The Seven Deadly Sins: Employment Law For Start Ups

Labor & Employment Newsletters The Resource

While all employers must be mindful of the myriad of state and federal laws governing the employment relationship, small, newly-formed businesses, or “start-ups,” can be especially vulnerable to costly employment law mistakes.  Often growing out of a casual culture of collegiality, new businesses may forego the necessary employment formalities recognized and reinforced by larger companies.  Smaller businesses also may have no one designated or qualified to handle issues involving human resources.  One bad actor or malcontent on the start-up team can lead to big legal headaches down the road.  This issue of The Resource will examine the most common employment law mistakes made by smaller employers and start-ups.

1. Hasty Hires

New businesses are often generated by social or family relationships.  Friends and family may provide seed money or offer “sweat equity” to get your business started.  The temptation is to accept this assistance without regard to any formal arrangement.  Uncle Bud may offer to pay your rent for a year.  Cousin Bill may offer to work nights and weekends in exchange for some undefined interest in the company down the road.  Uncle Bud’s investment and Cousin Bill’s undefined interest could turn into major liabilities for the company once it becomes successful and begins to generate a profit.  Any contribution to the business, large or small, should be clearly identified in a written agreement (preferably prepared or reviewed by an attorney) that spells out what if any interest in the business that contribution will garner. 

New companies may also tend to settle for a convenient warm body at the outset, without regard to how the individual will fulfill the role once the business gets off the ground.  While Ted may have been an awesome college roommate, he might not be your best choice for handling the company’s finances.  All employers, large and small, should hire carefully and do some due diligence before making an offer to join the team.  Although they may seem like needless formalities, applications, resumes and reference checks will help to ensure you find the right fit for your new business.  Better to focus on a candidate’s education, training, work history and references rather than social or familial attachments.

2. Botched Background Checks.

A reference check can be a valuable tool in assessing whether an individual will be an asset to your new business.  Before making a hiring decision, employers should look into a candidate’s background and job history.  Whether in an application or by verbal inquiry, employers should ask a candidate for the names and addresses of meaningful past business contacts, both employers and co-workers, in order to assess the candidate’s qualifications.  To ensure that the contact will cooperate and provide truthful information, you may ask the candidate for a release of liability for the reference.  It is also advised to check whether or not the candidate has a criminal record.  In some jurisdictions, due to so-called “ban the box” laws, employers cannot inquire about a candidate’s criminal background until after a conditional offer of employment has been made.

If an employer utilizes a third-party provider to conduct a background check, the employer must comply with the Federal Fair Credit Reporting Act (the “FCRA”).  As it applies to employers, the FCRA has four basic requirements:

• The employer or prospective employer must provide the employee or applicant with a clear disclosure that the employer or prospective employer may get a “consumer report.”

• The employer or prospective employer must obtain a written signed authorization from the employee or applicant before obtaining the report. The disclosure must be in a document that is separate and apart from any other employment document like an application, but the disclosure and authorization can be in the same document. 

• Before an “adverse action” is taken against the employee or applicant based on the report, the employer or prospective employer must provide a pre-adverse action notice to the applicant or employee, along with a copy of the report and a copy of the “Summary of Rights” that is published by the Federal Trade Commission. 

• The employer must provide notice of the adverse action taken. This notice must include the name, address and telephone number of the agency that ran the report, a statement that the agency did not make and cannot provide a reason for the employment decision, a notice that the employee or applicant can get a free copy of the report from the agency within 60 days and that he or she can contest the report with the agency.  The FCRA does not provide a specific amount of time for how long an employer must wait after sending the pre-adverse action letter before it can send the (second) adverse action letter. However, while not a binding law or regulation, Congress has stated that five business days is a reasonable time period to wait after the pre-adverse action letter before taking adverse action.

3. Dreadful Documentation.

Both applicable state and federal laws (and best practices) require that employers create and maintain documentation throughout the employment relationship with regard to hiring, compensation, leave, discipline and termination.

At hire, the employee and the employer are required by federal immigration laws to complete a Form I-9 to confirm the employee’s identity and eligibility to work in the US.  Under the Federal Personal Responsibility Work Opportunity Act (“PRWOA”), Employers must also report all new hires to a designated state agency.  A list of those designated agencies by state can be found through the US Department of Health and Human Services website, at https://www.acf.hhs.gov/css/resource/state-new-hire-reporting-websites.

In addition, under the laws of most states (and as a best practice), at the time of hire, employers must give new employees information about the time, place and frequency of pay, preferably in writing, including their salary or wage rate, expected hours of work and the payroll schedule.  New employees should also receive written copies of the employer’s vacation and leave policies, including rules regarding the accrual and use of leave and whether unused leave will be paid on termination.  Policies that are not in writing may be questioned if there is a dispute; policies that are not clear will be interpreted in the way that is most favorable to the employee.

During employment, the employer is responsible for keeping records of all hours worked by employees; all wages paid and deductions taken; and any leave requested and taken.  It is also a best practice to carefully document all performance reviews, any discipline imposed and all termination decisions.

4. Perilous Pay Practices.

The Federal Fair Labor Standards Act (“FLSA”) requires “employers” (with a few narrow exceptions) to pay their “employees” a minimum wage.  The concept of employment under the FLSA is broadly defined.  An “employer” includes “any person acting directly or indirectly in the interest of an employer in relation to an employee.”  An “employee” is “any person who is employed by an employer.”  The term “employ” is defined as to “suffer or permit to work.”  There are exemptions, however, for “Business Owners” (individuals who own at least 20% of the business and are actively engaged in its management) and for “Family Businesses” (businesses that employ only immediately-related family members).  Otherwise, a small business that does not pay its workers at least minimum wage could be subject to civil and criminal liability, including liquidated damages, penalties and attorneys’ fees.

The FLSA also requires employers to pay overtime of 1½ the employee’s regular rate of pay for hours work in excess of 40 in any given work week.  There are a number of exemptions from the FLSA’s overtime requirements, including exemptions for certain “white collar” employees performing executive, administrative or professional duties, but such exemptions require that the employee receive a salary of at least $455 per week for every week that the employee performs any work (with a few limited exceptions).  Failure to pay non-exempt workers overtime may also result in civil and criminal liability for a small employer.

There are many myths regarding wage and hour laws that could trip up a new business, such as:

• “An employer may provide comp time in lieu of overtime.”
  (This is not permitted except by public sector employers.)

• “Salaried employees are exempt from overtime rules.”
  (Not entirely true: the employees must also receive a minimum salary of $455 per week AND meet one of the white collar duties tests in order to be exempt.

• “A small business may use unpaid volunteers.”
  (Also not true—only religious or charitable non-profit organizations may use unpaid “bona fide” volunteers.

5. Marginal Management.

Because of their casual culture, early stage companies will often operate based on trust, and forego establishing formal rules, policies or expectations for their employees.  While a small company may not need a full-blown employee handbook with formal policies, it should have processes in place to investigate and address any employee complaints and to manage poor employee performance.

Performance management is especially important in an early stage company, where resources are frequently in short supply, manpower is limited and productive employees are at a premium.  First and foremost, the employee must know what is expected of him.  While no one wants to be micromanaged, the failure to set clear goals and expectations for workers may leave them unmotivated and adrift.  It is nearly impossible to correct performance issues where the employee has received no guidance or feedback on a regular basis. 

Where clear expectations have been communicated to the employee, and the employee fails to adequately meet those expectations, the employer should first determine whether the performance goals are achievable and what barriers may be impeding the employee’s performance.  If the employee’s poor performance persists, even after the employer has taken corrective action to realign the performance goals or to otherwise address the employee’s failure to perform, the employer should promptly impose disciplinary measures designed to resolve the issue.  Failure by the employee to improve should result in termination of the employee’s employment.  The longer bad habits and poor performance persist and are permitted to become the status quo, the harder it is to address them.  The lack of management is poor management.

6. Calamitous Contracts.

There are a variety of reasons why an early stage company may not utilize written contracts with employees.  The business may not be able to afford to pay an attorney to prepare the documents.  The founders may believe that their relationship of trust makes such formal arrangements unnecessary.  However, as a business grows, it needs to protect its most valuable assets, whether those assets are technological advancements, a body of knowledge, a team of employees or a customer base or referral network.

Typical protective covenants to be signed by employees include those involving the assignment of inventions, nondisclosure and confidentiality, covenants not to compete and covenants not to solicit customers or employees.  The failure to have these types of protections in place can lead to disastrous results.  In addition, poorly drafted covenants may offer little or no protection.  While the fees necessary for the preparation of these types of agreements may seem an unnecessary expense, paying a qualified attorney to prepare these protections for your business may be dollars well spent. 

7. Terrible Terminations.

In the US, the general rule is that employment without a promise of continued employment for a specific term is employment “at will,” which may be terminated by the employer or the employee at any time for any reason.  While employment at will is the rule, it is not a “get out of jail free card.”  There are many exceptions under both state and federal laws, and, in particular, laws prohibiting discrimination, retaliation and violation of public policy.  In addition, although an employer is not legally required to give a reason for an employee’s termination, the best practice is to give an honest explanation for the adverse action.  Otherwise, the employee (and perhaps the EEOC and a jury) will be free to speculate about the employer’s motive.

The primary defense to any wrongful termination claim is a legitimate and nondiscriminatory reason for the termination.  The primary pitfalls are poor documentation to support the decision to terminate or providing a less than honest reason for the termination.  A lack of any documentation to support the employer’s reason for the termination decision draws into question whether the termination was warranted.  However, poorly documented issues can be even worse than no documentation.  Performance reviews that are non-committal, indecisive or ambiguous can provide support for an employee’s contention that the termination was not due to performance issues.  The ultimate error made by employers however is providing an untruthful reason for the termination.  Employers may wish to avoid confrontation or spare the employee’s feelings by stating that the termination is due to an “elimination of the position” or a “lay off” rather than due to poor performance.  When the employer is confronted with a charge of wrongful termination, evidence that the proffered reason was false or even partially untrue, gives rise to an inference that the real reason was an illegal one.

The best practices for all employers:

• Communicate expectations, preferably in writing;

• Document all performance issues;

• Take prompt action in response to problems;

• Be honest in addressing performance issues; and

• If problems persist, do not wait to terminate.

Employment issues are challenging for employers of all sizes, but for early-stage companies with few resources, they can be especially daunting.  Avoiding these seven common employment law mistakes can save your small business from much distraction, pain and expense down the road.

NOT LEGAL ADVICE: This publication is not to be considered specific legal advice and should not be relied upon in lieu of advice from an attorney. Each client’s situation is unique, and if you have need for legal advice, you should seek advice from an attorney.