Enforceable Covenants Not To Compete
Employers frequently require their employees to execute employment agreements that contain covenants not to compete. Each state has its own laws regarding whether such covenants may be enforced, and under what circumstances. Minnesota's law is fairly consistent with the laws of most other states. Although courts disfavor covenants not to compete because such covenants are anti-competitive, courts frequently enforce them against departing employees in appropriate circumstances. To enforce a covenant not to compete against a former employee, a company generally needs to demonstrate that:
- The covenant not to compete was supported by consideration when it was signed.
- The covenant protects a legitimate business interest of the employer.
- The covenant is reasonable in scope to protect the employer, without being unduly burdensome on the former employee's right to earn a living.
Contracts generally must be supported by consideration to be enforceable, which means the promising party must receive something of value in exchange for the promise. When a covenant not to compete is signed before the employee begins employment, the employment itself supplies the requisite consideration. If the employee signs the covenant after beginning employment, however, mere continued employment is not considered valid consideration; the employee must receive something else of value in exchange for the covenant, such as a promotion or other significant benefits that would not otherwise have been available if the employee did not sign the covenant.
Protection of a Legitimate Business Interest
In Minnesota, legitimate business interests that may be protected by covenants not to compete include (1) customer relationships, and (2) confidential information. The desire to prevent a former employee from competing merely to prevent lost business, in and of itself, is not considered a legitimate business interest.
Customer relationships. The goodwill in customer relationships that were maintained and developed by an employee during the scope of employment is an asset that belongs to the employer. Thus, an employer may use a covenant not to compete to prevent a former employee from using such customer relationships to compete with the former employer. Covenants not to compete are frequently enforced to prevent a former employee from soliciting his or her former customers to buy competing products or services from the new employer.
Confidential information. Covenants not to compete are frequently enforced where the former employer's "confidential information" may be used or disclosed unless the employee is restrained from competing. The employer must generally demonstrate that it kept the information relatively secret from the public and competitors, and that the information gives the employer some competitive advantage or that it would be useful to competitors. The information must not be readily ascertainable from public sources. It can concern such things as products, marketing and strategic plans, sales data and forecasts, and even customers. Also, confidential information must be distinguished from the employee's own general skills, knowledge and experience gained on the job, which the employee is free to use in competing against the former employer- otherwise, employees would not be able to advance in their careers. The line between an employer's confidential information and an employee's general knowledge and experience is often difficult to draw, and it will depend on the specific facts of each case.
Even without a covenant not to compete, an employee has a duty not to use a former employer's confidential information to compete with that employer. As a practical matter, however, it is often difficult to enforce that duty unless there is a covenant not to compete, which is why employers frequently utilize them.
Reasonableness of the Restraint
In deciding whether to enforce the covenant, courts will consider whether, based on the specific circumstances, the covenant is reasonably necessary to protect the employer's legitimate business interests, or whether the covenant is too broad and unduly burdensome on the employee. Courts making this determination will evaluate both the duration and scope of the restraint.
Duration. What is a reasonable length of time depends on the particular facts. If the covenant is designed to protect confidential information, then its duration should not extend beyond the time at which the information would be expected to become stale. If the covenant is designed to protect customer relationships, it should not last longer than the length of time reasonably needed to erase the association between the former employee and employer in the customer's mind. Courts routinely find covenants that last one year, and sometimes two or three years, to be reasonable in duration.
Scope. Courts look at whether the geographical area covered is reasonable in light of the interests to be protected. This depends in part on the specific services that were performed by the employee, and the employer's interests that are at stake. As to sales representatives, for example, covenants that apply to geographical areas in which the employees did not work for their former employers are frequently considered overbroad. Courts will generally not restrain a former employee from working in a geographical area in which the former employer does not do business. In the case of sales representatives, the territorial scope of the restraint may also properly be defined by the customers with whom the employee had contact, rather than by geography.
As to managerial and technical employees, courts may enforce covenants that apply in any area in which the former employer competes, if the new position threatens the use or disclosure of the former employer's confidential information. Courts recognize that as to managerial and technical employees, the geographic location where the employee will be working is less important than the services the employee will be providing, i.e., whether the employee is going to be working on similar products or services for the new employer.
Overbroad Covenant. If a court finds the covenant is too broad, it may narrow its duration or scope and enforce it as modified. However, if the covenant is so overbroad on its face that it was clearly intended to prevent lawful competition rather than to protect legitimate business interests, the court may refuse to enforce it at all. For example, a covenant that restrains an employee from competing in any capacity anywhere in the world is more likely to be stricken in its entirety rather than judicially modified. The rationale is that otherwise employers would have no incentive to draft reasonable covenants in the first place, and employees unaware of their rights would assume they are bound by the unenforceable covenants.
If a former employee is breaching an enforceable covenant, courts will typically enforce the covenant by issuing an injunction restraining the employee from violating the covenant. The court may also award money damages for losses already caused by the breach. Hiring an employee in violation of an enforceable covenant may also subject the new employer to liability for damages, which may include the former employer's attorney fees incurred in seeking judicial enforcement of the restraint. When hiring an employee subject to covenant not to compete, it is therefore important to determine whether doing so will violate an enforceable covenant.
Sale of Business
Finally, covenants not to compete are also frequently used in the context of a sale of a business. The general principle that such covenants are only enforceable to the extent reasonably necessary to protect legitimate business interests applies in the sale-of-business context as well. However, courts apply this standard much more liberally in the sale-of-business context, where enforcement is rarely refused.