals found that it was reasonable for the trial court to determine that the plaintiff’s employment was NOT terminable at will.

As the Pedro case illustrates, in certain circumstances, an owner/shareholder may be able to make a persuasive argument that she is entitled to lifetime employment.  Clearly, in the closely held corporation context, general principles of at will employment do not apply.  Integrity, good faith, honesty and fairness are the touchstone principles that govern the treatment of an owner/shareholder employee.

Subsequent generations of owner/employees, however, may not be in precisely the same position as a company’s founding members.  As one New York court observed when confronted with a family member/owner/employee who left a closely held company after having been caught stealing from the business, “Even if an original participant had had a reasonable expectation of personal employment, after his death the surviving shareholders would not be bound to employ any dolt who happened to inherit his stock.”  Gimpel v. Bolstein, 477 N.Y.S.2d 1014, 1019 n.6 (Sup. Ct. 1984).  The court went on to note that the then-current owners, two generations removed from the founders, “cannot fairly be said [to have] entered into the business with the same ‘reasonable expectations’ as partners do.”  Id.

Finally, in your question you state that your employee is not competent.  Although privately held companies must ensure that shareholder/owner employees are treated with care, this does not mean that closely held corporations have no flexibility with respect to incompetent employees or employees who have engaged in wrongful conduct.  Depending on the nature and severity of your employee’s incompetence, your firm may be positioned to take appropriate disciplinary action against her, up to and including discharge.  It is important, however, that your company afford her appropriate procedural safeguards so she cannot make an argument that the company trampled upon her rights.  (This topic was covered in the recent QQ # 140, so you may wish to review that analysis if the bases for discharge are central to your situation.)

Privately Held Corporations, Quirky Question # 140

Quirky Question # 140:

We have a small closely held company. Our owners are family members and a few close friends. Happily, our company has been increasingly successful. Unhappily, one of our executives does not seem capable of growing with the company. We have made a difficult decision to get rid of this at will employee. When we advised him of this decision, he said that because he felt he had been treated unfairly for some time, he had spoken with a lawyer. He also told us that he is not truly an “at will” employee and that we owe him higher duties. He claims we have breached the covenant of good faith and fair dealing. What is he talking about?

Dorsey’s Analysis:

There are a number of additional pieces of information we would need from you to be able to provide you a comprehensive response to your question.  But, even without this data, we hope that we can point you in the right direction. There are some aspects about the fact pattern you described that cause concern, and that likely will cause you some concern, as you will see from the observations below.

Before turning to the critical questions, let’s make some general observations that nevertheless could be outcome determinative. First, as you likely know, there is not a federal law concerning the management of closely held corporations. Closely held companies are creatures of state law, and state laws on these issues are not uniform. Your first order of business, therefore, is to review (or have your attorney review) your state’s laws regarding closely held corporations. The degree of protection afforded your employee and the substantive and procedural rights he enjoys may be influenced significantly by these statutes and the judicial decisions interpreting these statutes. Second, even though there may be a relevant state statutory scheme, you also should explore your state’s common law to ascertain what rights are afforded your employee. As you likely know, some state statutory schemes supplant completely (or “preempt”) common law. But, in the area of closely held corporations, the preemption analysis may not apply at all or may apply only in part. Third, you did not mention in your question whether, at the time of its inception, your company established By-Laws, a Shareholder Agreement, or other fundamental corporate documents regarding the structure and governance of your company. If so, these documents could bear significantly on the rights of your majority and minority shareholders, including minority shareholders who are employees. Fourth, it is not clear from the information you provided whether your employee has a contract and whether that contract included any representations regarding duration of employment, or circumstances under which a discharge might be warranted. Fifth, your question does not really explain why you and others within your company have reached the conclusion that he is not capable of “growing with the company.” Has he engaged in misfeasance or some other wrongful conduct? Has he engaged in any conduct that clearly would justify a discharge “for cause”? Sixth, what types of feedback have you provided this employee regarding the performance deficiencies that you now have concluded warrant his termination? Keep in mind that procedural failings (e.g., no notice of his performance problems, no opportunity to rectify those problems, tolerance of the same type of problems in others, etc.) often can affect the analysis of the substantive correctness of your decision.

To recap these preliminary points: a) examine your state law on closely held corporations and the decisions interpreting your state’s statutory scheme; b) examine your state’s common law decisions that bear upon the rights of majority and minority shareholders, particularly those minority shareholders who also are employees; c) review your company’s origination documents, particularly those regarding the structure and governance of the company and any agreement describing shareholders’ rights; d) evaluate whether your executive has any contract (whether in writing or oral, including quasi-contractual arrangements) that would affect his employment rights; e) consider carefully the individual circumstances relating to this employee, focusing on why you have concluded that his performance no longer is adequate for your company; and f) assess whether you have provided adequate procedural (and substantive) guarantees for this employee.

With those preliminary observations in mind, let’s evaluate a few of the general principles that may affect your situation. In general, your employee is correct – by virtue of the fact that he is an executive in a closely held corporation, courts will hold your company to a higher standard than they would for an executive in a publicly traded company. In New York, for example, the Court of Appeals noted that the Legislature “has shown a special solicitude towards the rights of minority shareholders . . ..” In re Kemp & Beatley, Inc., 473 N.E.2d 1173, 1177 (N.Y. 1984). The courts in New York and elsewhere have emphasized the differences between shareholders in publicly traded companies and closely held companies. Owners of closely held corporations are held to the highest standards of fiduciary duty – honesty, loyalty, candor, and trust. Owners of closely held companies, and the duties they owe each other, have been compared to the relationships and duties owed among partners. Indeed, some courts have characterized closely held companies as “chartered partnerships.”

Courts also have noted that employees in closely held companies have different expectations than those in publicly traded companies. For example, in the Kemp & Beatley case cited above, the court observed, “”It is widely understood that, in addition to supplying capital to a contemplated or ongoing enterprise and expecting a fair and equal return, parties comprising the ownership of close corporation may expect to be actively involved in its management and operation.” Id. at 1178.

Quoting O’Neal, a leading commentator on closely held companies, the Court of Appeals, stated further,

“‘Unlike the typical shareholder in a publicly held corporation, who may be simply an investor or a speculator and cares nothing for the responsibilities of management, the shareholder in a close corporation is a co-owner of the business and wants the privileges and powers that go with ownership. His participation in that particular corporation is often his principal source of income. As a matter of fact, providing employment for himself may have been the principal reason why he participated in organizing the corporation. He may or may not anticipate an ultimate profit from the sale of his interest, but he normally draws very little from the corporation as dividends. In his capacity as an officer or employee of the corporation, he looks to his salary for the principal return on his capital investment, because earnings of a close corporation, as is well known, are distributed in major part in salaries, bonuses and retirement benefits.’” Id. (citation omitted).

As this analysis illustrates, courts and commentators view closely held companies differently than their publicly held counterparts. Moreover, employee shareholders are given special deference in terms of their treatment by the majority shareholders.

As noted above, states have their own independent statutes governing closely held companies. Many of those statutes discuss “oppression” of minority shareholders. Few of these statutes, however, define the word “oppression.” The question, therefore, is whether a minority shareholder/employee can argue that he has been “oppressed” if discharged. The NY courts have answered this question affirmatively. “A shareholder who reasonably expected that ownership in the corporation would entitle him or her to a job, a share of corporate earnings, a place in corporate management, or some other form of security, would be oppressed in a very real sense when others in the corporation seek to defeat those expectations and there exists no effective means of salvaging the investment.” 473 N.E.2d. at 1179.

The court held that assessing whether conduct was oppressive should be based on the complaining shareholders’ “reasonable expectations.” Id. The court stressed, “oppression should be deemed to arise only when the majority conduct substantially defeats expectations that, objectively viewed, were both reasonable under the circumstances and were central to the petitioner’s decision to join the venture.” Id.

Several key themes are evident from the many New York cases addressing these issues. First, oppression is judged in large part on the minority shareholder’s “reasonable expectations.” Second, the standard is objective, not subjective. Third, the expectations are not confined to the issue of dividends or valuation – expectations also may relate to an ongoing role in management, continued employment, and/or other facets of corporate involvement. Fourth, it is not enough for a minority shareholder merely to express “disappointment” with the majority’s decisions. (Again, as the Kemp court observed, “Majority conduct should not be deemed oppressive simply because the petitioner’s subjective hopes and desires in joining the venture are not fulfilled. Disappointment alone should not be equated with oppression.”)

As reflected in your question, you consider your employee to be employed “at will.” In general, absent a contract of employment defining the duration of employment and/or the grounds for discharge, a company’s employees are employed “at will.” This means that an employee may be discharged at any time, for any (legal) reason, or no reason at all, with or without notice. With few exceptions, this basic tenet of employment law has little to no applicability for a minority shareholder of a closely held corporation who also is an employee. As described above, both state legislatures and state courts have demonstrated “special solicitude” for the rights of the minority shareholder. This solicitude applies equally to the minority shareholder in his/her status as an employee.

This does not mean, however, that a minority shareholder/employee can never be terminated. Although the playing field is tilted decidedly in the employee’s direction, there are at least two alternative analyses that can justify a closely held company’s decision to terminate an employee shareholder. First, the courts have looked to the legitimate interests of the controlling, or majority, shareholders and their need to manage the company effectively. Second, the courts have assessed the terminations of shareholder/employees from the “good cause” perspective.

Even those courts that impose partner-like fiduciary obligations (good faith, candor, loyalty, etc.) on the majority shareholders have recognized that majority shareholders must have some flexibility to manage and run the company. These courts have concluded that the otherwise high standards of fiduciary duty cannot be used to stymie the legitimate actions sought by the majority shareholders, even if those actions have some adverse consequences for the minority shareholders. As explained by the Supreme Court of Massachusetts, “we are concerned that the untempered application of the strict good faith standard . . . will result in the imposition of limitations on the legitimate action by the controlling group in a close corporation which will unduly hamper its effectiveness in managing the corporation in the best interest of all concerned.” Wilkes v. Springside Nursing Home, Inc., 353 N.E.2d 657, 663 (Mass. 1976). The court identified several areas where the majority shareholders needed to maintain both control and flexibility: declaring or withholding dividends; deciding whether to merge or consolidate; establishing the salaries of corporate officers; dismissing directors without cause; and hiring and firing corporate employees.

The Wilkes court went on to establish a two-part analysis to evaluate actions taken by the majority shareholders that would benefit the corporation but arguably disadvantage the minority shareholders. First, the courts should examine “whether the controlling group can demonstrate a legitimate business purpose for its action.” Id. Second, the courts must “weigh the legitimate business purpose, if any, against the practicability of a less harmful alternative.” Id.

The question then becomes whether there is a less harmful alternative to discharging your executive. Perhaps you could provide him a chance to demonstrate that he too can grow with the company. Or perhaps you could provide him a “last chance” warning to demonstrate that he can meet your company’s legitimate performance expectations. Alternatively, another less harsh option would be to alter his position, possibly with a commensurate reduction of his salary. These alternatives are not risk free, especially for someone who, as he advised you, already has retained counsel.

The alternative analytical model that some courts have utilized is to require that the discharges of minority shareholder/employees meet a “good cause” standard. The notion simply is that there must be some circumstances under which a non-performing minority shareholder/employee can be discharged. For example, if an employee engaged in workplace violence, the company must be free to discharge him even if he is a minority shareholder. Conversely, however, if the employee merely engaged in periodic absenteeism or demonstrated performance deficiencies in some other non-material way, it is doubtful that good cause could be established.

The bottom line is that your employee does have rights that do not exist for most employees. Your majority shareholders owe the minority shareholder/employee significant fiduciary duties. Moreover, as the discussion above illustrates, these duties take your executive out of the “at will” context.

In addition, as long as your employee remains employed, he will have additional rights that should be honored scrupulously by your company. You should assume that your company’s future conduct will be scrutinized closely by your executive employee, his lawyer, and ultimately, the court. As difficult as it is to manage a current employee who is suing or threatening suit, as long as he is employed, you owe him significant obligations.  [We did not ask whether your executive falls in the category of “family” that you referenced above, or whether he merely is a “close friend.” If the former, the potential tensions could be exacerbated further.]

It is beyond the scope of this discussion to delineate all of the statutory and common law rights that may be available to your company. But you should familiarize yourself with the statutory requirements that may be imposed on your company with regard to this employee. Your failure to do so could enhance his argument that he is being treated unfairly by the company.

At Will Employment, Quirky Question # 114

Quirky Question # 114:

We are a national company with operations in virtually every state.  We stress to our employees that they are employed “at will” giving them the right to resign at any time for any reason, and preserving our right to terminate their employment at any time, for any reason not prohibited by law.

Recently, an employee in one of our Montana facilities who had been working with us for about three years engaged in conduct that violated our company’s policies.  We fired him as a result.  He now contends that we did not have a “good reason” to fire him.  We told him that while we had one, we did not need a “good reason” to fire him due to our standard policy of at will employment.  He claims that at will rules don’t apply in Montana.  That can’t be, can it?

Dorsey’s Analysis:

As you described, your company terminated one of your Montana employees for violation of one of your company’s policies, believing that you had the right to terminate “at will” employees at any time for any reason not prohibited by law.  Your employee, however, has asserted that at will employment rules do not apply in Montana.  Your employee is correct.  With limited exceptions, none of which appears to apply to your factual situation, Montana rejects the concept of at will employment.

Discharges in Montana are governed by the Montana Wrongful Discharge from Employment Act (“WDEA”).  Under that statute, employee terminations are limited to terminations for “good cause.”  The WDEA defines “good cause” as “reasonable job-related grounds for dismissal based on a failure to satisfactorily perform job duties, disruption of the employer’s business operation, or other legitimate business reason.”  MCA, Section 39-2-903(5).  In turn, Montana courts have explained that a “legitimate business reason” means a “reason that is neither false, whimsical, arbitrary or capricious, and it must have some logical relationship to the whims of the business.”  In short, as the WDEA and the decisions interpreting the statute make clear, Montana employers do not have the flexibility afforded employers in most, though not all other states, to terminate an employee at any time for any legal reason.  (I include the word “legal” in the last sentence because even in at will states, an employer may not fire an employee for a reason prohibited by law; for example, an employer cannot fire someone because of his or her race, sex, age, disability, etc.)

Notwithstanding the Montana statute, you should not despair.  The mere fact that Montana is not an at will state does not suggest to me that you have violated the WDEA, or that your company has acted wrongfully.  The WDEA makes clear that “a discharge is wrongful only if . . . the discharge was not for good cause . . . or the employer violated the express provisions of its own written policy.”  MCA, Section 39-2-904(b)-(c).

As stated in your question, you believe that your employee “engaged in conduct that violated [your] company’s policies.”  You did not specify which policies were violated, but it strikes me that violation of a number of different types of policies would justify discharging an employee.  For example, if the employee brought a weapon to work in violation of company policy, that action would warrant discharge.  Similarly, if an employee stole funds from the company, stole company product, damaged company product or equipment, or engaged in any other conduct that was criminal in nature, it would be relatively easy for a company to establish that it had “good cause” for the discharge. Other hypothetical examples that readily come to mind include violation of a company’s sexual harassment policy, violation of an insider trading policy, violation of a policy prohibiting disclosure of confidential trade secret information, and violation of a policy proscribing fighting in the workplace.  There are undoubtedly numerous other types of policies, the disregard of which would warrant discharging an employee.

Moreover, Montana courts have found that an employer’s “reasonable belief” that an employee has engaged in inappropriate conduct may justify the employer’s actions.  For example, in Koepplin v. Zortman Mining, Inc., 267 Mont. 53 (1994), the court concluded that an employer’s reasonable belief that an employee had engaged in threatening or harassing conduct constituted good cause for discharge under the WDEA.  Finding that an employee’s threats and harassment of other workers was “disruptive of the employer’s business operation,” the employer had “the right to serve its own legitimate business interest by discharging the [plaintiff].”

In addition, Montana courts have held that actions that expose the employer to litigation or liability constitute “legitimate business reasons for discharge and for discharge and good cause under Montana’s Wrongful Discharge Act.”  Montana courts have emphasized, for example, that an employer “need not wait until it has been successfully sued for harassment to determine that it has a problem employee and that termination is warranted.”  See Bourdelais v. Semitool, Inc., 2002 ML 3961, at *62-72 (Mont. Dist. Ct.).

Although a well-grounded discharge decision (including one based on the fact that the employee was not meeting the employer’s performance expectations) will not run afoul of the WDEA, four general admonitions are important to consider.

First, as described above, one of the specific statutory violations described in the WDEA is that the employer has not violated the “provisions of its own written policies.”  This statutory definition ups the ante with respect to the written policies utilized by employers in Montana.  Regardless of the underlying content, the policies should be clear and well written.  Ambiguities should be eliminated.  Your company (and other Montana employers) should review carefully the policies the company has adopted and the way in which the polices are enforced to ensure that you are not creating a risk of a WDEA violation.

Second, as also noted above, Montana employers may be able to avoid any potential liability for an employee discharge if they had a “reasonable belief” that the employee has engaged in wrongful conduct.  This implies that the employer has conducted an investigation appropriate under the specific facts and circumstances to evaluate meaningfully the offending conduct and its potential consequences.  Precipitous decisions, made without any investigation, or decisions based upon superficial and careless investigations, will not meet that standard.

Third, Montana employers should be sensitive to the issues of inconsistent enforcement of company policies, and inconsistent treatment of individuals who violate company policies.  With respect to the former, it would be relatively easy for a plaintiff to construct a compelling argument that the policy violation for which he or she was terminated was not one that warranted discharge, if other employees had violated those policies in the past without significant repercussions.  Employees fired for offenses that others had engaged in without consequence could make a decent argument that this conduct could not truly have been “disruptive to the employer’s business operations” since others who had behaved in a similar (or identical) manner were still gainfully employed.

Fourth, a corollary observation to the point above is that discrimination cases often turn on the issue of differential treatment.  For example, if an individual in a protected class were discharged for the same type of conduct that those outside the protected also had engaged in without repercussions, there is a significant risk of a discrimination claim.  Thus, even if the court found that employer had “good cause” to discharge the employee, thereby eliminating potential exposure under the WDEA, an employer still could face potential litigation and/or exposure for violation of federal or state anti-discrimination statutes.

In sum, your ex-employee is correct that Montana is not an at will state.  But, the Montana WDEA does afford employers the right to terminate employees for good reason.  If the policies that you referenced in your question were important, clear, and consistently enforced, and your company had a reasonable belief that the policies were violated, your discharge decision should be affirmed.  Finally, the WDEA incorporates some protections for employers that mitigate the effects associated with the rejection of at will employment.  But that’s a topic for another day.