By

Michael D. Freeborn

(Reprinted with permission from Petroleum Equipment & Technology, Sept./Oct. 1997)

Phil has a nice little business as an authorized installation and service contractor for petroleum handling and marketing equipment. The equipment, such as gas pumps manufactured by companies like Gilbarco and Tokheim, is installed at numerous gas stations in Phil’s territory. His company is paid for the installation and any warranty work which may be required later.

In turn, Phil is required to stock parts and have trained technicians on his payroll. Maintaining the inventory of parts is easy. Keeping good technicians is more complicated.

First, Phil has to arrange for training of a new employee. The rookie shows up for work on the first day, barely knowing the difference between a gas pump and a phone booth. Before he can work on the equipment he needs license certification on a host of complicated subjects. This costs money.

Second, some installation and service contractors recognize that it’s nice to have someone else pay the training costs. So they just lay in the weeds until Phil has sent the employee through school. Then they offer him a couple more dollars per hour, and bingo, it’s bye-bye graduate.

Third, while Phil’s business is located in the dust bowl of Oklahoma, the training is provided by a school in scenic Oregon. Every time Phil sends an employee off to school for a few days, there’s a risk he might discover that Oregon, or any of the other states en route, is a nicer place to live. (Nothing against Oklahoma, you understand.)

So Phil has a problem like many others have had: How you gonna keep ‘em down on the farm?

One solution, of course, is for Phil to make sure he’s paying the "going rate". (For our purposes, the going rate is defined as just barely enough to keep them from going.) Sometimes, though, even that is not enough. So Phil calls me and asks if I can draft an employment contract with a covenant not to compete, which will prevent his employees from bailing out before the ink is dry on their diplomas.

This is not so easily done.

More than two centuries ago, a noted legal scholar 1/ observed that there are three great relationships in private life:

1. Master and servant,

2. Husband and wife, and

3. Parent and child.

(After typing this, my secretary said the first two were repetitive of each other. Very funny. Actually, she was just overlooking that lawyers frequently use the phrase "master and servant" as the equivalent of employer and employee.)

Because the relationship of employer and employee is so pervasive and important in our society, employment law has become a maze of common law doctrines, judicial pronouncements, administrative agency findings, statutes, and rules regarding enforcement of contracts. It differs from state to state. However, some general principles can be set forth.

An employer generally cannot prevent a former employee from competing with the employer, unless they are bound by a valid covenant not to compete.

Many lawyers, and even some courts, erroneously believe that a restrictive covenant will be enforced as long as it is supported by valid consideration and is reasonably limited in duration and geographic scope. 2/ However, this is not always true.

For a covenant against competition to be valid, the scope of its restriction must also be reasonably related to a legitimate interest of the employer sought to be protected. The extent of the restriction must be no broader than necessary to protect such an interest. One court has defined the legitimate business interest as "a business interest, not fictitious, which, when weighed against the public’s interests in a free economic arena, is worthy of protection in order to encourage and stimulate business efforts and innovations."  3/  Well. That certainly clears things up, doesn’t it?

While courts are not always helpful in defining what interests can be protected, some interests that have been considered legitimate include:

1.  Long-term customer relationships;

2.  Goodwill;

3.  Confidential information in general;

4.  Trade secrets in particular;

5.  Customer lists and other confidential customer information; and

6.  Special, unique and extraordinary skills.

Most of these won’t apply to Phil. If a technician moves to Oregon, it will not jeopardize Phil’s long-term customer relationships, goodwill, confidential information, trade secrets or customer lists, because Phil is not in competition with installation and service contractors in Oregon. Customers in Oregon haven’t even heard of Phil.

But, what about number six?

In some states, a covenant not to compete may be enforced if the employee’s services are special, unique or extraordinary, even where no other protectible business interest of the employer is involved. For the employee’s services to fall within the meaning of this rule, however, the services must be such that the employee could not be replaced, or that the loss of his services would result in irreparable injury to the employer.

In most situations, an employee’s services will not be of the kind necessary to uphold such a covenant. The services of most employees, even skilled artisans, are generally not considered so special, unique, or extraordinary. For example, a court has held that a technician hired to service copy machines does not have special skills of a sort that allows the employer to restrain him from competing after termination of the employment. 4/

As a result of training provided by the employer, an employee does acquire valuable skills and knowledge necessary to perform his job. Naturally, the employer would want to protect this investment and prevent such an employee from using the same skills and knowledge on behalf of another company. Courts have held, however, that the employee also has a legitimate interest at stake. The employee wants to use his acquired skills and knowledge when, where, and in the type of work he chooses.

In other words, this is an area where the employer’s interest and the employee’s interest directly conflict. Faced with this conflict, courts are often reluctant to protect the employer to the detriment of the employee. Instead, the courts frequently hold that the general knowledge and skills of an employee belong to the employee, and are not a protectible employer interest. Only under special circumstances will the employer’s interest outweigh that of the employee.

Fortunately, there is a better way. It’s what I call the Fleischman Strategy, named after Dr. Joel Fleischman.

Dr. Fleischman is a Jewish internist raised in New York City, who financed his medical education through a scholarship from the state of Alaska. Unfortunately for him, the terms of his scholarship required him to repay it by serving as a general practitioner in Alaska for four years after graduation. Because there were no openings in Anchorage, he was sent to the remote town of Cicely (pronounced like Sicily), population 849.

Cicely is north of the Arctic circle and 200 miles from the nearest town, Sleetmute. Dr. Fleischman was the only Jewish person in the entire Borough of Arrowhead County. In Cicely, he earned only $465 a month after taxes. Unhappy as he was to be there, however, Dr. Fleischman had a contract that was very effective: it kept him in Cicely for four long years.

I know this because I watched nearly every episode of "Northern Exposure" on CBS from 1990 to 1994. If you watched any of it, you know what I’m saying.

Although I haven’t reviewed Dr. Fleischman’s contract in particular, I have a pretty good idea how it must have been written. Moreover, I am convinced that the same terms which kept Dr. Fleischman in Cicely, against his will, should likewise keep Phil’s well-trained technicians on the job in Oklahoma.

Whatever your civics teacher may have taught you about indentured servitude, the fact is that a well-written contract can be a thing of beauty.

Here’s how it is done.

There are six points in the Fleischman Strategy, the first of which is a Training Reimbursement Contract. This can be part of a written employment contract, or it can be a separate agreement. The key is that it does not directly seek to prevent the employee from working elsewhere (as did the covenant not to compete), but instead assures in advance that the employer will be reimbursed for the costs of training if the employee leaves before a specified date after the training -- say, one or two years.

Note that "costs" is plural. It should be defined in the contract to include not only tuition, books, travel, lodging and meals, but also the cost of lost productivity. If the employee is being paid during training, the employer has incurred that wage cost, as well as the lost revenue which would otherwise have been received if he was working. Tote it up. It is probably a bigger number than you thought. When all is said and done, it is easy to spend as much as $20,000. (I am told that a fully trained service technician working on Gilbarco equipment undergoes 32 classroom days of training.)

There’s no harm in letting the employee know just how big the number is. Indeed, if the employee is completely aware of the size of the investment you are making in him, the result may be increased motivation, loyalty and gratitude -- a significant human resources benefit.

Don’t be concerned that you cannot precisely measure in advance all the costs, to the penny. It is neither possible, nor necessary. This brings us to the second point of the strategy, a liquidated damages provision. Acknowledge in the Training Reimbursement Contract that it is impractical or impossible to specify the precise amount to be reimbursed if the employee leaves prematurely. The parties thus agree that the damages in the event of breach shall be liquidated in the amount of "X", where X is ample to fully reimburse the employer for everything. (If you wish, you can amortize the liquidated amount downward, over the life of the contract.)

If the employee balks at signing such an agreement, this should be a warning signal that perhaps he is already thinking of other employment. Insistence on a Training Reimbursement Contract before sending employees off to school thus serves as a useful screening device, to make sure you are sending only those who are not already harboring thoughts of greener pastures.

You may be wondering about the difficulty or expense in enforcing the contract, and this brings me to point three in the Fleischman Strategy -- a confession of judgment clause, sometimes called a cognovit. This says that in the event of default by the employee, such as his premature departure, the employer is entitled to file suit and have judgment entered against the employee automatically. In other words, the employer is authorized in advance to "confess judgment" on behalf of the employee. The Supreme Court has held that judments entered on the basis of cognovit clauses are not unconstitutional per se. 5/

If this sounds too good to be true, you are partly right. Even though confessed judgments are not unconsitutional per se, the Due Process Clause of the Constitution requires that the debtor have an opportunity to challenge whether the cognovit was knowingly and voluntarily given, and to assert other defenses, before execution of the judgment. So, states which allow confessions of judgment typically require that the judgment be "confirmed" by serving process on the debtor and giving him a chance to contest the judgment. 6/

It is, of course, conceivable that there may indeed be defenses to a Training Reimbursement Contract. Suppose, for example, that the employee is a minority, and he says that the reason he did not serve out the entire term of the contract is that he was improperly fired or discriminated against for racial or other illegal reasons. Under these circumstances, it might well be inappropriate to enforce a judgment against him.

But as long as the employer treats the employee fairly, and the cognovit has been signed knowingly and voluntarily, there will probably be no defenses to defeat the judgment entered by confession, and it will be confirmed in short order.

The likelihood of this is further enhanced by points four and five of the Fleischman Strategy -- contract clauses entitled Consent to Jurisdiction and Award of Attorney Fees.

If Phil’s technician has run off to Oregon, the cost of finding him and serving a summons could be significant. But, if by signing the contract the employee has also signed a consent to give the court in Oklahoma exclusive jurisdiction over any disputes, and has appointed as his agent for service of process an agent in Oklahoma, getting a judgment by confession will be relatively simple. Moreover, if there are any defenses to the judgment they will also have to be heard in Oklahoma. This makes the litigation more costly for the employee, who now lives in Oregon, than the employer, who remains down the street from the courthouse, in Oklahoma.

Most important, the employee now knows that fighting the case may prove even more expensive than paying what he owes, because the attorney fees for both sides will ultimately be assessed against him if he loses. This shifting of economic risk is a remarkable deterrent against frivolous defenses.

Finally, let’s assume that you have obtained judgment by confession, have served the employee with process notifying him of the judgment, and it has now been confirmed. What next? If he still hasn’t paid, we come to point six of the strategy, registration of the judgment and garnishment.

The judgment can be registered in Oregon, or wherever the employee or his assets can be found, and a court in Oregon or elsewhere can issue a garnishment summons. You can garnish wages, bank accounts and, if necessary, conduct discovery to find other assets. These procedures go by different names in different states, but they are all designed to accomplish the same thing: give full faith and credit to the judgments of sister states. It may take a while, but as long as the employee doesn’t go bankrupt you can continue collecting what you are owed. And keep in mind that, to the extent additional attorney fees are required, a properly worded Training Reimbursement Contract will require the employee to pay those additional costs in the end.

The moral of the story?

Before sinking thousands of dollars in training, see your lawyer about a Training Reimbursement Contract. If he hasn’t done one before, feel free to have him get in touch with me. The laws in each state vary somewhat, so don’t assume that everything I’ve said here will conform exactly to the laws in your jurisdiction. But it’s likely that deploying the Fleischman Strategy will be a whole lot better than nothing.

_________________

Footnotes:

1/  See W. Blackstone, Commentaries 410 (1765).

2/  Decker, 1 Covenants Not To Compete 75 (1993).

3/  United Laboratory, Inc. v. Kuykendall, 87 N.C.App. 296, 361 S.E.2d 292 (1987), aff'd in part, 322 N.C. 643, 370 S.E.2d 375 (1988).

4/  Greenlee v. Tuscaloosa Office Products and Supply, Inc., 474 So.2d 669 (Ala. 1985).

5/  D.H. Overmyer Co., Inc. of Ohio v. Frick Co., 405 U.S. 174 (1972).

6/  See, for example, Community Thrift Club, Inc. v. Dearborn Acceptance Corporation, 487 F.Supp. 877, 883-84 (N.D.Ill. 1980).

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