The rest of you deadbeats are stuck with only five free weekly blog posts.
This week, the HR compliance tip was about a topic that I rarely discuss on the blog; namely, restrictive covenants. I suppose that’s because enforcement of non-competition and non-solicitation agreements is so very state specific. But, restrictive-covenant work is a significant part of my practice, and when I read this recent Third Circuit opinion over the weekend, I thought it was worth discussing.
The facts are relatively straightforward:
- All sales employees of the company must sign an agreement in which they agree not to solicit “clients, bona fide prospective clients or marketing partners of businesses of [the company] with which the Employee was involved or exposed” for one year after termination.
- High-performing employees who meet their sales targets are eligible to participate in a stock-option award program, but only if they agree to a second restrictive covenant agreement (RCA). So, this is voluntary but conditioned on their assent to the terms of the RCA.
- The RCA contains a strengthened non-solicitation provision which prohibits employees—for a period of one year following their termination (voluntary or involuntary)—from soliciting any company clients to whom the company “provides,” “has provided” or “reasonably expects” to provide business within the two-year period following the employee’s termination from the company.
- The RCA also contains a non-compete provision.
A few employees who signed the standard non-solicitation agreement and the enhanced RCA resigned from the company and went to work for a direct competitor. Cue the lawsuit.
Now, the court’s opinion analyzes New Jersey law. So, if you operate in a different state, your mileage may vary. (Some states won’t allow certain restrictive covenants. Period.) Plus, these cases tend to be so fact-specific that I’m not going to spill any more ink focusing on the nuances of this case.
Instead, I want to offer seven broader takeaways for employers that utilize restrictive covenants such as non-solicitation or no competition agreements.
- Most courts are willing to enforce a restrictive covenant that: (1) is reasonable is scope; (2) protects a legitimate business interest, (3) does not unduly burden an employee, and (4) adheres to the public interest. Thus, the broader your agreement, the less likely it is that a court will enforce your agreement as drafted. For example, if you restrict your employees from competing with you anywhere in the world, but you only operate in the Mid-Atlantic region, a court may frown on that.
- Even if your restrictive covenant is overly broad, courts may ‘blue-pencil’ (think: revise) your agreements to achieve an outcome that is fairer for both employee and employer. But, you lose control over how the court revises the agreement. (Note: Some courts will bypass the blue pencil and deem the entire covenant unenforceable.)
- The Third Circuit was receptive to having different, tailored agreements for various positions within the company, as opposed to a one-size-fits-all. The more integral/important the position, the more likely it is that the court will enforce the restrictive covenant. Conversely, if everyone in the company — from the person who sits in the C-Suite to the person who cleans the C-Suite — signs the same restrictive covenant, then that agreement may be more challenging to enforce.
- You must provide something of value (e.g., consideration) to the employee in exchange for the restrictive covenant. Generally, initial employment will suffice. In some states, continued employment will suffice (i.e., you can tell an employee in his or her third year of work, “Sign this, or you’re fired.”) In other states, you’ll need to provide additional consideration (e.g., raise, bonus, stock options, etc.) to a current employee in exchange for a restrictive covenant.
- Consider offering more consideration (higher salary, bonus, stock options, etc.) in exchange for signing the more restrictive agreements.
- Avoid relying upon anything in your employee handbook as your sole support to enforce a restrictive covenant. Employee handbooks usually contain disclaimers that they are not contracts between the company and its employees. Therefore, trying to enforce a restrictive covenant in an employee handbook may backfire.
- Be especially careful if you operate a multi-state business. Know which state law will apply to each restrictive covenant agreement.
That’s it for now. I’ll see you at 3 pm today.