Privacy and Employer-Owned Materials

August 3rd, 2009

I have probably generated 500 standard-form employee confidentiality/inventions agreements, and a good number of employee manuals, all of which say that basically anything an employee does on work time with employer-owned equipment (computers) belongs to the employer.

It is very useful to see the limits of these policies. A recent case from the New Jersey Appellate Division has some useful guidelines.  Here is my summary of the helpful considerations in under 500 words.

Case Facts
The CEO of a company got into a dispute with her employer.  The employer took back its computer when the CEO quit and found on it cached copies of emails the CEO had sent to her attorney from her personal Yahoo account.

The employer said that the emails belonged to it since *everything* on the computer belonged to it pursuant to the employer’s policies.  The CEO said that purely personal matters fell outside the scope of the policy.

Court Ruling
The appeals court said that it is not enough for a company to say it owns everything done on its computers- there has to be a need to reach out and take ownership of entirely personal matters.  Based on that, the court held that the emails were not the property of the employer and the employer had no right to hold and use them.

Useful Concepts
None of this is strictly relevant outside of New Jersey, of course, but the case brings up a few interesting ideas:

1) Personal vs. work email.  The CEO did not use her work email account to communicate with her lawyer.  This was an important point in establishing the CEO’s expectation that her emails would remain private.

2)  The court likens the employer’s actions to rifling “a folder containing an employee’s private papers” or examining “the contents of an employee’s pockets”.  To me, this is the most important point.  An employer can certainly *review* an employee’s file folders, but if it finds purely personal items it is obligated to return those to the employee.  Computers are no different- people may store personal information on them.  Employers need to be aware that they are not entitled to review or use these simply because the employer owns the computer.

Tags: ,
  • Comments Off on Privacy and Employer-Owned Materials

Managing Cash and Payroll Risk in Troubled Times

February 5th, 2009

Payroll is the biggest expense for most businesses, especially young companies.  When times get lean management looks for ways to stretch cash out as far as possible.  The dilemma is that most companies would like to reduce their payroll expenses without reducing headcount, since with fewer people to do the work it may take even longer to get through a tight spot and get business flowing again.  Here are some of the biggest traps to avoid.

Note- employment law is completely different from state to state in the US, so this post is even more California-centric than most I write.  The *right* answer for a given situation is also entirely fact-specific, so don’t rely on this as advice for your company.  Use this information to be forearmed, then go talk to your lawyer about strategies that will work for you.

1) Salary reduction.  Everyone takes a haircut in their salaries.  The question is how far salaries can be reduced.  In many cases, it can go all the way down to minimum wage.  The gotcha here is that there is a “special” minimum wage for computer professionals.  I wish I knew how this law came to be, but the gist of it is that administrative employees can go down to minimum wage ($8.00 in California; $9.79 in San Francisco) but computer professionals need to be paid at least $79,050 per year (~$36/hour).  Figuring out who is a computer professional goes beyond the scope of this blog and is a job for your friendly neighborhood employment lawyer.

2)  Stock in Lieu of Cash.  This is a popular one and a major gotcha.  Don’t do it.  The IRS sees stock and cash as equal compensation, so if Startup, Inc. pays Employee $50,000 worth of stock instead of $50,000 cash, Employee will still have $50,000 worth of income to report- and no cash to pay the taxes on it.  Ouch.

California doesn’t like this strategy either.  Under California law Employee will continue to have a claim for payment of the $50,000 until it is paid in cash.  The claim can not be legally waived by payment of any other type of compensation, esp. company stock.

The even worse news is that employee wage claims are one area where directors and officers of a company can be held personally liable.  There are cases where courts have declined to hold officers liable, but don’t count on it.  The rule of thumb here is to act as if any wage-related actions are backed by the directors’ and officers’ personal bank accounts.

3)  “Deferred” Salary.  It is much easier to tell employees that you need to reduce their salaries temporarily and will catch them up once ___ event happens (e.g. a funding event, major customer deal, etc.) than to cut salaries permanently.  Don’t do this either.  In legal terms “deferred” means they are entitled to the full salary amount and can file claims for payment if it never comes through.  If you need to reduce salaries do it permanently and tell people that *if* certain positive events happen the company will do its best to offer bonuses that recognize the sacrifices employees have made. No side-of-the-mouth promises to catch up, either.  The bonus has to be truly discretionary to avoid the deferred/unpaid trap.

4)  Switching to Independent Contractor Status.  This is another common practice that can work in some cases, but gets overused.  A company can reduce payroll expense dramatically by laying people off and then re-hiring them as independent contractors.  The problem is that the IRS and California authorities have the final say as to who is a W-2 employee and who is a genuine contractor.  An audit by either entity can result in huge penalties for companies that mis-classify personnel.  There is so much gray area here as well that you can be certain either entity will find violations once they start looking.  Again, talk to an employment lawyer for more information on how to properly classify people.

Tough times require creative measures.  If my experiences during the last downturn are any guide a lot of companies will take on uncomfortable amounts of risk in the employment area so they can keep stay afloat.  I hope this helps to point out some spots where the risk outweighs the benefits.

And once again, this is not legal advice for your company. These are complex issues and you need to talk to a lawyer in order to figure out the best way to navigate your company’s own particular minefield.  Be careful out there!

Tags: ,

How to Prevent iPod Technology Falling into the Wrong Hands

November 6th, 2008

VentureBeat posted an article yesterday about the very lucrative “advisory” contract Apple is giving Tony Fadell following his departure as head of Apple’s iPod division.  Here is a quick analysis of the legal landscape that may have led to this deal.

Noncompete Agreements Allowed in Many States, but Not California
In most US states companies are permitted to sign employment agreements that prevent a person from working for a competitor for up to a couple of years after the person ends his employment.  California has a different take.  It says that employees are always (with a couple of limited exceptions) free to work anywhere, but the the company can prevent the employee from using company-confidential information in the service of the new company.

California trained and practicing lawyer that I am, I had never focused much on this distinction until I started reading Bijan Sabet’s blog.  Bijan is a Massachusetts VC with a minor quest to get MA and other states to follow California’s rule.

For the record, I think that California has it right (big surprise, I am sure).  The Fadell situation makes an interesting case study.

Apple Pays Fadell to Protect its Competitive Advantage
If Fadell worked in Massachusetts, New York or most other US states, Apple could simply tell him he could not go to work for a competitor.  Fadell’s expertise is in developing portable audio/video players, so this might make him choose between not working at all for a period of time and trying to break into an entirely new area.  Since Fadell is in California, Apple can’t do that.  Instead, Apple had to figure out how much it was worth to keep Fadell on the sidelines.  VB reports that value is $300,000 per year through March, 2010 plus stock worth $7.6M at today’s prices.

The point here is that the burden fell on Apple as the employer to protect its competitive advantage without cutting off Fadell’s ability to make a living.  Fadell could probably have survived even without the extra compensation, but others might not be so fortunate and this is why I believe California has the rule right.  If a person is that valuable, the employer should pay to keep him/her on the bench.

Contrast With Fadell’s Replacement – Mark Papermaster
What makes this case even more interesting is that Fadell’s replacement, Mark Papermaster, is coming to Apple from IBM.  Papermaster apparently agreed to a noncompete restriction in his IBM employment agreement and IBM has now sued him and Apple to enforce the noncompete terms.  I am not certain whether Papermaster lived and worked in New York or whether his employment agreement was specifically governed by New York law.  If it was, he and Apple could have a hard time overcoming the noncompete restriction.

Tags: ,

Why Do Stock Options Expire 90 Days after Termination of My Employees’ Service?

March 7th, 2008

I get this question a lot from clients. It used to be a very simple situation- companies hired employees and granted them stock options as incentive for expected work. If the employees quit, it stood to reason that they were no longer providing valuable services.

Therefore, essential stock option terms included (i) vesting of the option based on time spent as an employee, and (ii) outright cancellation of the option 90   This post is about part (ii) of that formulation.

IRS rules codify both of these rules. Incentive stock options (the tax-advantaged kind) are only available to W-2 employees and can not be exercised more than 90 days after termination. The other kind, non-statutory options, are not subject to that restriction, but many or most stock option plans say that *all* options expire 90 days after termination of service regardless.

Most companies I work with hire a core group of personnel, but outsource substantial amounts of work (and value creation) to non-employee contractors. The model above has substantial flaws in that case, because it is hard to tell when a contractor “terminates” service.

So are the stock option plan terms wrong? ISOs are locked up by IRS statute, but should NSOs be more flexible to allow termination for more than 90 days after termination?

My answer is generally no, but occasionally yes. Stock options take a lot of attention to administer. They can easily end up “leaking” equity out to people who no longer provide value to a company. For this reason, I encourage my clients to adopt a policy of expiring options after termination. The 90 day period makes it easier to manage ISOs and NSOs without excessive brainpower.

At the same time, there are occasions when a company may wish to allow contributors to exercise options after termination. A private company with a number of long-term contributors (employee or contractor) and a relatively high stock price might choose to let these people retain their options after termination as a way of saying “Thanks for your efforts. We’d prefer that you exercise and get the stock itself, but the exercise price makes that prohibitive, so we’ll let you hold the options until we have a liquidity event”. These situations are few and far between.

The remaining question is how to handle contractors who may make valuable contributions, but work irregularly for the business. An investment banker in this situation might get warrants, which are identical to stock options except that they expire at a prescribed date rather than based on service.

My advice in this situation is to keep warrants for the bankers (the finance types are happier seeing that) and use stock options for contributors to the business itself. This is where an NSO that is exercisable regardless of the holder’s term of service to the business can make sense.  Cases like this in which people provide *really* valuable services that merit long-term options are few and far between, but they do come up.

Tags: ,
  • Comments Off on Why Do Stock Options Expire 90 Days after Termination of My Employees’ Service?