Can a Confidentiality Agreement Trump a Non-Compete Law? HP Thinks So.

Some very interesting legal news sparked up in the tech world this week, as recently-fired HP CEO, Mark Hurd, on Monday became the newly-hired president of Oracle, a major HP competitor.  HP almost immediately filed a suit in California to prevent that from happening.  The issue raised is whether HP can stop Mr. Hurd from working at a competitor based on his confidentiality agreements with the company. In many states, parties can agree to restrict a former employee from working for certain competitors in a limited geographic area (for example, a baker who can't work for any other bakeries within 20 miles for one year after termination).  Such non-compete agreements are generally enforceable if the duration and geographic limitation are reasonable.  The court aims to strike a balance between protecting legitimate business interests of the company with the ability of the employee to earn a living.

But California is one state that automatically voids the enforcement of non-competes (outside of certain transactions like the sale of a business) in order to promote open competition and support the employee's freedom of contract.  Other states have adopted similar laws, and even Massachusetts is considering changing its laws to be closer to California's.

In its complaint, HP is seeking what is called "injunctive relief" (in non-legal speak, they want the court to block his hiring at Oracle).  HP's complaint centers around the succinctly-named "Agreement Regarding Confidential Information and Proprietary Developments With Protective Covenants Relating to Post-Employment Activity for Incumbent Employee Working in California", and the later and much more appropriately titled "HP Agreement Regarding Confidential Information and Proprietary Developments", which Mr. Hurd signed on three different occasions.  The agreements restrict Mr. Hurd from performing job duties that are the same or similar to the job duties he had at HP only if that results in the unauthorized use or disclosure of HP's confidential information.  HP claims that Mr. Hurd simply can't do that at Oracle.

So the question for the court to decide is whether HP's confidentiality agreement is an appropriate restriction and not just a backdoor subversion of California's non-compete restriction, or whether Mr. Hurd can perform his duties at Oracle or anywhere else without using or divulging HP's confidential information.  The answer set an important example for how companies should handle agreements with their employees, particularly if they live in California.

Lexis Nexis Has Nominated The Business Law Blog as a Top 25 Blog Candidate and You Can Help

Okay, everyone - it is time to get interactive!  I received an email this week that Lexis Nexis has selected my blog as a nominee for one of the top 25 blogs in the Business Community.  First of all, I am very excited and humbled to be selected.  I, of course, know many of the other blogs on the list because I am a regular reader.  So to be nominated in that group is truly an honor. I started The Business Law Blog to help educate startups, small businesses, investors, and other interested readers.  As a practicing business law attorney, I help my clients on a daily basis to demystify the legal hurdles that their businesses face and help them navigate the path from startup to exit.  I share many of those insights regularly on this blog to help entrepreneurs and companies focus less on the law and more on minding their business.

Here is how you can help.

The Lexis Nexis folks have set up a site with links to all of the nominees (or see the logo on the right side of this page).  You can vote for your favorites by adding a comment to the bottom of that page.  In order to comment, you have to register, but (i) you don't have to be a lawyer, (ii) it is free, and (iii) they have adamantly assured us that there will be no solicitations.  So you have nothing to lose and you can rest easy knowing that your vote helped this blog reach a broader audience.  It should only take you a couple of minutes.

The initial voting period for the Top 25 blogs is open until October 8, 2010.  After the top 25 blogs have been announced, a Top Business Law Blog of the Year winner will then be chosen by the voters and by a select panel of judges ("Idol"-style).  So vote for your favorites, and if Daniel J. Ryan's The Business Law Blog is one of them, I will be ever so grateful.

And while you are at it, take a moment to post a quick comment here or send me an email with topics that you would like to see addressed, because I am always here to serve.  Have you been wrestling with a particular legal problem?  What issues is your business facing?

The Ghost of Par Value and its Real Effect on Startup Businesses

Par value is one of those legal mysteries involved in forming a business that entrepreneurs have never heard of and ten minutes after incorporation, may never consider again.  However, I ran into a situation recently where it mattered to one startup company (at least for a moment). For a quick bit of history, par value is an anachronistic concept where the company sets a stated value on each share of stock it authorizes.  States allow that par value to be any any amount, but typically it is set at zero or some very small value.  In the past, this amount had legal effect and represented that amount that was originally paid for the stock and made up the initial capital of the company.  However, now, it has little import aside from some minor accounting issues and calculating state taxes in some states (like Delaware).

I am working with a startup that was incorporated in Massachusetts and is now considering a reincorporation in Delaware.  The  founders originally choose to have "no par value" as is permitted in Massachusetts and did not give another thought to it because of what I stated above and because annual fees for corporations in Massachusetts are not based on par value.

When reincorporating in Delaware, the founders increased the number of shares (to provide some flexibility with investors and with employee equity plans) and assumed that the company would use the same no par value stock.  But in Delaware, there are two methods for calculating the franchise taxes that the company must pay every year.  Without going into the particulars of each of the calculations (because you would fall asleep on your keyboard), the franchise tax with stock at a par value of $0.01 per share resulted in an annual franchise tax of $350.00 whereas the same amount of stock with no par value could result in a franchise tax of $75,075!

The bottom line. In thinking of par value, do not think any more than this: just go with par value of $0.01 or less and don't think about it again.

Could the Recent Financial Reform Make it Harder for Your Company to Raise Funds

The recently enacted financial reform law (the "Dodd-Frank Wall Street Reform and Consumer Protection Act" for the sticklers out there) impacts a range of financial services and companies in the way they do business.  For startups and small businesses, it may just make it harder for you to raise funds.  That's because the Act changes the definition of "accredited investor" under the federal securities laws. For a bit of background, the securities laws were originally established in the 1930s amidst the Great Depression as a consumer protection initiative against excesses and fraud in the sale of securities.  Under the Securities Act of 1933, any stock or other securities sold by a company have to either be publicly registered or qualify under one of the limited exemptions.  Which means that companies can conduct limited offerings of stock to certain purchasers, and "accredited investors" fall into a special category with fewer requirements.  The logic being that they are more "sophisticated" than an average investor and can make more educated investment decisions (ed. note: this is regardless of what the last couple of years have shown).

For the past three decades, an accredited investor was any individual with a net worth of at least $1,000,000 - including the value of a primary residence - or who earned a personal income of $200,000 in the past two years (or $300,000 with a spouse) and with a reasonable expectation to repeat this year.  While the income test levels remain the same for now under the new law, the net worth test now excludes the value of the investor's primary residence. In addition, the SEC will have the authority - actually, the obligation - to revisit these amounts periodically in the future.

What does this mean for your company? From a practical standpoint, the new law means companies will need to revisit their subscription agreements and investor representations in offering documents to make any necessary changes before making any further offerings.  This should be done with the help of your company's attorney.

But the net effect is to make it harder to qualify as an accredited investor, which means that there will be fewer of them.  Since the income and net worth tests have remained at the same amounts since 1982, the effect of inflation means that many more people would qualify as accredited investors now than when these rules were adopted.  So this new law ameliorates that change to a certain extent.

But at the same time, it cuts down the available pool of potential investors in startups and small businesses.  That is a good thing in order to protect those people that technically meet the requirements but are otherwise unsophisticated investors.  But it could also result in an impediment to companies who need outside investors to grow, but won't or can't tap the more expensive institutional money available.

Best of Both Worlds: Converting Your Startup From a LLC to a Corporation

Entrepreneurs often ask my opinion on which type of entity is best for a startup or small business and, while I have written about this before, I generally say that one size never fits all.  That choice is made by each company depending on founder structures, short- and long-term planning, and, of course, tax.  I have seen companies start as corporations and as LLCs and both can be successful depending on your circumstance.  But are you stuck with that form once you make that choice?  That requires a bit of explanation. C-Corporations as Default? Many lawyers and entrepreneurs will tell you that all new startups must be Delaware corporations, and more explicitly, C-corporations.  This is the result of a common view that Delaware law is more friendly to your business than your state's, the courts are specialized and prepared to deal with business law issues that your company may face, and that a C-corporation is the structure that you will need in the event you take on investors (which you will certainly need if you are going to be taken seriously).

Without rehashing my previous post, I don't automatically subscribe to that line of thinking.  There are some startups that have very valid reasons for starting as, say, a limited liability company.  Those are mostly attributable to the flow-through tax structure and the flexibility of management and with allocations and distributions to the members. In other words, a company can take advantage of the tax savings of not having to pay corporate tax like a C-corporation during the early years of operation, the flexibility of adjusting the amount of distributions it gives to its members, and the freedom to customize management and ownership structures.

Can you Change your Entity? And if your LLC needs to be corporation later in life - for, say, investment or tax reasons - state laws provide mechanisms that vary by state for conversion from a LLC to a corporation (note: converting from a corporation to a LLC results in a much different, and less favorable tax treatment).  In Delaware, it is as simple as filing a conversion form.  In other states, such as Massachusetts, the same thing is accomplished through a somewhat more complicated conversion process or by enacting a full merger of your company into a newly-created Delaware entity.

What's it Going to Cost? Yes, there are both legal fees and filing fees associated with this type of conversion that will dissuade some companies from going down this route.  Your company needs to weigh the savings of flow-through tax treatment it will enjoy as a LLC with the cost of going through the conversion later.  And in addition to the legal fees, there are certainly some additional tax issues to consider (there we go again with the tax issues) particularly if you have passive members or hold certain types of debt.  But for many small and growing companies, you could accomplish a conversion without breaking the bank.  The key will be to make sure that your lawyer and accountant are involved early in the process.

Have you converted?  What was your experience?