ACG - Agency Consulting Group

The PIPELINE

A national monthly newsletter for agency principals dedicated to agency management topic

Non-Competition Agreements

Non-Compete Agreements have long been a source of dispute (and a lucrative source of income for many attorneys) when a departing employee or seller pierces an agreement not to compete with the employer or buyer with whom the agreement has been established.

The primary question from an employer/employee standpoint is, “Does the employer ever have the right to prohibit an employee from either taking accounts or from competing in other ways after that employee has departed the agency that has paid the employee for his efforts in the creation, relationship building and/or servicing of an insurance account that represents a part of the asset base of the employer agency?”

In the sale of an agency or book of business by one person or entity to another, the primary question is, “Does the seller have the right to either regain or sell insurance to accounts that the (s)he has sold to the buyer or does the seller have the right to reverse any part of the non-competition part of the sale agreement to which the seller agreed in the transaction with the buyer?”

We at Agency Consulting Group, Inc. are not attorneys. However, we act as Expert Witnesses on Insurance Agency norms, practices and disputes and have been asked on numerous occasions to opine on the industry standards regarding non-compete agreements and their validity or applicability under a variety of conditions. Our opinions are well-grounded in industry practices and in common sense.

First, non-compete terminology that prohibits someone from engaging in their chosen profession in their home area (the area with which they are familiar and a known entity) is generally unreasonable. Courts throughout the country have agreed that neither an employment agreement nor a sale agreement in the insurance industry can prohibit someone from continuing to make a living once they leave the company’s employment or once they sell an agency or book of business. For this reason, geographic restrictions are difficult, if not impossible to enforce.

However, in an employment situation, relationships created, information gathered and confidential data accessed while an employee of a company can certainly be subject to confidentiality and non-competition agreements – as long as those agreements are of reasonable duration. After all, the employee collected the data, established the relationships and administered the insurance account of the clients under the direction of and while being compensated for those duties by the employer company.

If you are hired as a carpenter and are asked to purchase lumber, use it to create a building and then make sure the building remains in sound condition over time, you would never have the right to take down the wall and take back the lumber once you left the contractor’s employment. Your employer paid for the materials and paid you for your skills and efforts to create the building. Similarly, if a producer is paid to solicit clients, evolve a relationship and maintain that relationship on behalf of the insurance agency, neither should he have the automatic right to re-solicit the client after leaving the agency.

Departed producers raise two very common objections to their prohibition from soliciting former employer’s accounts: 1) The customer has the right to go to whatever agent they choose, and 2) The customer’s relationship is with the producer, not with the agency – the agency would likely lose the customer anyway.

The answer to the first question is very straight-forward. If you have a reasonable time-sensitive non-compete clause active at the time of a producer’s departure from an agency, this does not prohibit the client from using whichever agent they desire. However, it DOES prohibit the former employee (who was a participant in the agreement) from ACCEPTING the client for the period agreed upon by the producer in the non-compete agreement. While customers certainly have free choice, an agent may not (by contract terms). No agent has ever been “required” to accept a customer – even if the customer desires the services of the agent.

The answer to the second objection is the reason for the insertion of a “reasonable time-sensitive” non-compete period. The agency originally hired the employee to solicit, or service, or administer the insurance programs for its clients. It presumably paid the employee to accomplish those tasks with the assumption that the customer base created comprised the growing asset value of the agency. If the employee is no longer employed by the agency it is the agency’s responsibility to replace the employee with another employee who will maintain and/or cement the relationship of the client with the agency. For a period of time the information created and known about a client is a part of the confidential information that comprises the intellectual property of the agency. The period of time during which that information is current is the period “reasonable” for a non-compete agreements duration. Most insurance accounts renew annually and, over a period of time, information becomes stale and must be updated to assure current customer information for the agency. Typically, sufficient information changes for a customer within two renewal periods to make the data known by the former employee “stale”, requiring the employee to regain that data through personal efforts, rather than utilizing confidential information known to the former employee while employed by the agency.

The duration of a reasonable non-compete term, therefore, is as little as two years (two full terms of renewal) and as much as three years (including partial policy terms after the employee’s termination and two subsequent renewal terms). An employee operating with a valid non-compete agreement must give the employer sufficient time to re-establish relationships with the client with another employee. Once that period is completed, the employer and the former employee are considered on a relatively ‘level playing field’ and competition is again fair. Information to which the employee was privy during his employment is stale enough that he must achieve his own information concerning the client. Sufficient time has elapsed to permit the employer to replace the employee in their relationship with the client making competition fair between the former employee (now soliciting the client as just another agent) and the current agent.

The answer to the question, “Does the seller have the right to either regain or sell to accounts that the (s)he has sold to the buyer or does the seller have the right to reverse any part of the non-competition part of the sale agreement to which the seller agreed in the transaction with the buyer?” also begs a common sense answer.

In the Old West they had a name for someone who would sell cattle to someone else, then come back and take back the cattle that he sold – A Rustler – and they hung rustlers.

What’s the difference between the Old West rustler and an agent who would sell his asset, primarily a book of business comprised of a group of clients who were expected to continue to renew and be serviced by the acquirer, and then take back his clients – either soliciting them on purpose or claiming that the client simply wandered back seeking his old agent? A rustler who claimed that the cows just wandered back home of their own volition is still a rustler if he doesn’t return the property that he just sold.

An honorable sale of clients from one agent to another actually puts a moral (if not legal within the terms of the agreement) obligation on the seller to assist the buyer in the transition of clients. After all, the value established on the intangible asset was based on the seller’s and buyer’s expectation that a revenue stream of customer renewals would continue. Often, a part of the purchase of an agency or book of business actually involves the seller spending time smoothing the transition in order to assure the buyer that he is receiving the value of asset that was sold to him.

This moral obligation does not imply that clients can’t leave the buyer for any reason. It is certainly the buyer’s responsibility to cement relationships with his acquired clients. If the clients decide to leave they may do so at any time. However, regardless of the buyer’s treatment of the clients and their subsequent decision to move to a new agent, their decision does not negate the prohibition against the seller accepting those clients back during the term of the non-compete agreement.

Non-Compete Agreements operate to protect the employer or buyer from employees or sellers soliciting accounts over which they had some control through production, service or any other form of client/agency relationship. In an agency or book of business acquisition this operates on all business involved in the sale. A second agreement is justified to prohibit former employees from taking any other account of the agency for which they may have had access to confidential information (regardless of their involvement with the client). That agreement is typically termed a Non-Piracy Agreement and it adheres to the same restrictions for the same reasons as the Non-Compete Agreement.

Protecting an agency or buyer from unfair business practices or competition by a former employee or by a seller who had access to confidential information and/or was paid to create the relationship for the agency is not unfair to the employee or to the seller. They have the right to sell ANY insurance product to ANYONE they desire – except to the clients that they either sold to the buyer or for whom they had access to information to which they would not have been privy had they not worked for the agency.

The problems that arise with most agreements of this type are due to unreasonable or vague terms. In an agency/employee dispute, the court tends to favor the individual in questionable issues. In a buy/sell dispute the court looks at the reasonable course of events unless the agreement has been so badly written that it expressly gives an advantage to one or the other. Clean up any non-compete language to make the intent of the agreement both reasonable and clear. Never execute an agency sales agreement without your own attorney involved in reviewing the terms of the agreement. But don’t listen to the naysayers who will adamantly (and incorrectly) state that non-compete agreements don’t work for the insurance industry. If an employee or seller were to be able to legitimately compete on every piece of business in their former book of business, most agencies would be relatively worthless instead of continuing to grow in value. Look at the on-going sales of agencies! Who would pay these kinds of prices for business that has no relative assurance of continuing to provide on-going revenue stream?