The value of a service business may be its employees. A major risk in an acquisition may be a mass exodus of key seller employees after the closing.
Here, the seller was an investment research firm. The buyer, which provides financial and economic research and analysis to institutional investors and newsletter products to mass market customers purchased the assets of the seller.
Key to the seller was the firm’s health policy research team. That team allegedly generated over 70% of the seller’s annual revenue.
A key seller employee managed that group. He worked for the buyer for approximately five weeks following the sale, during which time the parties engaged in negotiations regarding the terms of the employee’s continued employment. At the time, the employee managed a 2 member team that oversaw the firm’s health policy research.
The buyer and key employee could not come to terms on an employment agreement and the key employee left. The other two employees in the health policy team left the buyer on the same day. The key employee and one of his co-workers formed a competing firm the next day and the other former co-worker was hired by this new competing firm.
The buyer sued the employee in a federal D.C. district court Buyer claiming that their former key employee breached his fiduciary obligations to the firm by, prior to his departure, recruiting his two co-workers to join him in founding and operating the new business, thereby causing a “mass resignation” of the buyer’s health policy research team
The key employee filed a motion for summary judgment asking the court to dismiss the buyer’s claim against him, arguing that he did nothing wrong by hiring his two co-workers for his competing firm. The court refused to dismiss the claim saying that the jury has a right to determine whether the key employee’s actions amount to unlawfully inducing his co-workers to leave the buyer for the key employee’s competing firm.
The court noted that the key employee owed the buyer an undivided and unselfish loyalty during the term of his employment. However, the court said that the limits of proper conduct in hiring away co-workers for your competing business is not well marked.
On one hand, “it is normally permissible for employees of a firm, or for some of its partners, to agree among themselves, while still employed, that they will engage in competition with the firm at the end of the period specified in their employment contracts.” But, on the other hand, “a court may find that it is a breach of duty for a number of the key officers or employees to agree to leave their employment simultaneously and without giving the employer an opportunity to hire and train replacements.”
Under the so-called “pied piper” rule, the key managerial employee may breach his fiduciary duty owed to the buyer if, during his employment with the buyer, he solicits the departure of his health policy research teammates. “The rule is most clearly applicable if the supervisor-manager, as a corporate pied piper, leads all his buyer’s health policy research employees away, thus destroying the buyer’s entire business.”
Whether or not he merely presented his colleagues with an opportunity for employment elsewhere or crossed the line into `solicitation’ in violation of a fiduciary duty, is a fact question that is generally for the jury to decide.” Here, the court concluded that the buyer “offered enough— although just barely enough—circumstantial evidence to create a genuine issue of material fact” as to whether the key employee acted as a “pied piper” that led his health policy team to resign en masse.
The court noted circumstantial evidence in the record that supported the buyer’s pied piper claim. First, he and one of the other co-workers had numerous “closed-door” meetings in the days before they left the buyer, and the evidence shows that they had conversations away from the office about the possibility of starting their own business.
Second, the members of the team all resigned within an hour of each other. The key employee left the building but remained in the parking lot. The other employees quit and left the building together in the same elevator. Third, all three left the parking lot together and went immediately to one of the co-worker’s apartment, where they began the process of establishing the competing firm which was established the next day and usurped the buyer’s entire health policy research practice.
This case is referred to as Hedgeye Risk Management, LLC v. Heldman, Civil Action No. 16-935 (RDM), United States District Court, District of Columbia (September 29, 2019) https://scholar.google.com/scholar_case?case=7765851825007819022&q=%22asset+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017
A money carrot might be a more effective legal tool to manage this risk. Don’t know if it was considered or tried in this case. But it could include an attractive compensation package for the key employee that would be conditioned upon the employee’s successful performance over significant post-closing term of employment.
By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million
Telephone: 714 273-6291
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