From the May 2010 issue of American Agent & Broker •Subscribe!

How Safe are Non-Compete Agreements?

Non-competition clauses in contracts between producers and agencies have long been a source of controversy and differing interpretations. Many in California say they don't hold up, while some agency owners want them signed to at least create the perception on the agent's part that they cannot take their business with them if they leave the agency.

Such agreements have many names: covenants not to compete, anti-piracy clauses, infringement of trade secret clauses. However, all have the same objective: to prevent agents from taking their accounts with them when they leave an insurance agency. Many agents have been the targets of legal action because of these clauses. To avoid problems in the future, agents and their agency employers should make it clear at the time of hire about what will happen if their business relationship doesn't work out.

One way of resolving the issue is to give the agent a percentage of ownership in their book of business. When the agent leaves, he or she gets paid for that percentage at an agreed amount in the contract. Sometimes the calculation is the commission times the percentage of ownership the agent has in the agency. The agency can have first right of refusal to buy the agent's book, but if the agency declines to purchase, the agent should be free to take the business with him after paying the agency the agreed-on percentage. This protects the agency's original investment in writing the book and operating costs associated with servicing it. It also pays the agents for their work in selling and servicing the business. It is important to make sure the written agreement specifies what types of business the ownership refers to: is it only commercial and not personal lines? Does it only apply to accounts above a certain commission level and so doesn't include smaller policies such as business owner policies?

Another way of resolving the issue is to have no contract at all. In this type of "non-agreement agreement," the employment is at will and it is a free for all if the agent leaves. There is no legal action. It comes down to the strength of the relationship between the agents and their clients. This approach is common in the larger brokerage houses, when a newer agent has come aboard without a book of business. The brokerage, rightly or wrongly, believes it will retain most of the business since it is its name and extraordinary array of services that sold the business in the first place.

A less obvious way of inserting a non-compete clause is for an agency to put it on the back of an employment application. An agent may never know they signed one if they just sign the employment application, which is required by the human resource department as one of the documents that have to be signed prior to employment, as innocuous as a W-2. Agents must be extremely aware of what they are signing at the outset of employment because these agreements can come back to haunt them later.

One agent who worked for a mid-sized regional agency for more than 20 years before going out on his own realized to his chagrin that he had signed a covenant not to compete with his old agency years before. The agency attempted legal action, but not on the basis of the non-compete agreement; instead, the agency sued him for misuse and theft of "inside trade secrets." The agent had no recollection of signing this agreement.

Status varies by state

The legal status of non-compete agreements varies by state. In California, for instance, they are unenforceable. In other states, non-competition clauses are upheld by courts. However, courts will review them very carefully for three items: how restrictive is the agreement, what is the bargaining power of the parties, and how reasonable are the time and radius limitation on future sales activities. If the agreement is unreasonable chances are the court will strike down the agreement completely.

If non-compete agreements are unenforceable in some states, why have agents sign them? One reason is to create a paper trail that the agent acknowledges the business belongs to the agency. Another reason is to get an acknowledgement from the agent that he or she can't take business with them if they leave. Third, agencies demand the agreements be signed simply because they can--a power move by a stronger entity over the individual agent. Sometimes agency owners are so outraged that an agent dared to steal their business that they seek an injunction against the agent, preventing them from going after their former clientele. It benefits the agent to know what kind of agency they are joining before accepting employment.

However, even if agents do sign a restrictive contract with the agency, courts might strike down the contracts anyway. According to Neil J. Ticker, a business attorney in Monterey, Calif., courts go beyond not enforcing non-compete agreements and will even sanction agency owners for pursuing legal action against producers who take business with them. One exception, Ticker said, is if the agent has entered into an agreement to sell his book to an agency, has been paid for that book of business, and then goes out and attempts to take that business back by setting up another agency. If the agent just works for the agency and then goes out on her own, legally there is very little the agency can do to keep that business except to compete with that agent to retain it, even if the agent signed a contract with the agency.

"No-win situation" for agency

One large agency owner said the legal environment in California, and in general throughout the states, is very unfair to agency owners because it leaves them with no legal recourse when an agent takes the business with him after he leaves:

This is a no-lose situation for the producer and a no-win situation for the agency owner. You compensate producers to generate new business on behalf of the agency, you don't pay them to be in the process of building their own agency. Yet that's often how it ends up. In California, it is almost impossible to keep an ex-producer from pirating your business. The only chance an agency owner has is proving the ex-producer used trade secrets to take the business. The burden of proof is on the agency. You must demonstrate that extraordinary measures were taken to enumerate what those trade secrets are and what systems are in place to protect them. Then you must prove the ex-producer used those trade secrets.

Just because non-compete agreements are widely viewed as unenforceable in some states doesn't mean producers should sign them. What if the law changes while you are employed and they become enforceable at the time you are ready to leave the agency? It is best just not to sign them if you can avoid it. Some agents do not want to rock the boat and will sign their life away because they need the job.

The issue at the core of non-competition clauses is who owns business produced by an agent. The British political philosopher John Locke says in his "Second Treatise of Government" that a person owns a piece of land once he has mixed his labor with it. An agent who prospects, sells and services a client would appear to be the one who owns business since he or she does all of the work. The client identifies the agent with their account, not the name that appears on the policy. The agent who has spent years cultivating the relationship with her clients and helping them with their insurance needs will be sympathetic when they ask insureds to move their business to them.

It can seem unfair if the agents take business they never serviced. For example, if the agent writes the business and then hands it off to the CSR and agency staff which the agency pays for, the agency has expended a lot of resources for this business just to have it taken away by the departing producer. However, two arguments can be made here. The commission on that account should be enough to pay for the services provided to that account. Also, if the agent just hits and runs with the business, writing it and then ignoring it, most likely the customer will not know who that producer is when they come calling for the business. There has been no exchange of labor with that business and no ownership will be imputed to the agent.

If the agent sells an account in a group that the agency started and which preceded the agent's employment, most likely the solution to this is the market. The client went with the agent due to the attractive group rates the agency provided and will most likely stay with the agency that can get them the best rates. However, if the agent has forged a strong relationship that trumps price, the client will go with the agent. Barring slander by the agency or agent against each other, the decision should come down to the clients, since they are the ones paying for the policy. If customers want to stay with the agent who has worked for them, they will find a way to move their business. If the agent has done a poor job servicing the account or has been AWOL on the account, the business will stay with the agency or move to another agent who has doubtless been calling the prospect for years. When the agent leaves that foot in the door, the business will move not with the agent but to a new agent.

So there is a difference between ownership of business and control of business. It behooves both agent and agency to begin the employment relationship with an understanding about what will happen to the business if the agent leaves.

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