Thursday, June 5, 2008      Volume 6, Issue 21

This Week

1. Arthur Garrett III (Keller and Heckman LLP) clarifies the realm of "errors and omissions" insurance

2. William C. Wilka (Dudnick Detwiler Rivin & Stikker LLP) explains "garden leave" clauses in employment contracts

Next Week's All-Starss: Michael L. Hadley (Investment Company Institute); Cyrus D. Mehta (Cyrus D. Mehta & Associates PLLC)

1. Arthur Garrett III: You say "malpractice;" insurance lawyers say "errors and omissions"

PLI: Can you please describe the broad arena of "errors and omissions" insurance?

ARTHUR GARRETT III: Errors and Omissions ("E&O") insurance provides insurance coverage for the acts, errors and omissions of the insured in performing a service. Since it is typically purchased by professionals, it is often referred to as "professional liability insurance." The term "professionals" is broadly defined and interpreted to include anyone who has advanced knowledge and skills through specialized education and training. The E&O policies written and available generally cover a wide variety of professions, but typically, such policies are written to cover the errors and omissions of engineers, architects, and accountants. Professional liability insurance written for doctors and lawyers is often referred to as "malpractice insurance."

E&O insurance can also be purchased by non-professionals, such as brokers, insurance agents, title agents, and stockbrokers, who feel they need coverage in case they make a "mistake" through their acts or omissions, that may cause harm to others. Essentially, any company or non-profit that provides a "service" can purchase an E&O insurance policy.

Since E&O insurance is designed to cover the acts of those who provide specialized services, E&O insurance policies are typically narrowly tailored to the particular profession covered and/or service provided. The terms and conditions of the policy are often manuscripted (through endorsements) to ensure that the coverage being provided by the insurance policy is specific to the profession to which it applies.

All E&O coverage is sold on a claims-made basis and defense costs (claim expenses) are typically provided to the insurer within certain limits. This means that the claim must be made and reported to the insurer during the period of the policy and that the attorneys' fees and other defense costs incurred in defending or responding to the underlying claim will be reimbursed, but will cause the limits of the policy to exhaust.

E&O insurance is often purchased to fill a "gap" in coverage left by the commercial general liability (CGL) policy. For instance, the CGL is meant to cover, among other damages, bodily injury and property damage caused by the insured. However, nearly all CGL policies exclude coverage for bodily injury/property damage that arises from the provision of professional services. This can be a real problem for non-profit associations that perform the service of "certifying" technicians in a particular trade (e.g., welders, plumbers), and those "certified" technicians cause bodily injury or property damage to a consumer. If the consumer were to look beyond the technician and towards the association for redress, the CGL policy would not be of any assistance. For this reason, a lot of companies purchase a specialized form of E&O insurance, typically known as a "miscellaneous E&O" insurance policy, in order to "bridge the gap" and cover the risk of secondary or contingent bodily injury and property damage.

Directors and Officers ("D&O") insurance is closely related to E&O because it covers errors and omissions, but it covers directors and officers making decisions and offering advice on behalf of a company, as opposed to professionals making decisions and offering advice in the course of performing their professional duties for consumers.

Learn more from Arthur Garrett III—Download Errors and Omissions Insurance.

2. William C. Wilka: American employers starting to learn how to garden

PLI: What is "garden leave" and why do employers like it so much?

WILLIAM C. WILKA: "Garden leave" has become a common tool in English employment contracts for curtailing a departing employee's ability to work for the competition.1 Anecdotal evidence suggests that American employers, primarily on the East Coast, have begun inserting garden leave clauses into employment agreements. The enforceability of the garden leave clauses, however, remains untested in California courts.2

As it has developed in England, "garden leave" describes a situation where an employee must give notice of termination a significant period of time prior to the effective date of termination. The employee then is required to spend the time between the date of notice and the termination date away from the office, i.e., at home "in the garden." The employee receives full payment of salary and benefits, but is precluded from contact with customers or the employer's confidential information; most importantly, the employee is precluded from beginning employment with a new employer until the garden leave expires. The length of the garden leave varies, but in the reported English cases generally runs from six to eighteen months in length.

The obvious benefit to the employer from a garden leave provision is that it prevents the employee from working for a competitor until such time as his/her current technical knowledge has become less useful to a competitor, the contacts with customers have become dated, or the employee is otherwise rendered less valuable to a competitor. The cost to the employer may be significant in paying the full salary and benefits to an employee for a lengthy period of time while the employee is not engaged in any productive activity on behalf of the employer. Thus, such clauses may be appropriate only for senior executives, key technical employees or others who have access to truly confidential information and/or key clients. This necessarily sparing use of the garden leave tool may, in fact, make it more palatable to a California court than boilerplate clauses intended to restrict the post-employment activities of all, or a substantial part of, an employer's workforce. The garden leave provision can be tailored to specific workers in whom the employer has invested substantial training and exposure to trade secret information. Also, it is in the employer's interest to make the duration of the garden leave as short as possible in order to minimize the payment of salary and benefits during the leave.

Any garden leave provision should contain certain specific terms in order to increase the likelihood of its enforceability. First, there must be an express garden leave provision in the employment contract.3 Second, the garden leave provision must explicitly preclude the employee from working for anyone else for the term of the contract, and recite that he/she remains an employee during the notice period. Additionally, the garden leave clause should contain a term relieving the employer of an obligation to provide the employee with work during the garden leave period.4 The clause must explicitly state the employer's right to exclude the employee from the office or workplace, and preclude the employee from contact with customers, clients, or confidential information, e.g., a home computer that has access to a company network or database.

A garden leave provision could be a successful alternative in those jurisdictions where courts permit but limit non-compete agreements. Whether garden leave provisions would succeed in California courts is another question entirely, and very problematic. California decisional law, as noted above, is not interested in the "reasonableness" of a restrictive covenant. Rather, the courts of California examine a restrictive covenant based on its impact on employee mobility and the broad and firm public policy favoring open competition, i.e., that "every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind, is to that extent void." The Court might look no further than this analysis and conclude that because the garden leave provision restricts the particular employee's ability to take another job, it is void.

On the other hand, garden leave clauses, unlike traditional non-compete agreements, do not offend several of the principles underlying the argument for California's public policy stance against enforcing non-competition agreements. For example, the garden leave clause does not interfere with the employee's ability to earn a living, as he/she is paid in full with benefits during the term of the garden leave. Also, if the garden leave clause is used effectively with key management, sales and technical employees, who theoretically are more sophisticated and have greater bargaining power than regular employees generally, then the argument that the restrictive covenant is a product of unequal bargaining powers becomes less forceful. Moreover, the employer is motivated to keep the garden leave term as short as possible because of its cost, which runs contrary to the motivation for non-competition agreements, which is to extend them for as long as possible.5

At this point in time, it appears unlikely that a garden leave clause would overcome the public policy concerns of California courts. Nevertheless, one will never know for sure whether this innovative approach to preserving the employer's investment in training certain knowledge-based employees might be successful, until such time as a court examines it against the background of a specific fact situation.

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Download Avoiding Trade Secret Liability When Hiring and Losing Employees.