The concept of cross-guarantee liability was added to the Federal Deposit Insurance Act by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA). The pertinent provision states that any insured depository institution shall be liable for any loss incurred by the FDIC in connection with:

• the default (failure) of a “commonly controlled” insured depository institution; or
• open bank assistance provided to a “commonly controlled” institution that is in danger of failure.

This means that if two banks are “commonly controlled” and one of them fails, the other bank can be held liable to the FDIC for the amount of its losses or estimated losses in connection with the failure. As many of us see each Friday, the amounts of these estimated losses are often quite high. In fact, the FDIC’s estimated losses for 2011 bank failures were approximately 20 percent of total failed bank assets for the year. Accordingly, the prospect of cross-guarantee liability can be a tremendous financial issue for the surviving bank.

The concept of cross-guarantee liability was developed in response to some perceived abuses by multi-bank holding companies during the 1980s. In those instances, one or more institutions owned by a multi-bank holding company failed, causing significant losses to the FDIC, while the other subsidiaries of the multi-bank holding remained open and viable, allowing the holding company to continue to profit from their operations while the FDIC was stuck with the losses from the failed institutions. With authority to assess cross-guarantee liability now in hand, however, the FDIC has shown a willingness to assert cross-guarantee liability under facts that would not be considered by most to be abusive. In this cycle, the FDIC appears to be willing to take full advantage of the assessment authority granted to it by FIRREA, using cross- guarantee liability as a “sword” to provide a recovery to the Deposit Insurance Fund.

The imposition of cross-guarantee liability starts with an assessment of control. Whether institutions are “commonly controlled” for purposes of determining cross- guarantee liability depends upon whether each institution is under the control of a common entity under the Bank Holding Company Act of 1956, as amended (BHC Act). Because the determination of control is made under the BHC Act, the Federal Reserve’s BHC Act control guidance is helpful. However, this guidance is very dense and can be quite complicated, requiring a review of the ownership structure, management practices, and other business affiliations of the two institutions. However, one thing is clear: In questions of control, institutions that share “management officials”—common directors and/or executive officers—are generally more likely to be found to be under common control than those that do not, all other factors being similar.

As a result, institutions with directors who serve on other bank boards or as officers of other banks should assess potential cross-guarantee risk through the director nomination process. Nominating committees (or other committees of the board reviewing director qualifications) should ask the following questions:

• Does the individual serve on as a director or officer of another financial institution?
• Is there a basis for determining that the two institutions are under common control? Answering this question will likely require consultation with legal counsel.
• Is the other financial institution in a financial condition that is less than sound?

If the answer to all of these questions is “yes,” the nominating committee should think carefully about whether nominating that individual is a good idea. In addition, institutions guaranteeing board seats to investors (such as in connection with a private equity investment) should consider an exception to the nomination requirement when the election of the representative could create a risk of assessment of cross-guarantee liability.

A risk assessment requires an in-depth factual, legal and financial analysis. There are few organizations that will find out this issue places them at risk, but it’s worth attention because the consequences can be severe. As a result, an assessment of this risk should be an integral part of the annual nomination process.

This article was original published on BankDirector.com.

Related posts:

1. FDIC Brings Suit Against Former Directors and Officers of Freedom Bank of Georgia
2. Bank Eligibility to Bid for Loss Sharing Arrangements
3. FDIC Brings Suit Against Former Officers of Failed California Bank

The text of the final JOBS Act is available here.  We have previously summarized the provisions of the JOBS Act generally applicable to the community banks, as well as the impact of the Senate amendment to the JOBS Act.  In this post we focus on the timing implications for effectiveness of the amendments to Regulation D and shareholder thresholds for SEC registration and deregistration.

With regard to Regulation D, Section 201 of the JOBS Act requires the SEC to eliminate the prohibitions on general solicitation and general advertising in connection with Rule 506 and Rule 144A offerings, so long as the securities are only sold to accredited investors and qualified institutional buyers, respectively.  The JOBS Act requires the SEC to implement these changes no later than 90 days after the JOBS Act is signed by the President.  Until the SEC amends the existing regulations, general solicitation and general advertising will remain prohibited.

With regard to the shareholder threshold changes, Sections 501 and 601 of the JOBS Act immediately amend the statutory provisions related to the number of shareholders of record at which a company must register and when the company is permitted to register.  The statutory changes are effective immediately upon enactment of the JOBS Act.  However, the SEC has also adopted regulatory requirements based on the original statutory language that will likely need to be amended in order to fully take advantage of the revised thresholds.

Section 501 and Section 601(a) of the Jobs Act collectively amend Section 12(g)(1) of the Securities Exchange Act of 1934 to read:

Every issuer … shall -

(A) within 120 days after the last day of its first fiscal year ended on which the issuer has total assets exceeding $10,000,000 and a class of equity security (other than an exempted security) held of record by either —

(i) 2,000 persons, or

(ii) 500 persons who are not accredited investors (as such term is defined by the Commission), and

(B) in the case of an issuer that is a bank or a bank holding company …, not less than 120 days after the last day of its first fiscal year ended after the effective date of this subsection, on which the issuer has total assets exceeding $10,000,000 and a class of equity security (other than an exempted security) held of record by 2,00 or more persons,

register such a security by filing with the Commission a registration statement….

These changes, related to when an issuer needs to register, would appear to be effective without further regulatory action.  Accordingly, banks and bank holding companies that are not currently registered will be able to go up to 2,000 shareholders of record at December 31, 2012, and not be required to register with the SEC.

Section 502 of the JOBS Act amends the Exchange Act to provide that the definition of “held of record” shall not include securities held by persons who received the securities pursuant to an employee compensation plan in transactions exempted from the registration requirements of the Securities Act.  While the SEC is required to adopt safe harbor regulations to clarify this statutory language, such regulation is presumably not necessary for the change to be legally effective.  The JOBS Act does not place a time limit on the SEC for adopting such regulation.

Sections 601 and 602 of the JOBS Act also amend the Exchange Act to increase the deregistration thresholds for banks and bank holding companies.  While these statutory amendments will be effective immediately, with limited exemption, the SEC will be required to amend its regulations for the changes to be effective.  The JOBS Act requires the SEC to adopt implementing regulations within one year after the date of enactment.  Presumably, the bank regulators may also have to adopt implementing regulations for banks without holding companies that currently have securities reporting obligations to their primary regulator.

Under the revised statutes, banks and bank holding companies will be able to terminate their registration requirements under Section 12 of the Securities Exchange Act and suspend their reporting requirements under Section 15 of the Securities Exchange Act so long as they have less than 1,200 shareholders of record (as compared to 300 shareholders under the former statute – and still the thresholds for non-banks.)  As revised, Section 15(d) will provide an automatic statutory suspension of reporting under Section 15(d) for bank and bank holding company securities that are held by less than 1,200 shareholders of record as of the first day of a fiscal year.  However, the SEC will need to act to amend its related regulations to allow banks and bank holding companies to suspend their reporting requirements under Section 15(d) during the year, as well as to terminate their reporting requirements under Section 12(g).  Hopefully, the SEC will act before Form 10-K’s are due for fiscal year 2012, but the JOBS Act’s deadline will give the SEC sufficient runway to perhaps require banks to file another 10-K before being able to take advantage of the increased shareholder thresholds.

Related posts:

1. Impact of Proposed JOBS Act on Community Banks
2. Senate Adopts Slightly Amended JOBS Act Bill
3. SEC Adopts Rules Allowing Shareholder Access to Company Proxy Materials

As the bulk of the JOBS Act was approved without change, our summary of the impact of the JOBS Act on community banks remains accurate.

The amended “Crowdfunding” provision includes significant restrictions on the potential utility of the new exemption, particularly for how it may have utilized by community banks.  The ultimate utility of the Crowdfunding exemption will largely be tied to the implementing regulations to be adopted by the SEC.  Under the Senate’s version of the JOBS Act, the Crowdfunding exemption would be available for up to $1 million in issuances in any 12-month period, require investors to purchase no more than 5-10% of their net worth in the issuance, and require the use of either a broker or “funding portal” as that term is defined in the bill.

Significantly, the Senate’s version contains a number of required disclosures, prohibits general advertising of the terms of the offering (other than notices which direct investors to the funding portal or broker), and requires the issuer to file periodic reports with the SEC (as the SEC determines, by rule, to be appropriate).  In addition, the Senate version of the Crowdfunding exemption makes existing public companies ineligible to rely on the exemption.

If the Senate’s version of the Crowdfunding provision is ultimately accepted by the House, the utility of the exemption for small, private community banks will largely depend on the scope of the implementing regulations and the costs to make use of the required funding portal or broker.   Assuming the initial costs and ongoing reporting burden are minimal, private community banks may be able to utilize the Crowdfunding exemption to supplement annual capital growth with an equity investment that helps further engage the local community with the bank.

Related posts:

1. Impact of Proposed JOBS Act on Community Banks
2. Senate Adopts Small Business Lending Fund
3. Senate Adopts Corporate Finance and Executive Compensation Reforms

Emerging Growth Companies

The bulk of the JOBS Act, and focus of most of the congressional debate, is on the creation of a new class of registered companies deemed “Emerging Growth Companies.”  These registrants are not limited by business operations, and banks and bank holding companies could quality.  An Emerging Growth Company would generally consist of newly public companies (IPO registration statement effective after December 8, 2011), with market caps of less than $750 million and total gross annual revenues (presumably interest income plus non-interest income for banks) of less than $1 billion.  New registrants could quality for Emerging Growth Company status for up to five years following their IPO, at which time they would lose the advantages of being an Emerging Growth Company even if they otherwise continued to qualify.

An Emerging Growth Company would be exempt for the say on pay vote, as well as pay vs. performance and pay equality disclosures, and would not be required to have independent auditors attestations regarding internal controls under SOX 404.  In addition, they would be eligible to generally rely on the scaled disclosures otherwise permitted for smaller reporting companies.  In addition, an Emerging Growth Company would be provided the opportunity to initially file their draft IPO materials confidentially with the SEC and otherwise have greater flexibility in communications with regard to their IPO.

Modification of Securities Offering Exemptions

Within 90 days of passage, the SEC would be required to amend Regulation D and Rule 144A to permit general solicitation and advertising in Rule 506/Rule 144A  offerings so long as the securities are only sold to accredited investors or qualified institutional buyers, respectively.

The JOBS Act would also create a new Section 4(6) exemption under the Securities Act of 1933 to permit “Crowdfunding.”  Generally, issuers would be able to sell, without registration or reliance on an another exemption, up to $1 million in any 12 month period (or $2 million if audited financial statements are provided to investors).  Individual investors would be limited to not invest, in any 12 month period, more than the lesser of $10,000 or 10 percent of the investor’s annual income.  Any investors participating in such an offering would also be excluded from the “holders of record” calculations for purposes of SEC registration.  The new “Crowdfunding” exemption includes a number of procedural steps that would need to be complied with, but will also provide preemption from applicable state securities law registration requirements.  Accordingly, it could provide a means for small community banks to raise up to $2 million in any given 12 month period with minimal legal cost and without needing to limit themselves to accredited investors.  While not initially designed for community banks, it could help private community banks better integrate with their communities via their shareholder base.

“Super” Regulation A Authority

The JOBS Act would create an additional exemption under Section 3(b) of the Securities Act to permit aggregate offerings of up to $50 million in any 12-month period (up from the existing $5 million requirement under the existing statute and Regulation A).  The JOBS Act merely authorizes the SEC to establish this exemption, so the details (and attractiveness) of the exemption are still be determined.  Based on the statutory language and history of Regulation A, it would appear that compliance with the exemption would likely require the filing (and review) of offering materials with the SEC, but then generally permit public sales of securities without resale restrictions.  Like the existing Regulation A, issuers relying on the exemption would presumably not become subject to the periodic reporting requirements applicable to public companies, although the statute does require that issuer file audited financial statements with the SEC annually.

Increased Thresholds for SEC Registration and Deregistration

Under the JOBS Act, the statutory threshold for SEC registration for banks and bank holding companies would be increased from 500 shareholders of record to 2,000 shareholders of record. (For companies that are not banks or bank holding companies, the threshold would be 2,000 total shareholders of record or 500 non-accredited shareholders of record.)  This will allow banks and bank holding companies to increase their shareholder base without triggering SEC registration (and shareholders obtained through the “Crowdfunding” exemption would be further excluded from the count of shareholders of record.  No other changes are proposed as to how to count “shareholders of record.”

The statutory threshold for exiting SEC registration would also be increased for banks and bank holding companies (but not for other companies).  For banks and bank holding companies, the statutory cap before a registrant can terminate their registration under Section 12(g) and suspend their registration under Section 15(d) has been increased from 300 to 1,200 shareholders of record.  If passed, this could cause a significant number of community banks to reconsider whether SEC registration is an appropriate cost for their shareholders, and may enable a significant number of public bank holding companies to “go dark” without engaging in a “going private” transaction, while also increasing the possibility of larger institutions that may exceed the new 1,200 trigger considering a going private transaction.

Related posts:

1. Impact of TARP Capital on Community Banks
2. Tax Impact of Stimulus Bills for Community Banks
3. Senate Considering $30 Billion Small Business Lending Fund for Community Banks

The industry is beginning to draw attention to the statutory expiration of this unlimited coverage.  As originally initiated by the FDIC in 2008, the program was intended to stabilize large deposits in a time of crisis within the financial system.  The Dodd-Frank extension of TAG was completely paid for by financial institutions under the general deposit insurance assessment framework.  Community banks have arguably benefitted the most from the unlimited coverage provisions because the corporate, non-profit, and government depositors holding most of the affected accounts may have more concerns (real or imagined) about the continued solvency of small banks than of big banks.  Without the guarantee, smaller banks may have to rely more on pricing in order to retain these depositors, potentially exposing the insurance fund to greater risk. 

By one industry estimate, more than half of all TAG account balances (over $500 billion) are already held by just 19 banks over $100 billion in assets.  According to the FDIC, more than three-quarters ($191.2 billion) of Q4 2011 growth in domestic deposits was attributable to account balances subject to the guarantee.  The 10 largest insured banks accounted for 73.6 percent ($140.7 billion) of the growth in these balances during this period.  As of December 31, 2011, the average institution with less than $1 billion in assets had 15 covered accounts worth an average of $713,000.  Although liquidity is generally less of a concern than it was in 2008, these large depositors are more likely to seek loans and otherwise bank with institutions holding their TAG-size accounts.

The questions, then, are whether the industry and its regulators are unified around this issue and whether legislators will have the stomach to extend the program in an environment where initiatives seens to benefit banks are politically sensitive.  The original FDIC manifestation was optional, with participating banks paying for the coverage.  Although the Dodd-Frank version is universal, again, banks have picked up the tab through the assessment process.  Nonetheless, it is always possible that an extension of the program will be marred as a boon to banks and a burden to taxpayers.  

Notwithstanding the position of former Chairman Sheila Bair and some currently within the agency that the program should only be further extended by Congress, the FDIC stands at the center of the issue and could always extend the program administratively.  FDIC’s 2008 program was authorized under the FDI Act by a determination by the Secretary of the Treasury in consultation with the FDIC and the Federal Reserve that conditions of ”systemic risk” justified an exception to the least-cost-resolution requirements of the Act.  It was extended by the FDIC in 2009 as a continued response to this finding, although at that time the agency also cited as “additional authority” more general statutory language relating to its mission.  We believe there is footing for a similar, transitional extension of the program under this broader authority.  In fact, when the FDIC extended the program in 2010 through the end of that year, it reserved the right to extend the program through 2011 without additional rulemaking.  This was ultimately not necessary in light of Dodd-Frank, and we think an additional regulatory extension is unlikely to occur here without significant advocacy for it.  The Independent Community Bankers of America and the American Bankers Association, for their part, have recently outlined their views on the issue.  

Meanwhile, examiners are beginning to ask how banks are planning for the expiration of the program.  Many institutions are balancing this expiration with Dodd-Frank’s repeal of the prohibition on the payment of interest on business checking accounts (and by extension Regulation Q).  Challenging as this may be in a time of regulatory uncertainty, these considerations should also be evaluated along with Regulation D’s reserve requirements (where restructured accounts may become demand deposits).

Related posts:

1. Unlimited FDIC Insurance for Non-Interest Bearing Transaction Accounts
2. Unlimited Insurance for IOLTA Accounts
3. Enhanced Deposit Insurance Extended Through 2013

Rule 506 of Regulation D provides a widely-used safe harbor from the registration requirements of the Securities Act of 1933 for qualifying private offerings. Under current Rule 506, neither the issuer nor any person acting on the issuer’s behalf may offer or sell securities by any form of “general solicitation or general advertising,” and securities sold pursuant to Rule 506 may only be sold to “accredited investors” or persons who, either alone or with a representative, have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of a prospective investment.

The Advisory Committee is of the view that the restrictions on general solicitation and advertising prevent many privately held small businesses and smaller public companies from gaining sufficient access to capital sources and thereby materially limit their ability to raise capital through private offerings. The Advisory Committee noted that the investor protections afforded by the existing restrictions on general solicitation and general advertising are not necessary in private offerings where the securities are sold solely to accredited investors. Because the concepts of general solicitation and advertising are vague, the prohibition increases compliance and diligence costs for issuers of securities who seek to avoid potential activities that might be deemed to constitute general solicitation or advertising and thereby destroy the availability of the Rule 506 safe harbor.

The Advisory Committee’s recommendations are not binding. Modification to the current requirements would require either SEC approval or the enactment of legislation. In November 2011, the U.S. House of Representatives passed legislation that would permit general solicitation in Rule 506 offerings so long as all of the purchasers are accredited investors.

The SEC established the Advisory Committee in September 2011 to provide a formal mechanism through which the SEC can receive advice and recommendations specifically related to privately held small businesses and publicly traded companies with less than $250 million in public market capitalization.

For more information on this topic or other proposals affecting emerging companies, please contact any of the attorneys listed below or a member of the Bryan Cave’s Financial Institutions Client Service Group.

Eliot W. Robinson, Atlanta
(404) 572-6785
eliot.robinson@bryancave.com

Katherine M. Koops, Atlanta
(404) 572-6819
katherine.koops@bryancave.com

Robert D. Klingler, Atlanta
(404) 572-6810
robert.klingler@bryancave.com

Rob Endicot, St. Louis
(314) 259-2447
rob.endicott@bryancave.com

Brendan Johnson, St. Louis
(314) 259-2438
brendan.johnson@bryancave.com

Todd Kaye, St. Louis
(314) 259-2194
todd.kaye@bryancave.com

Rich Plumridge, Denver
(303) 866-0583
rich.plumridge@bryancave.com

Mark Weakley, Boulder
(303) 417-8549
mark.weakley@bryancave.com

Brett Souza, Irvine
(949) 223-7119
brett.souza@bryancave.com

Related posts:

1. Federal Reserve Loosens Restrictions on Private Equity
2. Conference Committee Approves Sarbanes-Oxley 404(b) Exemption
3. First Banks, Inc. Announces Successful Trust Preferred Consent Solicitation

H.R. 1965 would, for banks and bank holding companies, raise the SEC registration threshold to 2,000 shareholders and the deregistration threshold to 1,200 shareholders.

H.R. 2167, the “Private Company Flexibility and Growth Act,” would raise the SEC registration threshold for all companies to 1,000 shareholders and would exclude accredited investors and certain employees from the definition of “held of record” for registration purposes.

H.R. 2940, the “Access to Capital for Job Creators Act,” would permit general solicitation and general advertising for private offerings conducted under Rule 506, so long as all purchasers were accredited investors.

H.R. 2930, the “Entrepreneur Access to Capital Act,” would permit companies to conduct “crowd source” capital raises under a new exemption under the federal securities laws.  The proposed exemption would permit offerings of up to $5 million in which each investor contributed no more than the lesser of $10,000 and 10 percent of the investor’s annual income.  Any investors purchasing under this exemption would be excluded from the number of investors “held of record” for purposes of SEC registration.

Comparable attempts to raise the SEC registration threshold and otherwise alleviate the regulatory burden associated with capital raises have failed to gain traction over the last several years.  We will continue to monitor the progress of these bills, but will also continue to advise existing public banks and bank holding companies on potential means to deregister from the SEC and “go private.”

Related posts:

1. Reminder Regarding Inclusion of Trust Preferred Securities in Tier 1 Capital
2. High Rate Area Determination Relief?
3. Analysis of Public Company Securities Purchase Agreement

As recognized by the Federal Reserve, “the SBLF Subordinated Securities, like the CPP Subordinated Securities, are issued to Treasury as part of a nationwide program to provide capital to eligible banking organizations that are in generally sound financial condition in order to increase the capital available for lending to small businesses, thereby mitigating the ongoing effects of the financial crisis on small business and promoting financial stability.” The Federal Reserve also acknowledged that “the SBLF Subordinated Securities are in terms and substance substantially equivalent to the CPP Subordinated Securities.”

Not withstanding these goals and similarities, the SBLF Subordinated Securities will only be eligible for Tier 2 capital treatment, as required by the Collins Amendment portion of the Dodd-Frank Act. Notwithstanding the Tier 2 treatment, as a result of the Small Bank Holding Company Policy Statement, small bank holding companies (less than $500 million in consolidated assets) can still downstream the SBLF funds as Tier 1 capital into their subsidiary bank(s). By adopting this rule, the Federal Reserve confirmed that a Sub S or Mutual BHC that otherwise qualifies for the small banking holding company policy statement will not have to treat the SBLF funds as “debt” for purposes of complying with the policy statement (which limits the ability to pay dividends if the debt to equity exceeds certain ratios.

For Sub S or Mutual bank holding companies with more than $500 million in consolidated assets, it’s very difficult to rationalize why they would seek to convert their CPP Subordinated Securities (Tier 1) into SBLF Subordinated Securities (Tier 2). For all other groups of institutions, the capital treatment between TARP and SBLF either remains the same or is functionally irrelevant due to the Small Bank Holding Company Policy Statement.

As a side note, it’s now been 600 days since President Obama first floated the idea of providing additional capital to community banks to spur lending for community banks, 502 days since President Obama included the idea in his State of the Union Address (to a standing ovation from both sides of the aisles), and 174 days since the Treasury released the SBLF term sheet and application. We are not aware of any SBLF fundings, much less approvals. So much for “mitigating the ongoing effects of the financial crisis on small business and promoting financial stability.”

I am also a parent of a child with special needs. I just say that because I’m testing to see if related articles works by scanning similar terms. See also: I am the parent of a child with special needs. Should I give money to a relative to care for my child with special needs after my death instead of giving the money directly to my child?

============

Your expressed desires to your relative about the money create only a moral obligation on your relative and are not legally binding obligations that can be enforced. Further, if the relative dies, divorces or has financial problems, your child’s lifestyle could be negatively affected. Specifically, in a divorce, your child’s monies may be considered part of the marital property and part or all may be awarded to your relative’s spouse. If the relative dies, the money passes into the relative’s estate and goes to his or her beneficiaries or heirs, which might not be your child. Also, if your relative has to declare bankruptcy, creditors could put a lien on your child’s monies.

Related posts:

1. Fed Confirms Tier 2 Treatment for Sub S SBLF Funds
2. Federal Reserve Clarification of Tier 1 Treatment for TARP Capital
3. Reminder Regarding Inclusion of Trust Preferred Securities in Tier 1 Capital

• Preemption standard for national banks and federal thrifts is altered
• Codification of the requirement that a bank holding company act as a “source of strength” for any subsidiary that is a depository institution
• Federal Reserve is authorized to issue orders and regulations relating to the capital requirements of holding companies
• Heightened capital requirements for interstate acquisitions
• New restrictions on insider asset sales and lending
• Truth in Lending Act exemption threshold for certain credit transactions and consumer leases is increased from $25,000 to $50,000 (i.e., TILA coverage is increased)
• Repeal of Regulation Q and the underlying statute (permitting payment of interest on demand deposit accounts)
• Increase in next-day availability requirement for deposit items not themselves subject to next-day availability under the Expedited Funds Availability Act from first $100 to first $200
• Required credit score disclosure under the Fair Credit Reporting Act where adverse action is based in whole or part on a consumer report

We will continue to follow rulemaking and enforcement of the Act and provide updates linked to our dedicated Dodd-Frank page.  Regulators (and Barney Frank) are celebrating the law’s milestone today by testifying before the U.S. Senate on how the Act has improved supervision.  Stay tuned.

Related posts:

1. OCC Issues NPRM on Dodd-Frank Implementation, Preemption
2. OCC Opines that Federal Preemption Still Exists, Despite Dodd-Frank
3. Regulators Respond to Dodd-Frank

In Georgia, new consideration is not required to execute new non-competes, so employers are in a good position to strengthen their competitive protections under the revised statute, but action is required as only new agreements will enjoy the benefits of the new law.  The new law also governs restrictive covenants between distributors and manufacturers, lessors and lessees, partnerships and partners, franchisors and franchisees, sellers and purchasers of a business or a commercial enterprise, and two or more employers.

In-Term Covenants Generally

The bill codifies many aspects of the law in this area that had developed in the Georgia courts.  This includes the presumption that any restriction within an agreement that operates during the term of the underlying employment or business relationship is not unreasonable because it lacks any specific limitation on the scope of activity, duration, or geographic area as long as it promotes or protects the purpose of the agreement or deters any potential conflict of interest.

In addition, the following presumptions also apply to in-term covenants:

• Duration - A restricted time period equal to or measured by the duration of the parties’ business relationship is presumed reasonable.
• Geographic scope - A restriction which covers the areas in which the employer does business at any time during parties’ commercial relationship, even if not known at the time of entry into the restrictive covenant, is reasonable as long as the total restricted distance is also reasonable and/or the covenant contains a list of particular competitors that the restricted party may not contact for a limited period of time.
• Scope of competition - The scope of competition restricted is presumptively measured by the business of the employer or other person or entity in whose favor the restrictive covenant is given.

Post-Termination Covenants

Enforcement of contracts that restrict competition after the term of employment shall not be permitted against any employee who does not, in the course of his or her employment:

• regularly solicit for the employer customers or prospective customers;
• regularly engage in making sales or obtaining orders or contracts for products or services to be performed by others;
• perform the duties of a “key employee” or of a professional; or
• perform the duties of supervision and hiring/firing as a manager

This prohibition is not a major limitation on post-employment non-competes as most employees for which an employer desires to avoid competing with engage in one or more of these activity categories.  In the case of a post-employment covenant entered into prior to termination, any “good faith estimate” of the activities, products, and services or geographic areas that may be applicable at the time of termination will satisfy any provision of the new statute requiring a description of such activities, products, and services or geographic areas, as will any description that provides “fair notice of the maximum reasonable scope of the restraint . . . even if the description is generalized or could possibly be stated more narrowly to exclude extraneous matters.”

Through provisions that codify other aspects of Georgia case law, the following types of restrictive covenants are presumed reasonable in time under the new statute:

• Post-employment covenants – 2 years (measured from the date of termination of business relationship)
• Distributor, dealer, franchisee, lessee of real or personal property, or licensee of a trademark, trade dress, or service mark covenants – 3 years (measured from the date of the termination of the business relationship)
• Sale of business covenants – 5 years or the period of time during which payments are being made to the seller (measured from the date of termination or disposition of interest)

Non-Solicitation Agreements and NDAs

In non-solicitation covenants, express reference to geographic area or types of products or services considered to be competitive will not be required.  Courts will instead look to whether the employee had “material contact” with the prospective customers during his or her employment for the purpose of providing products or services that are competitive to the employer’s business.  This is a very broad term under the new statute.

As noted above, under the new law, NDAs need not contain any limit on the period of time for which a party may agree to maintain information as confidential or as a trade secret, or any limit on the geographic area within which such information must be kept confidential or as a trade secret, for so long as the information or material remains so.  The law permits restrictive covenants as to information that constitutes a trade secret as well as other information about the business of an employer disclosed to or of which the employee became aware as a result of his or her employment, has value to the employer, and is not generally known to the employer’s competitors.

Burden of Proof and Applicable Law In Light of the New Statute

Finally, under the revised Georgia statute, the person or entity seeking to enforce a restrictive covenant must plead and prove the existence of a “legitimate business interest” justifying the covenant.  This is also a very broad term and includes, among other things, trade secrets and other valuable confidential information, substantial relationships with customers or vendors, customer goodwill, and extraordinary or specialized training.  If the party seeking enforcement establishes prima facie evidence that the restraint is in compliance with the provisions of the statute authorizing it, then any person opposing enforcement has the burden of establishing that the specified restraint does not comply with such requirements or that such covenant is unreasonable.

As noted, the new law applies to restrictive covenants entered into on or after May 11, 2011.  Because of a prior constitutional challenge to the statute, agreements executed prior to November 3, 2010, are subject to the old law, as in all likelihood are covenants dated between November 3, 2010, and May 10, 2011, inclusive.

Related posts:

1. Georgia Amends Legal Lending Limit Statute
2. Georgia DBF Proposes Rule to Address Legal Lending Limit Statute
3. Georgia DBF Withdraws Proposed Rule