January 01, 2018

Effective Strategies in Drafting and Enforcing Non-Competes

Societal skepticism is growing about non-competes, but they are important tools when used with care.

Edward H. Pappas and Daniel D. Quick

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One of my primary objects is to form the tools so the tools themselves shall fashion the work and give to every part its just proportion.

—Eli Whitney

In the second half of the 20th century, noncompetition agreements went from largely banned in most states to almost uniformly accepted and enforced. While California has long taken a different view, most jurisdictions enforce non-competes so long as they protect legitimate business interests and are “reasonable” as to scope, duration, and geographic reach. Many jurisdictions also allow courts to “blue pencil” non-competes—a process by which a court may still enforce a facially overbroad non-compete by applying it only to the extent deemed reasonable.

While non-competes tend to be discussed largely in legal circles, they entered the public sphere in 2014 with gusto with the now infamous revelation that Jimmy John’s had non-compete agreements for its sandwich makers and delivery drivers. There has been resistance to non-competes here and there over the years. For example, Massachusetts has engaged in an annual tradition of introducing legislation to ban or scale back non-competes. Real momentum toward a reexamination of the prudence, fairness, and even macroeconomic effect of non-competes took a meaningful step forward in 2016, however. That is when the White House issued a report opining that non-competes were over-used and a threat to the economy, which was followed by a “call to action and set of best practices for state policymakers to enact reforms to reduce the prevalence of non-compete agreements that are hurting workers and regional economies.” The White House, Fact Sheet: The Obama Administration Announces New Steps to Spur Competition in the Labor Market and Accelerate Wage Growth (Oct. 25, 2016), https://obamawhitehouse.archives.gov/the-press-office/2016/10/25/fact-sheet-obama-administration- announces-new-steps-spur-competition. There is also a growing body of academic literature and commentary by lay journalists opining that non-competes hurt the economy and worker rights.

It is too early to say whether we are in the midst of a sea change in our culture’s tolerance of non-compete agreements, but these developments underscore the need for companies and the lawyers who represent them to take a business-like approach when it comes to non-competes. This means deploying non-competes selectively within the workforce, drafting them appropriately and with care, and then enforcing them as part of a broader business strategy and philosophy. This article provides advice on how to more prudently consider the use and enforcement of non-competes in order to align with overall business goals and enhance the likelihood, when necessary, of enforcement by the courts.

The Jimmy John’s situation presents the worst-case scenario for employers. The non-compete agreement itself was very broad and was included in a list of mandatory documents that franchisees had to have their employees execute. Once challenged, Jimmy John’s had to backpedal quickly, first discontinuing use of the non-compete agreements going forward and eventually agreeing not to enforce existing ones. Sarah Whitten, Jimmy John’s Drops Noncompete Clauses Following Settlement, CNBC.com, June 22, 2016, www.cnbc.com/2016/06/22/jimmy-johns-drops-non-compete-clauses-following-settlement.html.

Uses of Non-Competes

There are two common uses for non-competes: the protection of trade secrets and (to a lesser extent) the protection of customer relationships. As parties have pushed the boundaries of what constitutes a trade secret, however, courts have expanded the rationale for non-competes to cover “confidential” business information—a much more amorphous and subjective category that is potentially very broad, as the Jimmy John’s non-compete demonstrates. As for customer relationships, the traditional rationale for enforcing non-competes against salespeople is that the personal contacts they made and relationships they built were the goodwill of the business, not their personal asset. Hence, giving the employer time to rebuild that relationship after a salesperson leaves is generally accepted as a legitimate basis for non-competes.

The White House report suggested that the trade secret rationale for non-competes could not explain their broad use, both in terms of the number of people bound by non-competes as well as the industries where non-competes are used. Moreover, the report suggested that unequal bargaining power between employers and employees leads to overuse:

In addition, regardless of whether they promote the protection of trade secrets, the agreements can sometimes be implemented in ways that create confusion or lack of transparency for workers.

Many workers do not realize when they accept a job that they have signed a non-compete, or they do not understand its implications.

Many workers are asked to sign a non-compete only after accepting a job offer. One lower-bound estimate is that 37 percent of workers are in this position.

Many firms ask workers to sign non-competes that are entirely or partly unenforceable in certain jurisdictions, suggesting that firms may be relying on a lack of worker knowledge. For instance, California workers are bound by non-competes at a rate slightly higher than the national average (19 percent) despite the fact that, with limited exceptions, non-competes are not enforced in that state.

The White House, Non-Compete Agreements: Analysis of the Usage, Potential Issues, and State Responses 5 (2016), https://obamawhitehouse.archives.gov/sites/default/files/non-competes_report_ final2.pdf.

With citations to states that have passed laws curtailing the use of non-competes, the White House report flagged the following as potential indicia of abuse:

  1. Execution of non-competes by low-wage employees;
  2. Presentation of non-competes after job offers are made;
  3. Failure to explain the non-compete to potential hires;
  4. Use of intentionally overbroad non-competes (e.g., reliance on blue penciling by courts);
  5. Even though most states do not require consideration beyond continued employment for a non-compete, failure to provide additional consideration;
  6. Enforcement of non-competes even where employees are fired without cause; and
  7. In some areas, enforcement of non-competes that limit consumer access to important services (e.g., health care).

Id. at 8–15.

The White House’s subsequent “call to action” targeted lawmakers and urged them to pursue “best-practice policy objectives, including one or more of the following”:

  1. Ban non-compete clauses for categories of workers, such as workers under a certain wage threshold; workers in certain occupations that promote public health and safety; workers who are unlikely to possess trade secrets; or those who may suffer undue adverse impacts from non-competes such as workers laid off or terminated without cause.
  2. Improve transparency and fairness of non-compete agreements by, for example, disallowing non-competes unless they are proposed before a job offer or significant promotion has been accepted (because an applicant who has accepted an offer and declined other positions may have less bargaining power); providing consideration over and above continued employment for workers who sign non-compete agreements; or encouraging employers to better inform workers about the law in their state and the existence of non-competes in contracts and how they work.
  3. Incentivize employers to write enforceable contracts, and encourage the elimination of unenforceable provisions by, for example, promoting the use of the “red pencil doctrine,” which renders contracts with unenforceable provisions void in their entirety.

The White House, State Call to Action on Non-Compete Agreements 1–2 (2016), https://obamawhitehouse.archives.gov/sites/default/files/competition/noncompetes-calltoaction-final.pdf.

Drafting Non-Competes

Even though the change of parties in Washington might suggest that the federal government will not lead the charge on non-compete reforms, a business that uses non-competes in a shotgun manner is increasingly likely to create employee ill will and face the prospect of an unenforceable agreement in the event of breach. Care in drafting and appropriate handling of employees when they start work and when they leave the job will lend credibility to the employer.

Each state has markedly different rules governing the enforceability of non-competes, including rules relating to duration, scope, and the role of consideration, but the common theme is that to be enforceable, a non-compete must protect the employer’s legitimate business interest and must be reasonable in scope, duration, and geographical area. Courts typically balance the employer’s interest, the public interest, and the employee’s interest in earning a living when determining the reasonableness of a non-compete. Accordingly, a non-compete should interfere as minimally as possible with an employee’s ability to earn a living and should be no broader than necessary to protect the employer’s legitimate business interest. It is critical for the employer to check with its counsel on a regular basis to review any non-competes in use and verify that they still comply with state law.

Lawyers drafting non-competes for employers should consider a number of factors. Initially, the agreements should be limited to selected categories of employees where there is a real need to protect a legitimate business interest, such as executives who have access to trade secrets or other confidential and proprietary information, and salespeople who have established personal relationships with customers. Drafting a non-compete for every last employee, from the chief executive officer down to the janitor, will only invite attack.

Similarly, it is not advisable to use one standard non-compete to cover all employees. A non-compete should be tailored to the specific area in which the employees work, and different non-competes should be drafted to address different types of concerns in different segments of the business. For example, it may well be appropriate to have different non-competes for the head research scientist and the sales person.

Don’t get greedy. Better to draft non-competes narrowly to protect legitimate business interests rather than broadly to prevent competition in a certain industry. A non-compete that is drafted primarily to prevent an employee from leaving his or her employment will universally be found unenforceable. Accordingly, the non-compete should be narrowly designed in terms of scope, duration, and geography to protect a business’s legitimate business interest, and no more. For example, a salesperson may be prohibited from soliciting customers with whom he has established a relationship for the period of time that it would take the employer to achieve an equal footing with the departing salesperson—i.e., the time needed for a new salesperson to develop an equivalent relationship with the former employee’s customers. Or a departing employee may be allowed to work for a competitor in the same industry but not in the same line of work.

Although many state courts have held that continued employment in exchange for a non-compete is sufficient consideration for a non-compete, consider providing other consideration beyond continued employment for a current employee who has not yet signed a non-compete. This could include, without limitation, salary increases, bonuses, improved benefits, or promotions.

If the non-compete is designed to protect a legitimate business interest and is reasonable, it should apply even if an employee is terminated without cause. Nevertheless, the non-compete should be drafted to clearly state that it is enforceable whether the employee is terminated with or without cause. An employer should also consider tying the non-compete to the time period for severance benefits or other post-employment benefits. This will enhance the enforceability of the non-compete as long as the time period is related to the interest being protected.

Finally, lawyers should counsel employers to adopt clear policies that include the presentation of a non-compete to a candidate before an offer is extended, together with a fact sheet describing the operation and effect of the non-compete. Such a policy will reflect the transparency and fairness of the non-compete and increase the chances that a court will enforce it. The employer should also develop and issue strong policies to prevent misappropriation of files and electronic data, which may lessen any anxiety about the necessity of requiring a non-compete.

But enforcement is sometimes necessary. To begin with, lawyers should advise clients to schedule exit interviews with departing employees subject to non-competes to determine why they’re leaving, where they’re going, and their job duties for their new employers. Company representatives should remind each departing employee of all relevant agreements, including the non-compete, and the employee’s obligations under them. The company representative should reinforce and explain—orally and in writing—the company’s expectations of the employee regarding the non-compete and any confidentiality or other post-employment restrictions.

Enforcement

When an employee leaves and breaches a non-compete, the employer and its counsel must move quickly and make several key decisions, often with only incomplete information. First, they should ascertain whether the non-compete has been violated and how. This is often difficult because the employee may not be forthcoming about the employee’s new employment or job duties. Whatever facts are available should be presented to litigation counsel to obtain advice on whether the courts will enforce the agreement.

Second, even if the non-compete is violated, counsel and the employer must assess what level of risk is really presented by the new employment. If there is no real risk, then litigation is a waste of resources, and it will be difficult to obtain preliminary relief if the company cannot show irreparable harm.

Third, the employer should consider a broad range of concerns that will dictate whether to act on the breach or let it slide. Sometimes the employee has gone to work for a key customer or business partner, and “rocking the boat” is simply not an option. Sometimes the employee has a great relationship with one of the employer’s best customers, and if counsel starts sending incendiary cease-and-desist letters, the customer might take it out on the client. Sometimes there are other issues afoot—a potential employment discrimination claim or issues about a bonus—that should factor into a decision to pick a fight. And litigators and employers need to weigh basic issues such as the cost of enforcement, the diversion of executive time and effort, and the focusing of public attention on a lawsuit should the matter end up in litigation.

Alternatively, non-compete enforcement may be particularly critical because the employee’s new employer has been raiding the client company, which needs to put an end to the poaching. Or the client’s information technology department learns that the employee has been sending an unusually high number of files to her home email address two days before she quit, suggesting potential misappropriation. The scenarios are endless, but these sorts of peripheral facts almost always enter the calculus.

Fourth, the employer must weigh the risk of inaction, or acting too slowly. Even a valid non-compete will not be enforced if the employer sits on its hands and fails to move promptly. In addition, if the employer is considering “letting it go” in a particular instance, that may open the door to future contract-breakers, who might argue that the employer is arbitrarily enforcing its agreements or has waived its rights, or that its purported interests are really excuses for acting against the employee for other reasons, such as individualized animus.

Assuming the non-compete has been breached and is enforceable, there are a few basic scenarios. In cases in which there is a flagrant and clear breach that directly attacks the legitimate interest protected by the non-compete, enforcement should be strongly considered. This is why the client has non-competes in the first place, and failure to act and act quickly in face of an unambiguous breach could jeopardize its entire regime of trade secret protection and non-compete usage.

Thus, when there is a relatively clear breach and other “plus factors,” enforcement is warranted. Such plus factors might include evidence of misappropriation of information, pre-departure acts of sabotage, dishonesty on the way out the door, or improper pre-departure solicitation of customers or other employees. Because these elements suggest that the employee is a “bad actor,” the company faces a higher risk of harm and its agreement stands a greater chance of being enforced.

On the other hand, there are tough cases in which meaningful factors cut against a guns-blazing approach. After analysis, litigators gearing up to begin enforcement might recognize that the non-compete agreement is overbroad or works some significant inequity. The client might also lack sufficient information to know whether its interests are jeopardized by the new employment and have some reason to doubt anything beyond speculative harm.

For each of these scenarios, usually the first step is a fair and clear, yet firm, cease-and-desist letter, both to the employee and the new employer. There are certainly situations where going immediately to court for a temporary restraining order is necessary, but unless the exigencies demand it, a letter often results in a negotiated resolution that allows both parties to live with the outcome without the time and expense of litigation. Moreover, there may be a legitimate misunderstanding as to the facts, which can be cleared up by dialogue following a letter.

The letter should be drafted with care, as it will end up in front of the judge should litigation follow. It should describe the legitimate basis for the non-compete and how the employee has breached it and address any plus factors that might be present. Factual description need not be voluminous, and the letter should take care not to defame the employee to the new employer. But a basic outline of known facts lends credence and reasonableness to the demand. Most importantly, the letter should demand a relatively short response date, and the client must be prepared to move forward with enforcement if there is no adequate response.

If filing litigation, the key to enforcing a non-compete at the preliminary injunction stage is reasonableness—both as to the non-compete’s terms and as to the overall equities of having the court enforce it in this particular instance. Because judges are human and an injunction is a creature of equity, judges must be convinced that what they are doing is “right.” Where an employee has engaged in some other act of deceit or misappropriation, the court will be more likely to view enforcement of the non-compete as necessary and appropriate.

Non-competes are important tools that can be used to protect a company’s legitimate business interests, such as trade secrets and customer relationships. They should be drafted and enforced prudently, not to prevent an employee from changing jobs but to prevent a departing employee from harming the company’s legitimate business interests. Especially in today’s environment, where abuse of non-competes garnered unfavorable attention from the last White House, businesses must act with care.

Edward H. Pappas and Daniel D. Quick

The authors are with the firm Dickinson Wright in Troy, Michigan.