BE CAREFUL WHEN DRAFTING ASSET PURCHASE AGREEMENTS: EMPLOYMENT CONTRACTS NOT AUTOMATICALLY ASSIGNABLE

If you are the purchaser of the assets of an existing business, you have to be careful to list all the assets you are actually purchasing in the asset purchase agreement. In one case, a court held that the asset purchase agreement in question did not include employment contracts of top employees. Consequently, a top employee decided to open his own company in direct competition with the purchaser even though his contract with the selling company had a noncompete clause.

The court held that since the asset purchase agreement did not list employment contracts as assets, there was no legal transfer (or assignment) of the contract. The court also addressed the issue of whether the transfer of the employment contract with a noncompete clause without an employee’s consent would be valid against public policy.

In the case, Hedgeye Risk Management, LLC v. Paul Heldeman, et al, (District Court, District of Columbia, 2016), the issue in part was whether the defendent/employee breached a noncompete covenant in a contract he had after the selling employer sold assets to plaintiff/new company. The court held that there was no breach of contract because the asset purchase agreement did not list employment contracts as assets for transfer. Therefore, the plaintiff/acquiring company had no claim for breach of contract.

Plaintiff attempted to claim that the intent of the asset purchase agreement was to include all employment contracts. However, the court held that the terms of the contract itself determine the rights and liabilities unless the language is ambiguous. In this case, the court held that the language of the asset purchase agreement was not ambiguous, did not include employment contracts and was not subject to interpretation of a party’s intent. Moreover, it questioned whether this was the intent in this particular case.

The court stated that an assignment of an employment contract would not be automatic when a company purchases another company’s assets. Moreover, the court stated that contracts with noncompete clauses are suspect in that an employee may have a right to negate the transfer of the employment contract when there are such covenants because of public policy reasons. The court referred to other cases where it was held that a non-compete clause is personal in nature and is not assignable without an employee’s consent. An employer’s successor in interest does not inherent the contract.

In other words, courts have held that an employee may have a right not to approve the assignment of the employment contract to a successor in interest when there is a noncompete clause. The court held there is good reason for the rule in that covenants not to compete should be construed narrowly because they are a constraint on an employee’s right to earn a livelihood. The employee may not be wiling to suffer restraint on his or her employment for the benefit of the new employer.

The court distinguished an asset purchase agreement from a merger. It stated that, among other points, because the original company did not merge into the purchasing company, the purchaser company did not become a party to the employment contract.

What to take from this
When reviewing or drafting asset purchase agreement be sure to include all assets, list them, including employment contracts if the purchaser want to keep them. Moreover, due diligence is necessary on all the employment contract. Whether a contract with a non-compete clause is transferrable could be a public policy issue, negating the transfer, without an employee’s consent.  Feel free to contact me for further discussion at dbosco@boscolegal.com

ATTEMPTING TO BYPASS AN SEC ADMINISTRATIVE PROCEEDING IS AN APPARENT NO GO (HOW THE PROCEEDING DIFFERS FROM FEDERAL DISTRICT COURT)

Congress authorized the Securities and Exchange Commission (“SEC” or “Commission”) to bring civil actions to enforce violations of the Securities Exchange Act of 1934 (the “Exchange Act”), and the regulations promulgated thereunder. The Commission is empowered to bring such actions in either federal district court or in an administrative proceeding before the Commission. An SEC administrative enforcement action culminates in a final order of the Commission, which in turn is reviewable exclusively by the appropriate federal court of appeals.
In one recent court case, a respondent in a SEC proceeding attempted to bring a “sister action,” in federal court at the same time. The respondent was actually attempting to challenge the constitutionality of the administrative proceeding. (Hill v. SEC, et al, Eleventh Circuit, 2016). The issue was whether the respondent in an SEC administrative enforcement action could bypass the Securities Exchange Act of 1934 by filing a collateral lawsuit in federal district court challenging the administrative proceeding on constitutional grounds.
The appeals court held that the district court lacked jurisdiction over the respondents’ collateral attacks. The court found that it was fairly discernible from the review scheme provided in the statute that Congress intend the respondent’s claims to be resolved first in the administrative forum, not the district court, and the if necessary, on appeal to the appropriate federal court of appeals. The court reasoned that the Commission could rule that the appellant/respondent did not violate securities laws, in which case the constitutional question would become moot.
The court discerned that the general intent of Congress was to channel all objections to a final Commission order, inducing challenges to the constitutionality of the SEC’s administrative law judge or the administrative proceeding itself, into the administrative forum and to preclude parallel federal district court litigation. The court found that the respondents’ constitutional challenges were not outside the type of claims that Congress intended to be reviewed within the statutory scheme.
Interestedly, the court never addressed the challenge of whether an SEC administrative proceeding is constitutional, by only that any objections to the proceeding itself, including constitutional objections, are to be brought within the proceeding. Whether the SEC proceedings are constitutional appears to be a decision for another day.
SEC proceedings do differ from proceedings in Federal Court, mostly involving discovery issues as more fully described below.
How SEC Administrative Proceeding differ from proceedings in federal court

SEC administrative actions differ from cases brought in federal district court in several respects. The administrative action begins when the Commission serves the respondent with an Order Instituting Proceedings (“OIP”). The Commission then presides over the action, but it typically delegates review to an Administrative Law Judge (“ALJ”). Unlike an action brought in federal court, in a proceeding before the Commission the Federal Rules of Civil Procedure and Evidence do not apply, and the respondent does not enjoy the right to a jury trial. Instead, the SEC’s Rules of Practice govern administrative proceedings. Among other differences, the Rules of Practice provide for more limited discovery. For example, the Rules of Practice allow the taking of depositions at the Commission’s discretion, only upon a finding that the prospective witnesses will be unavailable to testify at the hearing. The Rules of Practice also do not provide for routine document production, instead requiring parties to request that the ALJ issue subpoenas. Administrative actions proceed relatively quickly along fixed timelines set by the rules.
When the Commission delegates review to an ALJ, the ALJ holds an evidentiary hearing and then renders an initial decision with factual findings and conclusions of law. Either party may appeal the initial decision to the Commission. The Commission’s review authority is broad. It may affirm, reverse, modify, set aside or remand for further proceedings, in whole or in part, an initial decision by a hearing officer and may make any findings or conclusions that in its judgment are proper and on the basis of the record. Conversely, if there is no appeal to the Commission, and the Commission declines to exercise its right to review on its own, the ALJ’s initial decision becomes the final decision of the Commission for all purposes.
Regardless of whether the initial decision is appealed, the administrative process culminates in a final order of the Commission. The process of obtaining judicial review begins with the filing of a petition in the court of appeals that triggers the court’s jurisdiction. Upon the filing of the record in the court of appeals, the court’s jurisdiction becomes exclusive. Although other provisions of the Exchange Act provide limited district court jurisdiction over some types of securities related claims, the Act contains no express authorization for district court review of a final Commission order.
Feel free to connect with me on LinkedIn if not already connected; or contact me for additional discussion at dbosco@boscolegal.com. Open to networking, referrals and new opportunities.

PERILS OF BEING AN ESCROW AGENT: WHERE DISPUTES ARISE

In many ventures, from real estate to filmmaking finance, there may be the need for the services of an escrow agent (e.g., a bank, an attorney, title insurance company, or an escrow company) who acts as the holder of funds for eventual payment from one party to another party. In some cases, disputes arise among the parties and escrow agent. This article reviews some of the situations when disputes occurs.

The risk of being caught up in a dispute can cause some potential escrow agents to decline the offer to act as an escrow agent because of the risk of being involved in a dispute or accused of wrongdoing. Other entities make a business of being an escrow agent, earning fees and living with the risks involved.

Sometimes the escrow agent is caught in the middle of a dispute between the contracting parties, who join the escrow agent in litigation or accuse the escrow agent of wrongdoing even if there is no wrongdoing on the part of the escrow agent.

An escrow agent has a fiduciary duty to transfer property (usually cash) from one party to another. Part of this duty is to examine documents to make sure that the seller and buyer ( or the investor and startup, or investor and filmmaker, etc.) follow the terms of the sale or investment, and to serve both the buyer and seller in the transaction.

The scope of the fiduciary duty is defined by the scope of its contractual duties under an escrow agreement. If the escrow agent acts in accordance with its obligations under the escrow agreement, it has not breached its fiduciary duty.

Disputes may occur when parties to an escrow agreement attempt to impose upon the escrow agent an obligation in addition to its limited duties under the express terms of its contract. Also, dispute occurs when a contractual provision is incomplete, unclear or ambiguous. If it is complete, clear and unambiguous, courts must enforce it according to the plain meaning of its terms.

Sometimes an escrow agreement may require the agent to ratify a condition precedent, i.e., to make sure the one party or another did what they said they were going to do before releasing the monies. Disputes occur because one party may accuse the agent of not making sure that pre-conditions are met before releasing money or refusing to release monies when met. Additionally, disputes occur when there is the issue of whether the escrow agent has a duty to validate the actions of parties (i.e., make sure the parties really did what they said they did). All this must be set forth in the agreement.

Another potential roadblock is when the escrow agreement requires the approval of one of the parties to release funds but never receive the approval even after all conditions are met. Or possibly the parties will not provide a release of liability to the escrow agent. If the party does not give approval or the escrow agent doe not get releases, then the funds could be in “limbo.” The escrow agent may be caught in the middle, or may even have to file a lawsuit to resolve the issue.

Parties sometimes act in extremes to get their way, and the escrow agent in caught in the middle of it all. Looking at the big picture, one can only hope that in business dealings (including those involving escrow agreements) the actions of the parties involved are not so extreme as to exceed the bounds of a civilized community, which some deal makers seem to forget.