Overview
State law governs most post-employment restraints, and since the rules vary significantly by jurisdiction, restrictive covenants must reflect the limitations acceptable under the law likely to control. The covenant not-to-compete must define the scope of prohibited activities, where the prohibition applies, and how long it will last. The reasons that the company requires protection against unfair competition should be stated, such as employee access to confidential information; relationships with customers, suppliers, and others; and/or knowledge of operations, plans, finances, etc.
Fundamental Employee Rights
Absent a covenant not to compete or breach of a confidential relationship, employees may plan to compete with their employer while still employed and can leave employment and compete with a former employer.
Protectible Interests of Employers
When an employee's position enables the employee to learn proprietary information, the employee's departure exposes the business to unfair competition by the former employee because knowledge of his former employer's confidential information, operations, and customers may provide an undue advantage.
- In most jurisdictions, employers have a limited right to protect against such competition, and restrictions that are reasonably necessary to protect an employer are valid. Some states have legislation limiting the right of employers to restrain competition. Legislation may cover all employers (e.g., California Business & Professional Code § 16601 et seq.) [http://www.leginfo.ca.gov/cgi-bin/displaycode?section=bpc&group=16001-17000&file=16600-16607], or laws may focus on specific professions (e.g., Massachusetts General Laws ch. 112, § 12X) [https://malegislature.gov/Laws/GeneralLaws/PartI/TitleXVI/Chapter112/Section12x]. Since an employee's agreement not to compete after employment ends is in restraint of trade [http://heinonline.org/HOL/Page?handle=hein.journals/nylr57&div=24&g_sent=1&collection=journals], it will be strictly construed. Any ambiguity in a post-employment noncompete agreement will be construed in favor of the employee. In suits to enforce restraints, employers bear the burden to show that the restraint is no greater than necessary to protect a legitimate business interest; is not unduly harsh in curtailing an employee's ability to earn a livelihood; and is reasonable. Prohibiting a former employee from employment in any capacity by a competing company is often deemed unreasonable. When an employee is hired, it is appropriate to obtain a representation that the employee is not covered by any agreements restraining the employee's right to perform the duties of the position, and that the employee will not disclose any former employer's confidential information.
Consideration for Enforceable Covenants
A covenant must have consideration flowing to the employee. Accepting employment at-will is sufficient consideration to support a restrictive agreement by an employee. But if the only consideration for the agreement is the employment itself, courts diverge on whether an enforceable agreement restricting post-employment competition must be signed before employment commences.
- In some states, although an employer never mentioned at the time of hiring that there would be any post-employment restrictions on competition, courts will enforce a covenant signed after employment commenced. In other jurisdictions, noncompete agreements are void for lack of consideration when employers fail to include them in the original terms of employment. (E.g., Or. Rev. Stat. Ann. § 653.295 [http://www.oregonlaws.org/ors/653.295]. Even in states where continued employment is insufficient consideration for a covenant signed after an employee began working, when the agreement is supported by independent consideration, it will be enforceable. A wage increase, a bonus, a new benefit, or a change in status can be sufficient consideration for covenant agreed to after employment commences. (E.g., Battleground Veterinary Hosp., P.C. v. McGeough, No. 05 CVS 18918 (N.C. Super. Oct. 19, 2007) (when relationship established before covenant signed, consideration for covenant requires pay raise or new job assignment) [http://www.ncbusinesscourt.net/opinions/101907%20Order%20Webpage.pdf]
Confidential Information
Covenants not to compete will be enforced to prevent the misuse of employer trade secrets, customer contacts, and other confidential information, but an employer seeking to protect trade secrets must be able to show it has taken steps to preserve the information's secrecy by adopting nondisclosure policies, conveying to employees the confidential nature of secret information, and enforcing security measures. The Uniform Trade Secrets Act (UTSA) [http://www.uniformlaws.org/shared/docs/trade%20secrets/utsa_final_85.pdf], adopted in many jurisdictions, empowers employers to protect information that derives value from not being generally known. UTSA protections apply only to information that a business makes reasonable efforts to keep secret.
Reasonable Restraints
Lack of durational and geographic limitations renders a covenant void. A former employee's agreement not to compete against his ex-employer will be upheld if the restraint is no wider geographically and no longer in duration than reasonably necessary to protect the business of the employer. (E.g., Concord Orthopaedics Prof'l Ass'n v. Forbes) [http://www.courts.state.nh.us/supreme/opinions/1997/copa.htm]
- Determining the reasonableness of a restraint requires an examination of surrounding circumstances, including the nature of the employer's business, the subject matter, the purpose served, the situation of the parties, the nature of the former and subsequent employment of the employee; whether the employee is highly skilled or unskilled; and whether the covenant is necessary to prevent the solicitation of customers.
Reasonable Geographic Restraints
When the primary concern is the employee's knowledge of customers, the territory should be limited to areas in which the employee made contacts during his employment. A covenant related to the territory where the employee was employed will generally be accepted as a legitimate protection of the employer's investment in customer relations and good will, but a restraint reaching everywhere the employer does business may be deemed overbroad.
Reasonable Temporal Restraints
The reasonableness of the temporal limitation depends upon the time required to obliterate in the minds of customers the identification formed during the period of employment. The higher in management and the more important the functions of the employee, the longer the time which can be justified.
Blue Penciling
A restraint that is found overbroad may be modified in some jurisdictions by making them more narrow, rather than striking them in their entirety. Different approaches are taken by the courts in such circumstances.
- Some courts will "blue pencil" (i.e., cross out) the overbroad provision. If the agreement is reasonable without the excised portion, the agreement will be enforced. Other courts will actually revise the restrictions agreed to by the parties.
Covenants Not to Solicit Customers
An employer has a protectable interest in at least current customers, if not all past customers. A covenant against solicitation of customers can protect business relationships with customers who might be solicited by a former executive, and a non-solicitation clause may be easier to enforce than a non-compete.
- A former employee may be forbidden from soliciting customers for a reasonable time after terminating employment if they are clients or accounts with whom the former employee actually did business or had personal contact. Covenants designed to protect customer relationships do not require geographical limitations, but a covenant preventing any contact with customers may be deemed too broad.
Employee Solicitation
Most courts will enforce contractual agreements restricting a former employee from poaching employees after the employment relationship ends. Such agreements, like covenants not to compete, must be supported by consideration.
Effect of Termination
Some states deny enforcement following a termination, depending whether termination was for cause or not.
- In such jurisdictions, if the employer has materially breached the employment agreement in terminating the employee, courts will not enforce a post-employment restraint. In some jurisdictions, courts will not enforce restraints against employees terminated without cause. (E.g., Eastman Kodak Company, v. Carmosino, CA 10-01062 (N.Y. App. 2010)) [http://www.nycourts.gov/courts/ad4/clerk/Decisions/2010/10-01-10/PDF/1121.1.pdf] By its terms, the agreement imposing post-employment restraints should apply regardless of whether the executive resigns, or is terminated with or without cause. One strategy for promoting compliance and achieving enforcement is to tie the period of the restraint to a severance package. In circumstances involving a termination without cause, where a severance package will be paid over time, severance payments may be conditioned upon compliance with the post-employment restraint.
Injunctions
A prompt injunction precluding competition by a former employee is usually the essential relief to avoid competitive harm.
- In general, an employer seeking to enjoin a former employee from competing pursuant to a contract must establish four elements: likelihood of success on the merits; greater injury would result from not enforcing the agreement than from enforcing the restrictions; irreparable harm will occur unless the injunction is granted; and the public interest would be served by granting the injunction. The agreement should contain an acknowledgement that, because of employee's knowledge and role in the company, a breach of the covenant not to compete would cause irreparable harm, the restraint would not prevent the employee from earning a living, and immediate injunctive relief to prevent the breach would be essential. The duration of an injunction may run from the date of the court's order, or from the termination of employment.
Damages
Former employees may also be liable for monetary damages measured by the net revenue lost due to the competition, disgorgement of the employee's profits, as well as other tort damages. Some jurisdictions will enforce a liquidated damage provision in an agreement not to compete, provided that they are not a penalty. Caution must be exercised, however, because in some jurisdictions, the presence of a liquidated damage clause may preclude injunctive relief.
CONCLUSION
A post-employment covenant not-to-compete should define what activities are prohibited, where the prohibition applies, and how long it will last, citing the reasons why protection is necessary. A prohibition against solicitation of customers is also valuable in preserving relationships with customers. Post-employment restraints should apply regardless of whether the executive resigns, or is terminated with or without cause. By linking the period of the restraint to the payout under a severance package an employer may increase the probability of compliance with the restraint, as well as the likelihood of success in its enforcement.
Additional resources
- Covenants Not to Compete: A State-by-State Survey, Ninth Edition Employee Duty of Loyalty: A State-by-State Survey, Fifth Edition Tortious Interference in the Employment Context: A State-by-State Survey, Third Edition Trade Secrets: A State-by-State Survey, Fourth Edition Former Employee's Duty, In Absence of Express Contract, Not to Solicit Former Employer's Customers or Otherwise Use His Knowledge of Customer Lists Acquired in Earlier Employment, 28 A.L.R.3d 7
Stewart S. Manela is a Labor & Employment partner with Arent Fox. Stewart's practice involves representing and advising employers on personnel decision making, planning employee terminations, and counseling employers regarding extraordinary employment actions such as mergers and acquisitions, reductions in force, plant closings, and union organizing. He has extensive experience with the employment laws and socio-economic programs that apply to companies that are involved in contracting with the federal government, and frequently advises government contractors.
