February 08, 2021 Practice Points

A Guide to the Enforcement of Forced Restrictive Covenants

Understand the competing factors to consider when drafting, disputing, and defending restrictive covenants.

By Eliyahu E. Wolfe and MacKenzie Gansert

Restrictive covenants prevent parties from taking actions they would otherwise be free to pursue. The enforcement of such covenants raises conflicting liberty interests: Their enforcement affirms parties’ freedom to contract, while restricting a party’s behavior; their invalidation undermines the freedom of contract, while granting greater personal freedom. How courts and legislatures balance these interests in determining the enforceability of restrictive covenants often turns on the parties’ respective free will.

Restrictive Covenants Can Be Essential to Deals

Restrictive covenants can be important to protecting contracting parties’ valuable and legitimate business interests. In some contexts, restrictive covenants can make a deal possible by contractually addressing known risks faced by the contract parties, including:

Sale of Business

A potential purchaser of a business could reasonably fear that the seller might join or create a competing business right after the sale. Here, a non-competition agreement provides the buyer peace of mind and could lead to a higher sale price.

Franchise Agreement

A franchisor’s business model requires sharing confidential information with franchisees. Without restrictive covenants in place, the franchisor runs the risk that franchisees will disclose critical information.

Employment

An employer may use restrictive covenants to ensure an employee does not poach clients, customers, or other employees, or take confidential information to a competing business.
 

Context Matters: The Who and Why of Restrictive Covenants May Dictate Different Results

The parties’ agreement to a restrictive covenant does not guarantee enforceability. Indeed, courts and legislatures treat restrictive covenants resulting from unequal bargaining positions with suspicion. And restrictive covenants that create undue hardship for one of the parties or that are overly broad may be found unreasonable and unenforceable. See Restatement (First) of Contracts § 515 (1932).

Courts have long recognized that relative bargaining power is critical to determining the enforceability of restrictive covenants. As the Seventh Circuit has explained, “business-sale noncompete agreement[s], which usually involve parties with relatively equal bargaining power, ‘stand in better stead’ than those in other contexts. Compared to noncompete provisions in employment contracts, those arising from business sales are ‘enforced on a more liberal basis.” E.T. Products, LLC v. D.E. Miller Holdings, Inc., 872 F.3d 464, 468 (7th Cir. 2017) (citations omitted).

While courts generally assess bargaining power by considering the surrounding transaction—the sale of a business, a franchise agreement, or an employment relationship—courts also consider the circumstances of negotiation. Presenting a potential employee with the terms of required restrictive covenants alongside an offer is quite different than thrusting the covenants on an employee on their first day, after they have left their former job.  Black’s Law Dictionary defines “coercion” as “[c]onduct that constitutes the improper use of economic power to compel another to submit to the wishes of one who wields it.”  Given the stakes involved in restrictive covenants, the absence of bargaining power due to economic necessity can be fatal to a restrictive covenant.

Jurisdiction Matters: Which State Law Applies Can Lead to Opposite Results

Courts and legislatures around the country differ in how they evaluate restrictive covenants. Some states heavily favor employees’ rights. For example, California has largely banned non-compete clauses.  Cal. Bus. & Prof. Code § 16600 (“Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.”).

In contrast, states like Georgia are more open to protecting business interests. After a 2011 constitutional amendment and the enactment of the Georgia Restrictive Covenants Act, Georgia courts now interpret restrictive covenants to provide reasonable protection to “legitimate business interests.”  O.C.G.A. § 13-8-54(a).

Practice Pointers

Well-drafted restrictive covenants should anticipate allegations of coercion and inequity. To protect against subsequent attacks on restrictive covenants, follow these tips:

  • Consider the parties’ bargaining power. Tailor the level of restriction in your covenants to the context.  Covenants in business sale contracts can be more restrictive than those required for employees.
  • Don’t overreach. Overly restrictive terms can backfire, so draft reasonable terms and be mindful of how restrictive covenants will impact the restricted party. Including reasonable geographic and temporal limits and making sure to only use restraints necessary to protect business interests increases the likelihood both that a party will honor the covenant and that a court will enforce it.
  • Have a backup plan. To mitigate the risk of invalidation or modification by a court, include a mandatory pre-suit mediation provision. If a restrictive covenant is later disputed, a pre-suit mediation provides a forum for negotiation before incurring more legal fees.

Eliyahu E. Wolfe is the principal attorney and MacKenzie Gansert is an associate at Wolfe Law, LLC, in Atlanta, Georgia.


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