Happy end-of-2012 to all from The Emplawyerologist! Now that we know from the last three posts about confidential information and trade secrets, ( Click here, here and here for a review) what other mechanisms are available to employers who wish to safeguard their secrets? Employers who are serious about ensuring that employees do not run off with information that affords them a competitive edge need to include restrictive covenants (also known as “non-competes”) in their employment agreements. What is a restrictive covenant? In short, it is an agreement by an employee not to engage in, work for or invest in a business that competes with his or her present or former employer. Does that mean that once your employee stops working for you that s/he can never work for any company that competes with yours? No. There are, of course, limits on how much an employer can restrict present and former employees, which we will address soon. As always though, we need to cover some basics.
First, what might a restrictive covenant look like? Typically a restrictive covenant will read very similarly to this one:
During the course of my employment with Fantabulous Firm, Incorporated (“FFI”) and for a period of two years after termination thereof, I hereby covenant and agree not to directly or indirectly, (a) become employed by or render services to any person, firm or corporation located within a 50-mile radius of any office of FFI where I worked or any territory where I sold/recruited/worked/conducted any business activity on behalf of FFI, that is engaged in any business competitive with FFI or any of its subsidiaries, or affiliates; or (b) engage in such business on my own account; or (c) gain a financial or other interest in any such business, directly or indirectly, as an individual or partner, shareholder, director, officer, agent, employee, trustee, consultant or any other relationship or capacity: provided however, that nothing contained herein shall be deemed to prohibit me from acquiring, solely as an investment, not more than 1% of the shares of capital stock of any public corporation.
Omigosh! What does all that mean? Let’s break down the legal mumbo-jumbo into the main components, and discuss each part in plain English:
- Time Limits/Perameters: The first phrase discusses when and for how long the restrictions will apply. An employee may not engage in the prohibited activity during his or her employment at FFI and for two years after termination of his/her employment. Note that our sample covenant does not limit the covenant to termination for cause. (We will briefly return to this point a bit later).
- Agreement language: Some might say this is the crux. This next bit of phraseology begins with the employee agreeing to refrain from certain activities, which are then listed. Here, the employee agrees not to work for or provide services as an independent contractor for a firm that competes with the employer, not to start his or her own competing business, and not to gain a significant financial interest in another business that competes with the employer. Note the language that limits both direct and indirect competition.
- Geographic Restriction: This language tells the employee the geographic areas to which the restrictive covenant will apply. Within the area(s) the employee may not work for or start his or her own competing business. Outside the geographic area s/he may. Why not leave out the geographic restriction altogether? Hang on to that question! The answer to that question and more is included in the coming attractions!
In our sample covenant, the employee is agreeing that s/he will not work for, run or hold a significant ownership interest in a competing business located within a 50-mile radius of any office where s/he worked for the employer or any territory where s/he may have conducted business activity on behalf of the employer both during and for two years after termination of his/her employment with FFI. Is this legal? It depends on the state in which the employer is doing business. California, Colorado, Hawaii, Montana, North Dakota and Oklahoma essentially void non-competes in the employment context. (Most states will allow non-competes in the context of a sale of a business.) Those states that do allow restrictive covenants in the employment context require that they meet certain stringencies, however. Some states will allow courts to modify restrictive covenants up to a point.
When and why would an employer want to use a restrictive covenant with its employees? Employers will use restrictive covenants to prevent certain of its employees from using its trade secrets, customer relationships and commercially sensitive information to the competitive disadvantage of the employer. Misappropriation of such information can occur either during or after termination of the employment relationship. Courts, in deciding whether and how to enforce restrictive covenants, have to balance an employee’s right to pursue employment or business opportunities commensurate with their qualifications against an employer’s right to protect proprietary information and customer relationships that it has developed at its own expense. Employees who accept work from competitors or who start competing businesses put themselves in a position where they are more likely to breach confidentiality provisions and misappropriate trade secrets than if they pursue opportunities that do not directly compete with their current or former employer. In some cases, it may be impossible for an employee to work for a competitor without disclosing or using confidential information or trade secrets. The idea behind a restrictive covenant is to prevent unfair competition. Working for a competing business without using confidential information or trade secrets obtained from one’s previous employer to the competitive disadvantage of the previous employer is fair competition. Courts generally will not enforce a non-compete that seeks to eliminate fair competition.
When and under what circumstances do courts enforce restrictive covenants and what factors do courts generally consider? Join The Emplawyerologist next week and find out! Meanwhile, enjoy your New Year celebrations!
Click here to learn more about Janette Levey Frisch, author of The Emplawyerologist.