Employers often enter into post-employment restrictive covenants (commonly referred to as noncompete agreements) with employees only to find that when the employees leave, the restrictive covenants are not enforceable or do not provide sufficient value to the company.
Here are seven steps to improve post-employment restrictions:
Identify the Legitimate Interest to Be Protected
An employer must have a legitimate interest that will be protected by restraining an employee’s ability to compete. Protecting trade secrets, confidential information or unique relationships with clients are generally recognized in many states as legitimate interests that will support enforcement of a restrictive covenant. For example, when an employee has access to marketing or product development plans, the employer may have a legitimate protectable interest in preventing the employee from using knowledge of that confidential information for a competitor. Similarly, if an employee develops unique relationships with the employer’s clients, the employer may have a legitimate interest in protecting the good will inherent in those relationships.
The employer should have a clear understanding of the legitimate interests a restrictive covenant is designed to protect before entering into the restrictive covenant. Once the protectable interests are identified and understood, the restrictive covenant should be crafted to protect those interests without overreaching.
Ensure the Restrictive Covenant Is Reasonable
Restrictive covenants will typically only be enforceable in most states if they are reasonable in scope, geographic range and duration. Reasonableness depends on the nature of the employer’s legitimate interest and varies from industry to industry, from position to position, and often from state to state. Drafting a restrictive covenant that is more likely to be enforced requires understanding what the company realistically and reasonably needs to protect its legitimate interests if the employee leaves.
For example, if the employee is a salesperson whose territory is the Pacific Northwest and the employer’s legitimate protectable interest is the salesperson’s unique relationships with clients in that territory, a restrictive covenant preventing him or her from selling a competing product in the Pacific Northwest might be reasonable. On the other hand, an otherwise identical restrictive covenant preventing him or her from selling a competing product anywhere in the United States may be overbroad and unenforceable.
Similarly, a three-year restrictive covenant precluding an employee from working for a competitor might not be reasonable if it is based on the employee’s unique relationships with clients and the employer only needs one year to introduce and train a replacement. Finally, a restrictive covenant that precludes a vice president of marketing with responsibility for one particular product line from working in any capacity for any company that competes with the employer, even on an entirely different product line, might be overbroad.
Consider Which State’s Law Should Apply
Determining what law applies to a restrictive covenant can make the difference between enforcement and irrelevance. For example, California has a statutory prohibition on the enforcement of most restrictive covenants, but New York will uphold restrictive covenants in appropriate circumstances. Employers that have all of their operations and employees in a single state typically apply the law of that state in their restrictive covenants. Employers with employees in several states, however, may be able to choose the law to apply. This requires analyzing the laws of the potentially applicable states and including an appropriate choice-of-law clause in the agreement.
In addition, restrictive covenants typically should contain choice-of-forum clauses requiring that disputes must be litigated in the state whose law was chosen. Courts in some states may ignore provisions choosing the law of a different state on the theory that their state’s public policy or interest in restrictive covenants overrides the parties’ choice of law. Many courts, however, will enforce choice-of-forum provisions and leave it to the forum state to determine which law to apply. Thus, if a restrictive covenant provides for Florida law, the agreement should also require that disputes be litigated in Florida.
To further increase the likelihood that choice-of-law and choice-of-forum clauses are enforced with regard to employees who do not work in the chosen state, the employer can ensure that there are contacts between the employees and the chosen forum. These contacts could include having the employees attend training programs in the forum state, report to management in the forum state, take on responsibility for clients or vendors in the forum state, or supervise employees in the forum state.
Many employment agreements and restrictive covenants require arbitration of disputes. Even if the parties prefer arbitration, the agreement should permit the employer to seek injunctive relief from a court.
Confirm the Covenant Is Supported by Consideration
Like most contracts, a restrictive covenant should be supported by valid consideration at the time of the agreement. Where a restrictive covenant is part of an employment agreement with a new employee, the offer of employment is often sufficient consideration. What constitutes valid consideration for a restrictive covenant with an existing employee can be a thornier issue.
In some states, continued employment of an at-will employee is valid consideration for a restrictive covenant. In other states, more tangible consideration — such as a raise or promotion — may be needed to support a restrictive covenant with an existing employee.
Decide Whether to Pay During Restriction Period
The company should decide whether to pay the employee during the post-employment restriction period and, if so, how much. Paying the departing employee may enhance the likelihood of a court enforcing the restrictive covenant, because, among other things, payments lessen the potential harm to the employee from enforcement of the covenant.
If payments will be made, the company should examine whether to pay only base salary or to also pay commissions or bonuses. The company should consider whether the agreement should permit payments to end if the employee violates the restrictions or should allow the company to terminate payments if the company does not wish to enforce the restrictive covenant.
Distinguish Between Restrictions
Not all restrictions are created equal. Notice provisions, garden leave and post-employment restrictive covenants serve different functions and can lead to different remedies if they are breached by a departing employee. For example, a provision requiring an employee to give 30 days’ notice theoretically provides the employer advance warning and an opportunity to prepare to replace the employee.
Many courts, however, will not specifically enforce notice provisions, so they might not give the employer the protection it seeks (although damages could still be available). Similarly, garden leave provisions require an employee to stay home from the office while remaining an employee in all other respects. This provides the employer with an opportunity to transition the departing employee’s responsibilities to a new employee before the departing employee begins working for a competitor. In practice, however, some courts enforce garden leave provisions only if they meet the criteria for enforcement of restrictive covenants.
Notice provisions, garden leave and post-employment restrictions are all potentially useful tools, but it is important to understand their benefits and limitations and to consider which of these tools provides the best protection in each situation.
Prepare to Enforce Before Employees Leave
Employers often seek to enjoin departing employees from breaching (or continuing to breach) their restrictive covenants. Seeking injunctive relief requires moving deliberately and quickly once an employee leaves. It is helpful for the employer and its counsel to identify in advance the steps they will take when employees breach their restrictive covenants. Steps could include ensuring that the company maintains files for each employee with copies of contracts and other key information, having template litigation papers prepared, or ensuring that the company’s IT professionals are equipped and prepared to search for evidence of misappropriation of company information or improper communications with company employees or clients.
Enforcement of restrictive covenants depends on a number of factors, many of which are within the employer’s control. Careful thought and drafting before restrictive covenants are signed can increase the likelihood and consistency of favorable outcomes when employees leave.
This article first appeared in Corporate Counsel, a Legal affiliate based in New York. •
Jeffrey S. Boxer, a partner at Carter Ledyard & Milburn, is a commercial litigator focusing on employment law, restrictive covenants, protection of trade secrets, arbitration and jurisdictional issues. He advises financial and international corporate clients on employment and unfair trade practices and breach of contract and duty issues.