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Terminating Management Personnel in Subsidiary and Other Business Investments, Contributed by Douglas A. Albritton, Reed Smith LLP

Monday, October 3, 2011

Introduction

Like a traditional employer-employee relationship, owners and investors of all varieties occasionally find themselves frustrated with key legacy management personnel who remain after an investment or acquisition. Far from being unknown quantities, these individuals probably were the subject of pre-investment due diligence, ranging from background investigations to interviews (of both the official and lower-level employees) to management assessment tests. More often than not, new employment agreements may have been negotiated with such personnel establishing, among other terms, specific job responsibilities, compensation, grounds for termination and new stock rights. Unfortunately, these processes do not always turn up all matters of concern. Prior conduct and even current practices may have gone undiscovered or purposefully concealed. In many instances, the official's post-investment outlook simply may have changed because he or she no longer is the controlling voice at the company and must account to new owners, and/or due to new-found liquid wealth resulting from the sale of personal ownership interests to the new owners or investors. Disputes may arise from simple disagreements about corporate strategy, or from more serious concerns relating to fulfillment of job responsibilities, the use (or misuse) of corporate property, and compliance with state and federal laws of general applicability. Left unaddressed, these problems can foment sarcasm and indifference among the general employee group, and, even worse, may generate liability risks for the company. When these matters arise, the new owners must decide whether the issue is minor enough to be capable of resolution through consultation, or whether the dispute is so severe (or repeated after consultation) that the circumstances require termination (even if the conduct is not "illegal" but nevertheless causes a loss of confidence in the official's ability to manage).Unlike terminations in traditional contexts, actions in this setting warrant the pre-termination consideration of a number of unique factors, and generally warrant pre-termination consultation with counsel to explore the multi-faceted legal issues that may be involved. In addition to the various legal issues that matters such as these raise, and depending on the size and nature of the business, contemporary business realities, including the speed at which information is distributed across the internet and through social media, may require parallel development of the company's message and a readiness to communicate that message as the need may arise through one or more channels. No short article such as this can set out all of the law that will be applicable in these settings. And, the law will vary state-by-state (especially on matters relating to "cause" terminations and stock rights). Instead, this article provides a short checklist of matters to consider when evaluating whether to terminate such a legacy official, and some of the issues that may arise thereafter. Pre-termination consideration of these and related issues will go a long way towards insuring the least-disruptive transition possible.

1. Get One or More Confidants on the Inside

When considering the termination of a high-ranking official, there are myriad matters that will require the assistance of someone else at the company to complete. This includes access to the computer and telecommunications systems, as well as physical access to the facilities and offices (including keys to open the building, the offices and any file cabinets). A good contact also will interface with outside counsel and any retained consultants or experts to help address other issues that may arise, including day-to-day operational needs.

2. Read the Employment Agreement, Understand any Applicable Employment Law

The new employment agreement may contain choice of law and forum selection clauses identifying applicable law and the venue (including potentially arbitration) for any dispute. It is important to further note that other agreements, including the investment agreement, the new stock plan and other corporate documents, may contain provisions relating to other aspects of the relationship (including stock rights), and may, inconsistently, provide for the applicability of other law or a different dispute resolution venue. Consider which agreement or agreements apply, and contemplate the response to any choice of law and venue challenges. Be ready to make those arguments from the moment that the official is first approached about termination. The new employment agreement may contain established grounds for removal, and may then link those grounds to resulting financial and stock contingencies depending on whether the termination is with or without "cause." Handled incorrectly, the employer's actions could give the employee good reason to resign with different financial and stock contingencies. It is common, for example, that salary, stock (put and call rights) and stock option rights will continue for a period of time after a no-cause termination but may immediately cease in a for-cause termination. Also consider whether the official has statutory or common-law minority shareholder rights, and what obligations may arise therefrom. The employment agreement's definition of a "for cause" termination (frequently requiring at least negligence or gross negligence) should be investigated in light of the applicable law for precedent interpreting those terms. In the absence of state law defining those terms in reported private employment disputes, most states have statutory "for cause" provisions for the removal of public officials and both those statutes and related case law may provide helpful precedent in the absence of other law. If the termination is "for cause," confirm that the standard is met by investigating and documenting the reasons therefore (including the identification of relevant witnesses and documents). Also explore whether the applicable agreement is clear that termination is effective upon announcement, or whether it is subject to either a "cure" period or an obligation that a court or other decision maker first "declare" that cause exists. If there is a cure right, investigate whether there are any cause categories not subject to a cure right. If there is an obligation to seek a judicial or other "declaration," consider placing the official on paid leave pending the completion of any such process. Finally, be sure to have considered any unique state or local law (as well as federal law) and satisfy yourself that the termination does not give rise to a claim for discrimination whether based upon a protected class or some other statutory protection (such as whistleblower protections).

3. Review Other Corporate Agreements

A terminated official may look for ways to retaliate against the company, such as by terminating (or breaching) other contracts with the company. If the official is a signatory for any bank accounts, consider removing that authority (if permitted) before any action. Likewise, consider whether the official is the company's landlord. If so, review the lease and explore each party's termination rights. Be prepared to go to court to stop any eviction efforts. The official may also have had other businesses that were not acquired. Do any of those provide essential goods or services to the company and, if so, what are the parties' termination rights under those agreements? If necessary, identify potential alternatives prior to the termination. Also, it is not uncommon for the utilities of many small businesses to have been in the personal name of the prior owner – make sure that the utilities are in the company's name and cannot be shut off by the former owner.

4. Secure the Office and Records, Hire Short-Term Security

An upset official (and his or her friends and/or family) may seek retaliation by causing a scene, or, even worse, by threatening other employees or damaging company property. To avoid these concerns, take steps before confronting the official to secure the office space. Change both the outside locks and those securing the official's former office. While other employees may have a need for the building key, limit access to the new lock on the official's office so that you can control access to that space (limiting arguments that anything was stolen, for example). Reset the password for the official's voice mail and computer access, and consider doing the same for all employees as the official may have logged on using other access codes before the termination. Consider whether there are any other entry points to the facilities or its systems, and take steps to protect against unauthorized access. Consider whether any remaining employees might become sources to pass information to the official, and take steps as necessary to protect against such circumstances. Modern litigation realities likewise will compel the collection and preservation of electronic and paper records potentially relevant to the dispute. Identify the personnel relevant to the matter, and collect and preserve the relevant information. Depending on the circumstances, it may be prudent to hire short-term, twenty-four hour security (such as off-duty police officers) for a period of time after the termination to protect against any unauthorized visits.

5. Get the Corporate Formalities in Order

It is likely that an acquired business is now part of a series of related operating and non-operating companies. As a result, the official probably is an executive of one or more of those companies, and similarly may serve on one or more boards of directors. The relevant corporate documents likely establish how removal from those positions is to be accomplished, and the relevant corporate resolutions and actions should be drafted and executed beforehand for quick implementation. If the termination is "for cause," for example, applicable law may require a resolution that such cause exists (and may even require a short description of the cause). On occasion, these documents may permit removal only through an official board meeting, and if the official serves on the board he or she may be entitled to both advance notice of the meeting, as well as an agenda of what is to be considered. In this circumstance, it may be proper to place the official on leave before the meeting, to avoid the circumstance of continued company access with a few days notice of a pending termination.

6. Prepare an Explanation for the Office

The termination of a senior executive may create cause for concern among the employees, and almost assuredly will lead to gossip about what happened. The employees need to be assured that the change will not harm the company, and similarly informed about who is replacing the executive (if anyone). Someone other than counsel should deliver this message (ideally another senior official or director, and not outside counsel), and that message should be delivered personally either in a group meeting or through smaller meetings. This should be done the day of the termination, hopefully within a few hours thereof. For example, if more than five employees are being let go (such as because the official had family members on the payroll who were performing non-essential functions), it may be most prudent to have security at the front door at the start of the work day, letting in the remaining employees and turning away those who were let go. The remaining employees could be directed to an office for an explanation of the circumstances, and those who were turned away could be provided with an envelope explaining that they were being let go and would be contacted shortly to discuss the matter. The explanation for the office does not need to be, and should not be, a nuts and bolts explanation of the dispute with the former executive. Rather, what should be communicated is the basis of what happened – the company has made a business decision to make a change, and this change will neither harm the company nor threaten the jobs of any of the remaining employees. Assure the employees that business will continue as usual, and let them know that if they have any questions they can privately meet with the designated person to discuss their concerns (avoid a group question and answer session). In this regard, the communicator should have a brief conversation with counsel about the content of the message – it is not difficult to make a positive statement and avoid defamation concerns.

7. Prepare an Explanation for Customers; Identify Personnel to Work with Those Customers

In all likelihood, the official will have relationships with some or all of the company's important customers. Even with a non-disparagement or non-solicit clause in the applicable agreements, the official may nevertheless contact those customers after the termination. Work with counsel to identify any such customers ahead of time, understand their recent dealings with the company, and be prepared as necessary to have personnel make personal visits or calls to address any concerns.

8. Confront the Official Outside the Office with Prepared Talking Points and a Separation Proposal

Prior to confronting the official, consider why the problem has arisen and develop the meeting talking points and any separation proposal in light of those considerations. If the official simply has become inattentive to business matters (perhaps because of new found wealth), consider a message tailored to that circumstance (which may rightfully express understanding for the change in work ethic and could be presented in such a manner). The message to an official who has taken actions that have harmed the business may simply detail knowledge of those actions, note that the matter is not then subject to debate, and lay out future steps that the company will pursue in the absence of a separation agreement. For location, generally speaking nothing good can come from terminating an official at the office. Regardless of whether this is a person who is likely to accept the decision and leave the dispute for an amicable resolution, or someone who may seek to provoke a loud or physical altercation, there simply is too much opportunity for disruption of the business and the creation of a scene for the other employees to witness (and then gossip about). The official, for example, is likely to insist on going to his or her office to collect personal matters and will then have access to the phones, business records and computer system. He or she may want to confront other employees to tell his or her "side of the story." Instead, if at all possible, approach the official outside of the office (such as at a hotel conference center in connection with a board meeting, while on a business trip, or some other location). Thereafter, consider collecting the official's personal matters and returning them outside of the office. If an office visit is required, consider scheduling that well after normal business hours and subject to supervision. If the situation presents potential claims against the official, consider the need to review files in the official's office before the official is permitted to remove property to take home. Generally, formal office space belongs to the employer and an employee's right to remove property without corporate review will be completely or significantly circumscribed by applicable law. Understand that law ahead of time, and if necessary negotiate a joint review among the company and the departing official.

9. Be Prepared for Court

Review of the agreements discussed herein, and the geographic location of the business and the official, will in all likelihood exhaust the potential fora for any dispute. Identify counsel in those jurisdictions able to handle any matters. Depending on the nature of the basis for the termination, prudence and preparedness may dictate that the business either stand ready with a prepared complaint, or actually commence litigation contemporaneous with the termination. Regardless of the choice made, the decision makers for the process should have a clear idea of what they want from the official in connection with the transition, as well as what accommodations they are willing to make in order to document a fair and prompt resolution if one can be reached.

10. Insurance

One of the most undervalued corporate assets is insurance. In an instance where the official is being terminated for cause, consider whether the official's actions triggered any coverage in the company's favor. Likewise, if the official responds to the removal with litigation of his or her own, consider whether the company's coverages provide for the defense or indemnity of any claims that are made. In either instance, be prepared to provide notice to the carrier(s) and to then work with them in completion of the matter.

Conclusion

The above list is a short summary of some of the matters that a company may wish to consider in connection with the termination of a legacy official. Once that official has lost management's confidence, whether due to inattention or, worse, malfeasance, there may be little or no business justification for delay. Experience teaches that careful consideration of the process, and pre-termination coordination of the various steps involved, will lead to a smoother transition that is less disruptive to the business and, more often than not, avoids litigation. 

Doug Albritton is a partner in Reed Smith LLP's Chicago office and has been practicing law for sixteen years. His practice focus is in the area of restrictive covenant litigation, as well as in representing investors, officers and directors in business, real estate and securities disputes. Doug provides his clients with sensible, well-rounded legal advice, based upon a deep understanding of their specific business issues and needs, and the efficient, but aggressive, pursuit of his clients' interests through settlement or verdict. Mr. Albritton currently chairs the American Bar Association's Business Litigation Committee within the broader Tort Trial & Insurance Practice Section. Doug can be reached via dalbritton@reedsmith.com.

Disclaimer 
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