When Teams Resign: How Private Equity Sponsors and Portfolio Companies Should React

Introduction

For sponsors with investments in portfolio companies whose value is dependent on employees’ client relationships, an apparently coordinated departure of a team of key employees to join or establish a competing business presents one of the most significant operational risks. For sponsors, these risks are often heightened, because portfolio companies may lack HR and legal infrastructure, and also because management may be inclined to treat departures as routine rather than as a potentially significant threat. 

If the sponsor gets the response wrong, it may (quite literally) watch client relationships, confidential information, and important competitive advantages walk out of the door. However, with proper planning and the right response (or set of responses) when issues arise, sponsors can significantly mitigate the risks, in particular by ensuring that garden leave and properly enforceable restrictive covenants are in place; taking effective steps to investigate and enforce any breaches which are identified; preserving client relationships; and maintaining business continuity and the morale of remaining employees.

Over the next few weeks, we will be publishing a series of posts with the aim of providing sponsors with a practical roadmap for handling coordinated employee departures at UK portfolio companies. Our posts will focus on cases where teams move from employers operating in the financial services sector. These businesses are often relationship-driven, with revenue concentrated in the hands of a few senior professionals. The regulatory environment also adds complexity, as FCA obligations around references, data handling, and the senior manager certification regime (“SMCR”) require careful navigation. Sponsors reacting to such cases may therefore need to address a number of specific challenges. Many of the suggestions we make will however also be generally applicable to businesses operating in other sectors.

 The topics we will be addressing as part of the series are as follows:

• Post 1 (this post): The immediate 48-hour response - IT lockdowns, protecting client relationships, and initial questioning protocols for departing employees.

• Post 2: Best practice for conducting forensic investigations, so that evidence of breaches can be identified in sufficient time to allow effective enforcement action to be taken.

• Post 3: Navigating data protection obligations, and the need to avoid regulatory problems while investigating employee breaches.

• Post 4: Understanding how inconsistent restrictive covenants can prevent enforcement against individual leavers with strong protections, and how to prevent such problems from arising.

• Post 5: Applying commercial pressure and seeking legal recourse in order to achieve effective resolution. 

The immediate 48-hour response

To start with an obvious but fundamental point, the employer must ensure that the departing employee’s access to the employer’s email and IT systems is suspended as soon as a resignation is tendered. Where contractual terms permit employees to be placed on garden leave, steps to achieve that should also be taken right away.

This isn't about being heavy-handed. Rather, it's about preventing ongoing access to confidential information and client data that could be used to facilitate breaches of post-termination restrictions. Delaying the suspension of access to IT systems or company premises by even hours may allow client lists, financial data, or other sensitive information to be downloaded.

Company electronic devices, including laptops, iPads and smartphones, should be collected immediately, ideally at the same meeting where resignation is accepted. If devices can't be collected that day, steps should be taken to suspend access remotely. And where the employer permits employees to use their own personal devices for work purposes, ongoing access to company servers should be suspended, and steps taken to ensure that confidential information held on such devices is identified and, if appropriate, irretrievably deleted.

 Securing client relationships

The employer will know which clients the departing employees managed. Accordingly, the employer should not wait to establish whether solicitation has occurred. Instead, the employer should reach out proactively to reassure clients, introduce new relationship managers, and maintain continuity. Communications with clients should be neutral and professional, and the temptation to disparage the leavers or suggest wrongdoing should be avoided. The message should be business continuity, not crisis management.

This achieves two objectives. First, it reduces the risk of client defection. But second, and importantly, it gathers intelligence about whether departing employees have already made contact. This may be valuable in the context of any prospective claim for breach of restrictive covenants.

Ask the right questions 

When an employee resigns, an interview should be scheduled with them as soon as possible. The interview should be conducted with experienced HR professionals, who should inform the employee that their recent IT activity is being reviewed, and that false statements could result in enforcement action. 

Those conducting the interview should ask specific questions and document the answers. Where there is a prospect of proceedings ensuing, litigation counsel should also be asked to comment on the proposed questions. 

While the specific questions to ask will vary from case to case, they will likely include some or all of the following:

• Has the employee (impermissibly) used their personal devices for work purposes? In any event, have they used their personal email accounts for work purposes? If so, what information is stored there?

• Does the employee retain company documents or confidential information in other formats, such as hard copies, USB drives, or in personal cloud storage locations?

• Can the employee provide a comprehensive list of clients they have dealt with?

• Does the employee have personal or family relationships with any of those clients?

• Where is the employee leaving to? 

• Where several departures have taken place simultaneously or in quick succession, what contact has taken place between the departing employees, and what do they each know of the others’ plans?

Inviting the employee to answer questions of this kind serves multiple purposes. 

First, it creates an initial contemporaneous record of what each employee is prepared to acknowledge to the employer. Inconsistencies (or, indeed, similarities) in responses to particular questions may help to establish coordination. While the move may have been prepared and executed by a closely-knit group of employees acting jointly, it only takes one weak link to undermine their joint narrative on any specific factual point. 

Conversely, the mere fact that a group of employees resigned in quick succession does not, in itself, establish collusion or conspiracy to breach their restrictive covenants – particularly in cases where the team is closely in touch and/or has recently been informed of the forthcoming departure of key colleagues. For each employee and alleged breach, the employer will need to establish the respective duties, collect evidence of the individual breaches, and of any individual acts of coordination or encouragement of others’ breaches. 

For this reason, it is important to conduct the interviews systematically with each departing employee, minimising the opportunity for them to coordinate responses. Where possible, this may be achieved by inviting them all at short notice to attend interviews which are conducted simultaneously but separately.  In cases of suspected wrongdoing, evidence that is subsequently identified may also demonstrate that the employee has been either untruthful or selective in their answers. 

Second, employees often reveal information in interviews that the employer (let alone the sponsor) did not previously know about. This may include genuine grievances and important operational input for the employer to take on board and address, separately from the issue of departures. In regulated sectors, it will be particularly important to consider the compliance implications in parallel to the HR and employment issues, when such information comes to light. E.g., if an employee purports to justify exporting confidential materials to their personal device or inbox by saying the practice is widespread as a response to, say, the limitations of the employer’s IT infrastructure, it may be an unacceptable excuse, but the statement will nevertheless require checking, in case the practice is indeed wide-spread among the remaining employees, and in case consideration does need to be given to an underlying IT issue and the wider regulatory implications. Any genuine and documented grievances will also be relevant as evidence in any future court proceedings, as they may be relevant to counterfactual questions on whether employee X would have joined a competitor in any event, e.g., in the absence (say) of inducement by employee Y.

Third, the interview puts the employee on notice that the employer is taking the matter seriously, and thus encourages them to do the same. This can warn off other employees who may have considered joining the leavers, without thinking the matter through (although, conversely, if interviews are conducted in a way that appears heavy-handed, this may in the long term encourage further departures). Careful thought should be given to these issues, in conjunction with legal advice from specialist counsel.

Next week: We'll address best practice when conducing a forensic investigation to uncover what actually happened – i.e., the unglamorous but vitally important tasks of reviewing emails, download logs, and employee communications.