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.
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 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.
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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