Do you use restrictive covenants, or noncompetes to prevent former employees from competing with your company? Typically, a noncompete prohibits former employees from working for a competitor or soliciting his or her former employer’s clients or live prospects. When an employee violates the agreement the employer sues, seeking an injunction barring the employee from working for the competitor, and money damages. If you or someone you know has taken this route before, you know that success is anything but certain. Is there anything else you can do? Maybe. In some cases you might actually be able to influence your former employee to willingly choose not to compete. How does that work? Let’s talk some more, after the jump…
So how do you get your employee to agree not to work for a competitor –and maybe even be happy (or at least not too upset) about it? Clearly you have to offer more than just your typical noncompete. One option: a forfeiture-for-competition clause. A what? Here’s how it works. You offer a benefit, usually some type of deferred compensation, to the employee at the beginning of or during his/her employment with you. You link payment of that benefit to an obligation not to quit your firm and work for a competitor. If s/he chooses to work for a competitor s/he forfeits the benefit.
What type of benefit might you offer? Many employers offer stock options or incentive compensation plans. Admittedly, deferred compensation is usually offered to employees in high-level positions. Forfeiture-for-competition clauses therefore might not be appropriate for employees that are not in high-level positions. On the other hand, courts may not feel a noncompete for rank-and-file employees is necessary to protect an employer’s legitimate interests. In other words, you probably shouldn’t make every employee sign an agreement with non-compete provisions — or at least not the same provisions.
What if you have a two-year non-compete with an employee who quit, starts receiving stock options two months later and then another six months later goes to work for a competitor? If you have a forfeiture clause does that only apply prospectively? If so are you now out the value of the stock options s/he has already received? Maybe, unless you also have a “clawback” provision. A clawback provision requires the employee to pay back compensation s/he received when certain specified events occur. Your clawback provision can specify that employees who go to work for a competitor after having received deferred compensation benefits must pay back what they received. The clawback can also require repayment of benefits if the employee divulges your company’s confidential and/or proprietary information, misappropriates trade secrets, violates company policies or disparages the company. This type of provision is sometimes also known as a “bad boy” provision. (Now I didn’t coin the phrase and I don’t know who did, so I can’t tell you who to scold for any sexism.)
You can probably see why forfeiture-for-competition clauses might be attractive. First, they provide an alternative to the usual lawsuit with its often unpredictable and inconsistent results. Second, and perhaps more important, it carries with it the possibility that the employee will often choose not to compete, because you are giving that employee a positive incentive. Whether the employee chooses to fulfill the don’t-quit-and-don’t-compete obligation will, of course, depend on just how much incentive you provide. The benefit you offer must be enough to make a difference. You might even be giving that employee an incentive to stay with you — or stay with you longer– in the first place. Perhaps even most important of all, is that in many jurisdictions a forfeiture-for-competition clause is subject to considerably less scrutiny than a typical noncompete. Many courts are much less concerned with the reasonableness of a post-employment restriction inherent in a forfeiture-for-competition clause than with a traditional noncompete. A restriction in a forfeiture-for-compensation clause can often be much broader than a traditional noncompete. Why is that? Here is the underlying reasoning: the employee can choose to retain the right to the benefits or compete and risk forfeiture. This is known as the “employee free choice” doctrine. It is a post-employment restriction, but it doesn’t deprive someone of their livelihood, because the employee who chooses to keep the money and refrain from competing will generally only do so if the income from the benefits plus the noncompetitive employment equals or exceeds what s/he would earn from competitive employment.
You may have also heard of a variant known as “garden leave”, in which an employee continues to collect a salary for a specified period of time but does no work for the employer — or any competitor–during that period of time. This sort of arrangement seems less common in the United States and more common in England, but it is an option. Since an employee would continue to draw his or her salary while not competing it would generally meet the requirement that it be reasonable and is less likely to encounter the same enforcement challenges as a traditional noncompete.
As attractive as a forfeiture-for-competition clause may be, there are some caveats. First, the benefit must actually be an incentive for performance with the company or for abiding by certain requirements, and cannot fall under the category of regular wages, such as ordinary commissions or bonuses (which might also violate state wage payment laws.) Stock options, phantom stocks, management incentive bonuses are appropriate for forfeiture-for-competition arrangements. Second, the forfeiture or competition must be a true function of the employee’s choice. In other words, the employee must either have voluntarily resigned or been terminated for cause. Most courts recognizing the validity of forfeiture-for-competition clauses will not enforce them if the employee was involuntarily terminated without cause. Additionally, there are still some courts that will scrutinize forfeiture-for-competition clauses just as closely as traditional noncompete provisions. Those courts will refuse to enforce restrictions they see as overbroad and will strike down forfeitures-for-competition if they feel the employer does not make sufficient showing of the protectable interest. Texas is one such jurisdiction (See Valley Diagnostic Clinic v. Dougherty, No. 13-08-00201-CV (Tex. App. — Corpus Christi Feb. 12, 2009).
Just to make sure we don’t make this post too long, let’s stop here for now and continue next week. See you then!
Disclaimer: This post and all its contents are for educational/informational purposes only, are not intended as legal advice, do not create an attorney-client relationship, and are not intended to replace consultation with competent employment counsel in the state(s) in which you employ people.
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