By Robert S. Gilmore and Kirsten B. Mooney, of Kohrman, Jackson & Krantz LLP, a Meritas Law Firm
To protect their business interests and decrease the risk of future litigation, employers regularly enter into non-compete agreements with employees to limit the employee's ability to work for a competitive employer. These restrictive covenants are often included in employment agreements but may also be found in a variety of other agreements, including stock option agreements, deferred compensation agreements, and bonus plans. An employee may also be required to sign the agreement upon his or her departure as part of a separation agreement.
This article summarizes 10 tips that both the "Former Employer" (the company seeking to enforce its non-compete) and the "New Employer" (the company that hires the employee with the non-compete) should be aware of regarding non-compete agreements.
The Former Employer
1. Carefully Draft The Non-Compete Agreement
The key word for drafting a non-compete agreement is "reasonable." A company should first identify its specific business interests it is seeking to protect, and tie these interests to the employee's post-employment restriction. Examples of such business interests may include customer goodwill, trade secrets, and/or confidential information. If the two cannot be reconciled, the non-compete agreement is unreasonable. The company should also make sure to explicitly describe the prohibited activity by specifying which activities are restricted, providing geographic boundaries for the restrictions, and defining a time-frame for which the non-compete agreement will be enforced. Generally, as a rule of thumb, restrictions for 12 months or less are likely considered reasonable whereas restrictions for more thantwo years are more difficult to enforce.
As a best practice when drafting, you should also check state law to find out if your state has specific laws or restrictions for non-compete agreements. Laws on these types of agreements vary by state, with some states finding them in violation of public policy and others providing wide discretion to employers. Due to the variety among states, choice of law provisions in non-compete agreements make sense. The employer may identify a specific state's law to govern the interpretation of the agreement, even before a dispute has arisen.
2. Conduct An Exit Interview
The Former Employer should conduct an exit interview with a departing employee to confirm their continuing legal and contractual obligation(s). At this time, the Former Employer may be able to gather valuable information regarding the departing employee's future employment, provide the departing employee copies of his or her agreement(s), and advise the departing employee of the company's expectations for post-employment conduct. This is also a perfect time to assess what company property the departing employee has in his or her possession, and demand the return of such property. After the interview, the Former Employer should require the departing employee to sign an acknowledgment form, certifying that the employee has returned all company property and has not retained any confidential information.
3. Upon A Violation, Determine Your Course of Action
Upon learning that an employee has violated a non-compete agreement, the Former Employer should assess the violation and conduct a rapid, thorough investigation. The Former Employer should consider the amount of proof it possesses, what type of harm the violation has caused, and what type of future harm the violation is likely to cause. At this time, a forensic computer analysis of the former employee's computer may also uncover further evidence of the violation.
After completing the investigation, the Former Employer should decide if it is best to send a cease-and-desist letter or proceed directly to litigation. A cease-and-desist letter reminds the employee of his or her obligations and demands the employee immediately cease the unlawful conduct and provide assurances of compliance. This cease-and-desist letter may be sent to the former employee as well as the New Employer.
4. Initiating A Lawsuit
The Former Employer may forego sending a cease-and-desist letter in favor of immediate litigation. Litigation is often preferred if there is significant harm or damage to the Former Employer and/or there is a likelihood that evidence will be destroyed. Typically, the goal in initiating a lawsuit is to obtain immediate injunctive relief. If the Former Employer chooses to proceed with litigation, it must be fully prepared to present a compelling case. It is within the judge's discretion to determine whether the Former Employer has met its standard of proof, and employers often have difficulty meeting this standard absent some "smoking gun" evidence.
When filing a suit, the Former Employer must also consider the court in which to file and whether it should name the New Employer as a defendant. If the Former Employer included a choice of venue provision, the court in which to file may already be decided.
5. Find A Mutually Beneficial Resolution
Because litigation is risky and expensive, the Former Employer may wish to find an early resolution that protects its interests. This could save costs, quickly resolve the dispute, and alleviate the Former Employer's concerns regarding the employee's conduct. However, keep in mind, this is a risk-benefit analysis. If the harm to the Former Employer's company is significant, then continued litigation may be its best option.
The New Employer:
6. Properly Interview Candidates From Competitors
If hiring from a competitor, the New Employer should first determine if the candidate is subject to a non-compete agreement (or other restrictive covenants, such as a non-solicitation agreement). Always ask the candidate about any restrictive covenants at the earliest possible time, whether in an initial meeting, telephone call, or formal interview. The New Employer should also examine the candidate's agreements that may include non-compete language and/or have a lawyer review any post-employment restrictions the candidate reveals.
In addition, the New Employer should assess the likelihood of litigation and potential claims against it if it chooses to hire the candidate. These may include tortious interference, aiding and abetting breach of fiduciary duty, misappropriation of trade secrets, and several other causes of action.
7. Require An Acknowledgment
The New Employer should make sure that the new employee is a "good leaver." A good leaver not only reduces the risk of individual exposure but also reduces the risk of exposure for the New Employer as well.
A good leaver is a candidate who has behaved appropriately in separating from previous employment. To be a good leaver, the candidate should return all materials and/or property to their Former Employer, avoid bringing any such property to his or her new position, and ensure that all ties are properly cut with the Former Employer. The New Employer should require that the candidate sign an acknowledgment, affirming that he or she has taken these steps.
8. Consider Whether To Indemnify The New Employee
Because of the potential conflicts of interest that may arise, the New Employer should encourage the employee to seek independent legal counsel regarding the enforceability of his or her non-compete. However, the new employee may ask the New Employer to indemnify him or her against potential litigation and/or pay attorney's fees obtained in acquiring a defense. The New Employer's response may depend on how much it wants to hire the new employee. Any agreement to indemnify the employee should be clear and exclude indemnification for intentionally dishonest or fraudulent conduct.
9. Promptly Respond To Any Cease And Desist Letters
Even if the New Employer does everything right, it may still receive a cease-and-desist letter from the Former Employer, complaining about the circumstances of the employee's hire and threatening legal action. A prompt response to these letters is important. The New Employer should use an appropriate (and not hostile) tone, provide assurances where necessary, and maintain an open dialogue. As these letters are often used as exhibits in resulting litigation, the New Employer should always draft the response for a potential judicial audience.
Cease-and-desist letters often include preservation notices which trigger a duty to preserve evidence. Accordingly, upon receipt of such letter, the New Employer should issue a document preservation notice to all pertinent individuals and appropriate IT personnel.
10. Defense Strategies For Litigation
In most states, non-competes are considered enforceable if they are reasonable. However, there are a number of defense tactics that may successfully invalidate the non-compete agreement. The New Employer may argue that the non-compete is too broad in geographic scope or duration and/or is unnecessary to protect the Former Employer's legitimate business interest(s). Generally, courts consider any limitation that creates an undue hardship on the employee as unreasonable.
However, be aware of the "blue pencil" rule. In certain states, the blue pencil rule allows a court, in its sole discretion, to tailor, reform, or modify an otherwise overly broad non-compete agreement to make it reasonable under the law. In other states, if the non-compete is considered unreasonable, there is no saving it.
Given the above challenges regarding non-competition agreements, employers on either side of the issue should follow an appropriate course of action to protect their business interests and avoid litigation.