Restrictive Covenants – Effective or Unenforceable?
Noncompete, nonsolicitation, and nondisclosure agreements, also known as “restrictive covenants,” are commonly used by companies to protect the business interests of the employer. In order to be effective, the agreements need to strike a balance between allowing employees to earn a living after leaving employment and protecting the employers’ trade secrets and business practices. Although the instinct of the employer may be to make them very broad, the more tailored and specific the agreement, the more likely that it will be held up if there is a challenge in the future.
Noncompete
Noncompetes are the least popular of the three
covenants. Employees don’t like signing them, and
judges routinely dismiss them. In some states, such as
California, nearly all noncompete agreements (NCAs)
are automatically void as a matter of law. The noncompete
clause typically provides that during and upon termination
of employment, the employee may not work
for, own interests in, provide services to, consult with,
loan money to, or otherwise support a competitor.
While state law serves as a check on the overly-restrictive
effects of some NCAs, it is widely acknowledged
that imposing these covenants on nonsales or key
personnel could be overreaching and not enforceable.
Limiting the reach of a noncompete is essential to
having it be held up if challenged. Many states, like
Georgia, explicitly permit such agreements as long as
they have time, geographical, and other limits. The
analysis can be very fact-sensitive, but companies
would be well served by limiting NCAs to clearly
established guidelines. While there is no bright-line
rule, a noncompete restricting the employee for a period
of two years or less is more likely to survive scrutiny.
If an NCA ends up being overly-restrictive, it may be
rewritten under a concept called “blue penciling,” which
allows a judge to make an otherwise impermissible
noncompete enforceable. A good practice is for different
levels of employees to sign different covenant
agreements, asking only the most critical employees to
enter into a noncompete.
Nonsolicitation
Nonsolicitation agreements (NSAs) are more acceptable
both by employees and the courts. However,
they can also risk being overly broad if not carefully
written. Nonsolicitation usually covers two categories
of people and entities. One is employees, contractors,
and suppliers of the employer. The other is customers
of the employer. A nonsolicitation of employees and
contractors is an agreement not to contact a person
with the intention of hiring them away from the
employer either during or after termination of
employment. These are not controversial and usually
agreed upon by employees without much discussion.
However, a nonsolicitation of customers is closer to a
noncompete, in that it is an agreement not to poach the
customers of a company by taking them to a competing
business, and is often the subject of negotiation, especially
by salespersons. It is easy to ask that an employee
should not ever approach any customer of the employer.
However, limiting the time period of the restriction
to a reasonable number of years and to customers that
the employee worked with will make the provision
much more enforceable and one that an employee can
agree is necessary. Most NSAs have a one-year term,
although sales people and management may be
restricted to 2 or 3 years. Additionally, a well written
NSA will only cover the customers that that particular
employee had substantial contact with. Again although
the instinct may be to make all poaching a violation
forever and for all customers, limiting the restrictions
will help the company in the long run.
Confidentiality/Nondisclosure
Protecting a company’s trade secrets and confidential
data is an important restriction. In some states
where noncompetes are not allowed, the NDA (nondisclosure
agreement) provisions are used effectively as a
means of restricting the activities of employees who
may join a competitor after termination. Unlike noncompetes
and nonsolicitations, companies can broadly
protect their rights in information that they have
created, compiled, developed, or that is uniquely theirs.
Some critical items that companies should always
protect are customer lists, pricing information, future
business plans, and relationships with partners.
Essentially, any information that may give a competing
business an insight into a company should be protected.
Beyond having employees sign NDAs, companies
should be careful to only disclose valuable information
on a need to know basis and appropriately marked.
Although employers may want employees to sign comprehensive and broad restrictive covenants, they would be better served to think through the various types of restrictions and limit both the time, scope, and coverage of these agreements to increase their effectiveness.
Business Insights is hosted by the Law Firm of KPPB LAW (www.kppblaw.com).
Sonjui L. Kumar is a founding partner of KPPB LAW, practicing in the area of corporate law and governance.
Disclaimer: This article is for general information purposes only, and does not constitute legal, tax, or other professional advice.
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