Many people think restrictive covenants are used primarily to restrict Producers from stealing agency information.  There are many legitimate reasons which make good sense to have some sort of restrictive covenant in place with at least your production staff and key people.   I actually feel it is imperative for you to have some sort of written confidentiality agreements in place with all employees.   The new laws make it almost mandatory to do so.  For the purpose of this article I will limit my comments to covenants with Producers.

My Story

I worked for an agency for many years as a Producer.  One of the promises made at my hiring was ownership and when the offer of ownership actually came, it was coupled with a true Covenant Not to Compete. (I will explain some different agreements later on.)

The degree of ownership offered was insufficient to attract me, so I refused the offer.   The offer magically reappeared at a larger percentage of the stock with a veiled threat that if I did not accept it, I should seek employment elsewhere.

Upon my acceptance of the offer, I became an indentured servant as did others, to the point that many of us eventually left the agency.   My clients came to me to write their insurance and I informed them of the covenant.  When I left this employer, my new employer agreed that should we attract any of the accounts from my former employer, we were willing to purchase the accounts to avoid problems and allow customers to stay with me if they contacted me and wished to move.   My former employer would not hear of it.  

As my clients contacted me I sent them back to my former employer explaining I was under contractual agreements with them and would require their permission were the account to come to my new agency.   My former employer would tell them, ”You cannot move your insurance to Howard.  We have contractual relationships that prevent him taking business.”  This would result in a phone call to me from my former insured, informing me, as one of my favorite insureds put it, “I guess I know whose interest that joker has at heart and it is certainly not mine.”

These accounts would then proceed to move their insurance to another agency.  My former employer lost them, I could not access them, and the insured was forced out of the relationship with me.   This was a classic lose-lose-lose situation.

The above story is an actual illustration of what I consider the misuse of a restrictive covenant.  My former agency was subsequently sold to a large bank and insurance organization.

Story of Others

My situation was not in any way unique. I am far from the first and will be far from the last to dwell in the small details of contractual language after leaving what I considered to be an untenable position with my former agency.   My goal in this article is to help some Producers and Principals understand how to make these agreements function effectively and fairly.  My secondary goal is to inform all of us—Producers and Principals—of the growing need for asset protection and unimpeachable compliance in the light of new state and federal laws mandating consumer rights.
Restrictive Covenants may be executed fairly to all parties involved.  In fact, they may be drafted so fairly that Producers will sign them at the time of the sale of the agency.  I have done this on several occasions when agreements were not in place and were necessary.  I have protected the Producer’s position with the agency and created fair agreements for all parties. I write this not intending to give legal advice or to inform you what can and cannot be done.   I write this intending to give the reader an overview of how to protect your business, honor relationships, maintain high compliance standards and secure your agency value.

Contents of Covenants

Whatever agreement you are drafting…

•  Non-Piracy Agreements
•  Covenants not to compete
•  Employment agreements
•  Employee confidentiality agreements

…there are certain elements that should be included:

• They need to contain provisions relating to compliance with The Graham Leach Bliley Act (GLBA).

• They need to contain provisions to comply with the Health Insurance Portability & Accountability Act (HIPAA).

• They need to reference a well defined company policy which needs to be in place for handling confidential information.

• They should spell out the fact the AGENCY owns the files, information and data, and that they consider it proprietary information.

• They should prohibit the solicitation of other employees.

• They should reference a clear policy that employees may not discuss confidential data with customers or in public places or at public meetings, and they should address what constitute appropriate discussions with other competitors or insurers.

• They should address the issue of “sole employment” and should clearly define what is permissible, and they should create boundaries for “moonlighting”.

• They should clearly prohibit discussion of internal matters with customers or outsiders.

Confidential Data
These agreements should define “confidential data” and how it may and may not be used.   They should also clearly delineate ownership of this data and where this data is to be kept.   The agreement should set forth what electronic means and machines are authorized to contain data, transmit data and utilize data.   They should also prohibit the use of or removal or misuse of this data  during or after employment.

Employees
The agreement should also address the issue of soliciting employees of your agency after the Producer has left.   The solicitation of employees can bring people to the producer who also possess confidential knowledge and have fewer restrictions on the use of your confidential data.   The agreement must clearly state that if the employee leaves employment, it is up to management to communicate information about the employee’s departure to customers.
Other Former employees can facilitate the departure of the client relationships to a key person who has terminated employment with  your agency.

Business Assets
The agreements further should set forth a definition of “business assets” and how they can and cannot be used or retained.   Expirations are the agency’s property and must be protected.  Many VERY EXPENSIVE court battles have been waged over this issue.

Protecting these assets is fair, even in the eyes of your Producers.  You have used considerable resources and have many valuable company and customer relationships that need protection.  Realize the value of your company relationships with your carriers and protect them.   This is simply good common sense, yet I find time and again no Producer covenants at the time of agency sale.   To address these values, we wind up negotiating the entire sale and having the agency sale contingent upon getting Producer contracts signed.   This is not where you want to be.

Making a win/lose a win/win

Protect yourself at sale
As an agency owner, you need reasonable covenants in place to protect yourself at the time of sale or merger, or to protect your business investment on an ongoing basis.   As I stated above, this is imperative to maximizing agency value.    It is not only important to have them in place with Producers but with agency partners, as well.  By leaving, partners can inflict more damage than any Producer can.   As far as other personnel are concerned, you need to have confidentiality protection and other agreements related to their employment with the agency.  This is a topic I will not venture into in this article.

Secure Production Relationships
As an agency owner, you need covenants in place to protect your production relationships with your carriers.   In one recent case, a group of highly specialized Producers moved from one large organization to another.   Not only were they able to take virtually all of the customers and force their former organization into spending millions in litigation costs, but the carriers for this business also severed their ties with the organization when the producers left.

Protect the business
Overall these agreements are imperative to protect the business entity itself, and preserve present and future value.   They are also important to protect the business from the adverse effects of compliance penalties and numerous other confidentiality and privacy issues.

Types of Covenants

There are many types of restrictive covenants depending on your business:

•  Sales organizations
•  Distributors
•  Printers
•  Manufacturers

Each type of organization presents different needs for restrictive covenants to protect the business.

In the insurance agency business, I am familiar with two types of restrictive covenants in wide use. They are both misunderstood and misused.

Covenants Not to Compete
When I was an agent and gained a degree of ownership, I was expected to sign a covenant not to compete.  It basically said I would not engage in the business of insurance within 100 miles of the office location.   Covenants not to compete have a place, but not for Producers.  It is my opinion that true covenants not to compete are to be used at the sale of an agency, the retirement of a Principal, or among senior partners in an agency.    This prevents them from leaving the partnership or otherwise engaging in the business in a fashion that would be detrimental to the agency, the book of business, or the purchaser of your business.

Non-Piracy Agreements
Non-Piracy agreements protect your book of business but allow the Producer the freedom to continue to operate.    A non-piracy agreement usually has all the other provisions relating to secrecy and procedures but prohibits the solicitation of business in the book of the agency.   The Non-Piracy agreement would allow the departing Producer to accept only business that approached them.   This is a bit touchier to enforce, but seems to work well if everyone is honorable.   They are commonly used in urban areas with a number of agencies and are commonly honored between agencies.    If the business leaves, as previously outlined, the agency who hires the producer pays a portion of the commission (typically 50%)  to the old agency for a three to four year period to compensate the agency who formerly employed the Producer, for the loss.  The agreement should also restrict the use of information from the agency and prohibit solicitation of employees as well as have a binding confidentiality agreement for reasons outlined below.

Confidentiality Agreements
I need to add another factor here in the changing world of insurance.  With the new privacy regulations and other applicable state and federal regulations, I feel every agent should have confidentiality agreements executed with all employees.   Our clients have confidential data in files and it would be difficult to make a case for protecting those clients in a regulatory review without employee confidentiality agreements in place.

Optimal Philosophy of Covenants in Insurance

Having both worked under covenants and designed covenants, there are three outcomes an agency can hope to achieve with a Producer and a Non-Piracy Agreement.

• Mitigate the adverse effect of the loss of the producer on the business;

• Not unnecessarily tie the Producer’s hands behind their back; and,

• The client should never have to know the agreement exists.

Mitigate Business Loss
The agreement with the producer should mitigate the adverse effect of the loss of the Producer on the agency.   Face it, you cannot eliminate the adverse effect, but you can mitigate the effect and protect your business.  Non-Piracy agreements can accomplish this or can create a real disincentive to take business away through the use of a penalty as discussed below.

Not Tie the Producers Hands
The Producer should have the freedom to do as they want and should not be made to feel like an indentured servant.  The Non-Piracy Agreement allows them to stay in place geographically without having to pick up and move unless they desire to.  The Producer retains some freedom under the Non-Piracy agreement, but is restricted from any solicitation of their old accounts.  This can be enforced through injunctive relief written into the contract, as well.

Protect Client
The client should never have to know the agreement exists.    When my former agency would try to enforce my non-compete, they created a great deal of consternation on the part of the client.  The consternation served no one as the client simply moved somewhere else.   Clients actually wanted me to sue so they could move.  I can guarantee they will never go back to my old agency.

Balancing the needs of the parties

Now before you go running away from me on these issues, let me talk a bit about balance.   Just like risk management for large accounts, YOU, the agency principal, need to determine in advance your philosophy of how you want to execute your agency plan and your Producer retention strategy.  Penalties are one way to do this.  Legal Fees are another way of protection.

Penalties
The penalties you put in place for violation so these agreements should reflect your agency philosophy of business relative to Producers leaving.   If you operate in an urban agency where people move around and everyone honors each other’s restrictive covenants, it is common to split the commission generated by the account for a three or four year period.  That is the equivalent of letting the Producer purchase the accounts that are loyal to her or him.

If you are adamant about keeping accounts in an urban area, you may want to build in a penalty that becomes a deterrent to taking accounts.  One of my clients charges four (4) times the annual commission on the account UP FRONT for violations.   Needless to say, he does not lose many accounts to Producers who have left.

Legal Fees
If you place the burden of legal costs on the party that loses the dispute, you will eliminate the possibility of someone “testing” you to see the result.   It is a fair burden to place on the losing party and works well to discourage litigation of all but legitimate, substantive disputes.

Your Philosophy
It is inevitable that you will lose people if you have an agency of any size at all.   Too many agents wait until they lose someone, have a problem with losing business, and then try to figure out what to do about it. Often they have few options and little redress. If you plan in advance (sounds like risk management…) you can predetermine the outcome to be approximately what you wish.  If you do not plan in advance you usually wind up with too many people, too many emotions, and things go less smoothly and are more costly than one would like.

In Summary, Protecting your assets is fair

In most jurisdictions I am familiar with, you can restrict access for a maximum of five (5) years.   As a practical matter, most clients will give you one chance to renew and then move if you do not do a good job.
Protecting your book is fair.  If you balance everyone’s needs, Producer’s will accept this premise and sign a reasonable agreement.

While this is not a legal treatise, I think it fairly points out the need for Restrictive Covenants. You can construct them fairly and allow all parties to do as they are pleased to do, however, protect your business and your agency.    If they don’t need you, why are they working for you?   Protect your agency value!