Mar, 2009 – Fortify your Agency against Eroding Value

The below article was published in the March, 2009 Rough Notes Magazine
Fortify Your Agency Against Eroding Value
By Christel L. Sarchet, CPA
Mike was devastated. He and Steve had been friends since college. They had lost touch for a while but
ten years ago, when Steve was between jobs, Mike had offered him a position as a producer in his newly
formed agency. Steve did not have industry experience but he caught on quickly, and as a result, he
developed a book of business which was second only to Mike’s for the entire firm. However, last month
when Steve caught wind that Mike may sell the business and retire, Steve decided to leave the agency to
begin his own business, taking many of his top clients with him. Now Mike was left to wonder what he
could have done to protect the agency he had worked so hard to build.
In an age of increasing depersonalization of many services, the insurance industry remains largely
dependent upon personal relationships. Insurance agencies in particular often find that the strength of
relationships among carriers, employees, and clients, determines their ability to grow and retain their
business. A reputation built upon consistently strong performance and service further enhances the
ability to grow and retain business, thereby making the agency more valuable to both the owners and
potential acquirers. As the fictional example above illustrates, however, the ongoing value of an agency
may deteriorate quickly unless protected. One step that Mike could have taken which may have
prevented the loss of business would have been to develop and implement strong employment
agreements.
An employment agreement is a written contract between an employee and employer which documents
the expectations between both parties. Employment agreements typically address such items as
employee duties, compensation, duration of employment and termination. However, strong
employment agreements for insurance agencies also include provisions which address the ownership of
the book of business, non-solicitation, and non-competition. These additional provisions can go a long
way in protecting the underlying value of an insurance agency, its expirations.
Ownership of the Book of Business
When Mike had confronted Steve about leaving and taking his top clients, Steve had been a little
indignant and puzzled. “They are my clients!” he had said.
Insurance agencies sometimes assume that business obtained by employees will remain with the agency
in the event that the employee departs from the agency. During the course of employment, employees
utilize the agency’s carrier relationships, existing client data, technology and various other proprietary
data in conjunction with their expertise to perform their duties. A court may uphold the agency’s
ownership of the business. However, rather than risk any confusion on the part of the employee, the
question of whether the agency or employee owns the book of business can and should be explicitly
stated in an employment agreement.
Non-solicitation
With Steve’s departure from the firm, Mike decided to hire Sherry, an experienced producer who had just
relocated from another part of the country. Having learned from his experience with Steve, Mike
requested that Sherry sign an employment agreement prohibiting the solicitation of clients obtained
during her employment with Mike’s agency.
A strong non-solicitation clause stipulates that upon termination the employee will not solicit or aid a
future employer in soliciting the agency’s clients or employees. While Mike may believe that he is
appropriately protecting the agency, he should also consider including prospective clients and agency
employees in the non-solicitation clause. Without also prohibiting the solicitation of prospective clients
and other employees, the value of the agency could be eroded if Sherry were to leave and recruit the
agency’s key talent and non-clients with whom the agency had begun cultivating relationships.
Non-Competition
The goal of a non-competition clause or agreement is to protect the agency from the direct competition
of a former employee working either for himself or a competitor, while not unreasonably impairing an
individual’s ability to obtain future employment. The enforceability of a non-competition clause may
vary by state. However, the likelihood that the agreement would be upheld in a court may be enhanced
by the inclusion of certain limitations.
Mike thought about the producers that had decided to stay with the agency after Steve’s departure. Jim
was a well-known and well-liked leader in the community. He had joined Mike when the agency was in
its infancy. Jennifer was a promising young producer that he was considering for promotion. He was
glad they had stayed and hoped they would remain with his agency. Nevertheless, with his new
understanding of the importance of employment agreements, Mike requested that both Jim and Jennifer
sign employment agreements which included non-competition clauses prohibiting all competition in the
city in which the agency was located for a period of three years following termination.
In the agreements with Jim and Jennifer, Mike has limited the scope of non-competition to only the city
in which his agency is located. By limiting the geography of the agreement, Jim and Jennifer still have a
reasonable opportunity to gain employment in the event of termination. Mike has done well to include
this limitation. Furthermore, Mike has limited the amount of time during which Jim and Jennifer may
not directly compete with the agency to a period of three years. As a typical time frame is two to five
years, three years appears reasonable. Mike has further enhanced the enforceability of the noncompetition agreements with Jim and Jennifer.
One thing that Mike has not addressed in the agreements with Jim and Jennifer is their consideration, or
financial incentive, to enter into a non-competition agreement. If Jennifer is offered a promotion or pay
raise at the same time that the non-competition agreement is signed, the increased pay and
responsibility may be deemed consideration and enhance the enforceability of the agreement.
However, unless Mike compensates Jim in some way, the agreement with Jim may not be viewed as
favorably.
More is Better
While it may appear that employment agreements are necessary only for key producers, it would be
good to remember that all employees have access to strategic client information and proprietary agency
records which should be protected.
Enforcement of employment contracts may vary depending upon the laws of individual states.
However, strong employment agreements are much more than a legally defensible contract. They
protect an insurance agency by clarifying expectations between the agency and it’s employees while
balancing the rights of the company with the rights of the employee. By developing and implementing
strong employment agreements an agency can go a long way toward protecting the most valuable
component of business, its relationships.
The author
Christel L. Sarchet is a Vice President of Mystic Capital Advisors Group, LLC, a national mergers and
acquisitions consulting firm, which focuses exclusively on the insurance industry.