Non-Competes CAN be Worth More Than the Paper They are Written on

Nov. 1, 2007
Corporate protection strategies on non-compete clauses

Late last year two rival appliance companies, Whirlpool and Electrolux, battled it out in the courts over a district sales manager who was enticed to jump between the companies. The sales manager had signed a "Leadership Agreement" with Whirlpool in June 2006 that included a one-year covenant not to compete and a one-year customer non-solicitation clause. After trading a few punches in both state and federal court, a federal district court judge denied Whirlpool's request for a preliminary injunction. Because the non-compete provision contained no geographical restriction and Whirlpool could not show that the sales manager had disclosed or was likely to disclose any confidential information to his new employer, the court concluded that injunctive relief was not warranted. Whirlpool not only left court empty-handed, it may have also hurt itself by creating the impression with other employees who signed similar "Leadership Agreements" that their agreements are similarly unenforceable.

Some companies that seek to judicially enforce non-compete clauses choose to settle such cases rather than risk an unfavorable court decision, and then seek to characterize the settlement as a victory -- even if the settlement allows the employee to continue to work for the competitor. For example, earlier this year, two rival printer manufacturers, Lexmark and Hewlett Packard, reached a settlement of two lawsuits over the enforceability of a non-competition agreement covering a high-ranking executive who abruptly jumped from one to the other company. The settlement required the executive to refrain from interfering with Lexmark customers for 18 months or disclosing confidential information belonging to Lexmark. It also required the executive to repay stock options he cashed and other payments he received from his former employer, but allowed him to remain with his current employer, HP, who presumably financed his repayment obligation. Although Lexmark stated that it was "pleased with the settlement, which protects Lexmark's legitimate business interests," this result plainly favored the new employer, who succeeded in effectively luring the executive away from Lexmark.

These types of lawsuits are proliferating. A recent study reported in the employment law press noted that the number of published court decisions dealing with non-competes has been dramatically increasing: by 37% from 2004 to 2006, and by 81% over the past decade. Yet, all too often employers that go to court to enforce non-competes and other types of restrictive covenants leave empty-handed or with half a loaf at best. That should be the exception instead of the rule.

This article sets forth corporate protection strategies that can be effectively employed by companies to maintain the upper hand when it comes to non-competes and other types of restrictive covenants with executives and key employees including a company's sales force. Those strategies should usually produce one of two desirable results: first, complete or near-complete success enforcing non-competes and restrictive covenants in court; or second (and better yet), a deterrent that causes key employees to either remain employed or to honor their restrictive covenants.

Corporate Protection and Litigation Strategies

  1. Minimize the use of agreements with "one-size-fits-all" restrictive covenants. While it is advisable for employers to require all employees to sign confidentiality and other standard agreements upon commencement of their employment (or thereafter), non-competes and other types of restrictive covenants are not necessary or suitable for all employees. Indeed, enforcement of such clauses against lower-level employees is unduly expensive and highly risky, with little benefit. In contrast, certain managers, directors, officers, and other executives may be appropriate candidates for broad non-competes, while salespersons and those involved in customer relationships are suitable candidates for customer restrictions.
  2. Resist the temptation to overprotect the employer's legitimate business interests. Non-competes and other restrictive covenants are generally enforceable to the extent they serve to protect the employer's legitimate business interests. Clauses drafted with unduly long durations, whether done carelessly or intended to "scare" employees or prospective employers, frequently backfire, as courts are far more likely to deny enforcement of overbroad restrictive covenants. (Some courts may narrow the duration, but many courts have expressed an unwillingness to do so.) One effective corporate protection strategy is to limit the duration, scope, and geography of non-competes and other restrictive covenants to protect 80-90% of the employer's legitimate interests. For example, a six-month non-compete is far more likely to be enforced by a court (or honored by the employee or a prospective new employer) than a one-year non-compete, even if a full one-year restriction is regarded as necessary to fully protect the employer. Likewise, limiting the scope and geography of a non-compete clause enhances enforceability -- as well as the likelihood that the non-compete will be honored.
  3. Limit the use of broad non-competes where customer restrictions will suffice. Traditional non-competes (where an employee is absolutely barred from working for a competitor) are historically more difficult to enforce in court than restrictive covenants limited to protection of customer relationships (sometimes referred to as customer non-solicitation clauses). Salespersons, in particular, are oftentimes perfect candidates for customer restrictions in lieu of broad non-competes.
  4. Tailor non-competes and customer restrictions to satisfy each particular state's requirements. While there are similarities among many state laws with respect to the law of non-competes and other restrictive covenants, what works in some states can be woefully inadequate in others. A few states require some financial or other legal consideration in addition to continued employment before they will enforce a non-compete, especially where the restrictive covenant is not entered into at the inception of employment. Other states require the geographical scope to be drafted in rather uncommon ways. Some states have statutes governing non-competes. For example, Florida has a state statute that is very favorable to employers seeking to enforce non-competes if the statutory provisions are followed, while Massachusetts bars certain types of non-competes for employees in particular industries. The courts in some states like Georgia have shown little patience for non-competes that do not meet the most stringent drafting requirements. Where an employer has operations in several states and wishes to use the same restrictive covenant language for all employees, the agreement must be drafted to satisfy the laws and judicial decisions in the most restrictive state involved. This critical drafting requirement is all too frequently overlooked, which leads to difficulty in enforcing restrictive covenants from state to state.
  5. Draft restrictive covenants in plain English, and don't forget to include reasonable clauses designed to provide notice to the former employer and make violations more costly. Too many non-competes and restrictive covenants are confounding to read. Courts are historically far less willing to enforce a long non-compete that is drafted in a cumbersome manner and filled with legalese than they are to enforce one that is clear and concise and uses plain English. It is also useful to include provisions that require notification by the departing employee of the identity of his or her new employer and anticipated duties. Early notice of this type of information gives an employer an early "head's up" that enforcement or threatened enforcement may be necessary. Likewise, employers are well served by including a provision that requires the losing party to pay the legal fees of the prevailing party -- provided the restrictive clause is well drafted and enforced in circumstances likely to lead to success in court. These types of clauses may also serve to deter key employees from departing in violation of their restrictive covenants.
  6. Select cases to enforce in court when there is evidence of a clear violation, and preferably where the employee has acted in a manner demonstrating "unclean hands." Well-drafted non-competes and other restrictive covenants are far easier to enforce against employees who have engaged in other breaches of their contracts or violated their common-law duty of loyalty. Such employees are referred to in the law as having "unclean hands." Such wrongful conduct may include theft of company property, improperly disclosing confidential information, soliciting coworkers to join the departing employee, failing to provide any required notice of his or her new employment, or engaging in other questionable or surreptitious activity. Conversely, it can be challenging to enforce even well-drafted non-competes against those employees who have conducted themselves professionally and provided full disclosure of their activities. Far too many employers seek injunctive relief in court upon the suspicion that the employee has engaged in improper conduct or with less than compelling evidence of "unclean hands." In those instances, it may be more prudent for an employer to de-select such cases for litigation and instead seek to settle the dispute in a favorable manner, or wait until it discovers clear evidence of a violation, in lieu of filing a court action that may not succeed due to an absence of proof.
  7. Update and redesign your corporate protection programs; avoid waiting until until after-the-fact. Many employers already have in place non-competes and other restrictive covenants that either were never enforceable or are no longer enforceable based on intervening court developments. One notable case decided last fall denied enforcement of a non-compete agreement signed by an employee over 20 years earlier. The court found the agreement unenforceable under West Virginia law for a variety of reasons. 1 Where restrictive covenants were signed by employees years ago, even finding a signed copy can be a headache. In any event, employers are well served to update and reevaluate their non-competes and restrictive covenants to ensure they are drafted in a state-of-the-art manner. Of the seven steps mentioned above, this one is by far the most important. Employers that update and reevaluate their non-competes and restrictive covenants to ensure they are drafted in a state-of-the-art manner are more than half-way to turning court losses into wins -- and far more likely to deter key employees from departing in the first place.

Other than a decline in revenues, few things are more upsetting to corporate management than being unable to prevent key employees from joining competitors, especially when departing employees are able to take away valuable customers, co-workers, and trade secret information. By following these steps, non-competes and customer restrictions can be worth far more than the paper they are written on.

Richard J. Reibstein is a Partner in the Employment Services Department of WolfBlock and heads the firm's labor and employment law practice in New York City. Russell E. Adler is an associate in the Employment Services Department of WolfBlock and also practices in New York City.

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