Sometimes an employer’s greatest legal concerns do not arise until after an employee has left the company. Unfortunately, it may be too late at that point for the employer to adequately protect its interests.
In the absence of a restrictive covenant in an employment agreement, a company’s former employees are generally free to immediately go to work for a competitor and to solicit their former employer’s customers and employees. This relative freedom can result in great harm to the previous employer, particularly in instances where the former employee had particularly strong relationships with customers, vendors or other employees. In short, unless a company requires that its employees execute legally enforceable restrictive covenants (often referred to generically as “noncompete agreements”), there may be no way to prevent former employees from taking the training and knowledge provided to them and putting them to work for a direct competitor.
In many ways, restrictive covenants are subject to the same basic requirements of other contracts in that they must be written, must be supported by consideration and must include sufficient certainty with respect to the terms of the agreement. In many states, however, restrictive covenants in the employer-employee context are subject to much more scrutiny than an ordinary contract. State courts follow the modern trend of enforcing noncompete covenants, but they continue to generally disfavor noncompete agreements as restraints on trade and construe them in favor of the employee. Restrictive covenants must be narrowly tailored to an employer’s legitimate, protectable interests. Furthermore, covenants not to compete that implicate important public policy issues generally are even more strictly construed.
When drafting a restrictive covenant, therefore, it is important for an employer to consider exactly what interests it wishes to protect and how narrowly it can tailor a restrictive covenant to accomplish its goals.
Although they are commonly lumped together and referred to as “noncompetes,” there are actually several different types of restrictive covenants that an employer can utilize when attempting to protect its interests. The appropriate type of covenant depends on the type of protection the employer needs. Generally speaking, restrictive covenants fall into one of the following categories.
In its purest form, a covenant not to compete prohibits a former employee from engaging in any business or activity that is competitive with his or her former employer. Because it is the broadest and most restrictive type of covenant, it is subjected to the most judicial scrutiny. To be enforceable, a noncompetition covenant must be reasonably limited with respect to duration, geography and the scope of activities engaged in by the former employee.
These covenants do not specifically prohibit the ability of a former employee to engage in competition. Rather, they prohibit the employee’s solicitation of customers (and sometimes vendors, suppliers or similar entities) who have established business relationships with the former employer. Similar to noncompetition agreements, non-solicitation agreements are reviewed as to whether they are reasonably structured to provide the former employer protection against unfair competition.
These covenants are similar to those regarding the non-solicitation of customers, but instead prohibit the former employee from soliciting or recruiting his or her former employer’s employees.
Information that is acquired through a confidential relationship may be protected even if the information potentially could have been obtained through independent research. Customer information that is not readily ascertainable, information concerning suppliers and information concerning customers’ specialized requirements, needs and product preferences may be entitled to protection, although each case is heavily fact-dependent. Employers may be able to protect their trade secrets and confidential information by relying upon the inevitable disclosure rule that prevents information from being disclosed when disclosure of such secrets would be inevitable based on the former employee’s employment with the competitor. It is important to note that, although many nondisclosure covenants include the term “trade secret,”
Some states have adopted a “blue pencil” rule that provides that an unreasonable restriction against competition may be modified and enforced to the extent that a grammatically meaningful reasonable restriction remains after the words making the restriction unreasonable are stricken.Courts may therefore enforce covenants not to compete to the extent that they are reasonably necessary to protect the employer’s interest without imposing undue hardship on the employee when the public interest is not adversely affected. If the scope of the covenant is reasonable as written, it will be enforced as written. If the scope is unnecessarily burdensome to the employee, however, it will be enforced only to the extent that it is reasonably necessary to protect the employer’s interest without imposing undue hardship on the employee when the public interest is not adversely affected.
Note: Judicial modification is not always available. Courts will refuse to modify a noncompete provision that has been oppressively drafted.
Generally speaking, time limits of one or two years will be enforced in most circumstances. Time limits must be no greater than necessary to protect the business interest of the employer. Restrictions longer than three years have also been approved but these are usually in the context of the sale of a business or of an interest in a business.
As with time limitations, territorial limits must be no greater than necessary to protect the business interests of the employer. Unless trade secrets are involved, covenants that embrace an area in which the employee never performed services are generally considered unreasonable. However, noncompete agreements are construed at the time of making so that an employer that reasonably anticipated a broader territory than was ever eventually worked may be able to enforce the restriction for the entire territory. The courts will typically enforce a covenant that encompasses the sales territory of the former employee. Sometimes, reasonableness may require that territorial restrictions be as narrow as just a few miles or be limited to the county in which the former employee worked. Depending on the nature of the business and its service area, broader, regional restrictions may also be reasonable. Even broad, national restrictions may be reasonable for certain types of businesses or classes of employees. For instance, although the geographic scope of a noncompete agreement for a horse trade publication was national, it was not overly broad where the former employer was one of only six or seven publications in the field with a national scope that covered Saddlebred horse shows regardless of where they were held in the country. In the business of selling music for radio and television advertising purposes, a restriction covering the United States, Canada and Mexico was reasonable given that plaintiff established that it did business in 48 states. In a case involving a dispute between a securities brokerage and one of its former salesmen, the court enforced a restriction that the defendant not be employed by any competitor within 1,200 miles of the employer.
It is not unusual for businesses to employ individuals outside the state where the business is incorporated or has its headquarters. The law in different states vary substantially concerning the enforcement of a noncompetition agreement, what limitations are enforceable and for how long or even whether such agreements are enforceable at all. Therefore, careful thought must be given before attempting to have every employee sign a company’s “standard” noncompetition agreement. Employers should review such agreements with their counsel to make sure that the agreement will be enforceable in the particular circumstances and that seeking to have it signed as a condition of employment will not result in liability under the law of another state. A multistate employer should review noncompetition agreements for compliance with the laws of every state in which the company does business. Some states, such as California and Oklahoma, simply refuse to enforce any post-employment restrictions even if the choice of law provision is for a state in which the restriction is allowed. Therefore, an employer should be hesitant if trying to use a one-size-fits-all approach for this state-driven issue.
In general, the activities that a noncompetition covenant seek to prohibit should be of the same nature as, although not necessarily identical to, those that the employee performed for his previous employer. Furthermore, the nature of the business interest that the employer seeks to protect should be clearly explained in the agreement.
The scope of competitive activities prohibited by a non-solicitation covenant should also be clear. It has long been settled that present customers are a protectable interest of an employer. Some courts have suggested that a restriction against solicitation of all former clients, regardless of whether the employee had any contract with the client, is overbroad. Some courts have suggested that a prohibition of soliciting “future clients” is too vague to be enforceable but others have suggested a restriction against soliciting prospective customers with whom the employee had contact may be enforceable. Again, the ultimate test is whether the restrictions are crafted in a way to provide genuinely needed protection to the former employer against unfair competition.
Courts generally have recognized that a covenant not to compete is assignable by an employer, unless the covenant says it is a personal services contract and not assignable.
Injunctive relief is almost always sought in lawsuits attempting to enforce restrictive covenants and is often the only issue that ends up being decided. Both the employer seeking to enforce a restrictive covenant and the employee (or subsequent employer) seeking to invalidate the covenant have the option of filing for a temporary restraining order, preliminary injunction and/or declaratory judgment. Damages are also available and can include both lost profits and incidental damages flowing from any breach of the covenant. As in other contract actions, punitive damages are not available.
Employers who do not secure any restrictive covenants are not necessarily without recourse in the event that a former employee discloses or uses certain proprietary information. Employees have a common law duty of loyalty to their employer not to disclose confidential information. The vast majority of states have adopted a version of the Uniform Trade Secrets Act (UTSA) and protect information that can constitute a trade secret even in the absence of any written agreement.
Policies and Forms
Chapter 06: Restrictive covenants and trade secrets