A common issue that arises in the employment context is whether a company may prevent departing employees from competing against it, soliciting its customers or using the company's information for their own purposes. Contract provisions that prohibit former employees from engaging in these types of activities are commonly referred to as "restrictive covenants." This Practice Point summarizes key points that every practitioner should know about restrictive covenants. For those interested in learning more, download this detailed outline on restrictive covenants.
Types of Restrictive Covenants
There are four basic types of restrictive covenants. A non-competition provision prohibits a former employee from competing against his or her former employer within a particular geographic area for a specified period of time. These are considered the most restrictive. A non-solicitation provision prohibits a former employee from soliciting its former employer's current, prior or prospective customers for a specified period of time. An "anti-raiding" provision prohibits a former employee from soliciting the former employer's employees, for example, to work at a competing business. A confidentiality agreement prevents a former employee from disclosing or using the proprietary or confidential information of his or her former employer, or that of its employer's customers. The information at issue need not constitute a "trade secret" per se; it must simply be confidential and not publicly available. A fifth, termed a "garden leave provision," is a relatively new import to the United States from the United Kingdom and other European countries. This provision requires an employee to give notice of his or her future departure. For a specified period, the employee remains employed, though he or she performs little to no work.
The most critical points to keep in mind are that the enforceability of restrictive covenants depends on state law and that the law varies by state. Many states have enacted statutes which provide a framework for courts in their jurisdictions to follow or presumptions as to when such restrictions are enforceable. The majority of states, however, assess restrictive covenants based on a "reasonableness" test. This is a fact-specific test grounded in common law. It provides that a restrictive covenant is reasonable, and thus, enforceable, if: (1) its terms are no greater than is required to protect the employer's legitimate business interest; (2) it does not impose undue hardship on the former employee; and (3) it is not injurious to the public.
While restrictive covenants are most commonly found in employment contracts, they may be included in several other types of agreements. Examples are stock grant agreements, severance agreements, or shareholder agreements. The last is notable. Shareholders are typically key employees with knowledge of the company's confidential information and business plans. Non-compete provisions in a shareholder agreements protect all shareholders by preventing any of the company's owners from using insider information to start or join a competing company at an unfair advantage.
Enforcing restrictive covenants involves competing considerations. Generally, public policy values the rights of individuals to pursue their chosen occupation without hindrance. Freedom to contract is considered a basic right. On the other hand, employers are acknowledged to have legitimate interests which deserve protection, such as their customer relationships, good will, investments in personnel and proprietary and confidential information. In certain industries, the public has an interest that courts may seek to protect. The healthcare field is an example; certain states view the doctor/patient relationship as deserving special protection above what a typical commercial relationship would allow. Evolution of commerce is another factor. In today's global, internet-based market, and depending on the industry at issue, a broad geographic scope (even national scope) may be entirely reasonable.
- Always check whether the state at issue has a governing statute that provides a framework or presumptions as to enforceability of restrictive covenants for courts in that jurisdiction to follow.
- If the state has no governing statute, review decisions that are most factually on point for guidance on whether the geographic scope and time duration of the restrictive covenant at issue is typically enforceable.
- Consider whether a choice of law and/or forum selection clause in connection with the restrictive covenant will be helpful. While such clauses provide certainty, certain states bar them to prevent "forum shopping."
- Companies operating in several states should ensure their restrictive covenants comply with the law of each jurisdiction.
- Stay abreast of legal developments—statutes are frequently amended and judicial views may change.
Stephen L. Brodsky is with Moritt Hock & Hamroff LLP in New York City, New York.
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