Many employers utilize employment contracts which contain restrictive covenants in order to protect their legitimate interests in their customers and proprietary business information. Restrictive covenants, which include non-compete, non-solicit, and non-disclosure covenants, are closely scrutinized by the courts in employment agreements, primarily because of the perceived inequality of bargaining power between employer and employee.
The courts also place great emphasis on the employee's right to earn a living, usually discussed in terms of the privilege of free competition. Even though there are a great many reported decisions in this area, the enforceability of restrictive covenants is usually subject to uncertainty in any particular case.
Initial Distinction Between Sale of Business and Employee Contract
An initial distinction must be made between covenants entered into as part of the sale of a business, as opposed to covenants which are included in employment contracts. Covenants entered into as part of the sale of a business are usually enforceable, at least in part. The rationale for this distinction is that a sale of business contract is far more likely to be entered into by parties on equal footing. In addition, the courts recognize that such covenants are often necessary to protect the value bargained for by the purchaser of a business. For these reasons, lesser scrutiny is also applied to restrictive covenants in partnership agreements.
While contracts in restraint of trade or tending to lessen competition are against public policy and are therefore unenforceable, restrictive covenants in employment contracts are considered to be in partial restraint of trade and will be upheld if strictly limited:
- as to time;
- as to territorial effect, and;
- are otherwise reasonable, considering the scope of the employer's business interest sought to be protected and the effect on the employee.
This three-element test has been described by the courts as a "helpful tool" in examining the reasonableness of the covenants being evaluated. The judge, rather than the jury, applies this test and determines whether the restraints are reasonable.
Common Types of Restrictive Covenants in Employment Agreements
"Covenants not to compete" or "non-competes" are the most common types of restrictive covenant in employment agreements. These provisions preclude the employee from competing with the employer and/or from working for a competitor of the employer for a period of time after the termination of employment.
Common variations of non-compete clauses are "non-solicitation" clauses (attempting to bar the employee from soliciting clients of the employer for a period of time after termination), "non-recruitment" clauses (barring the employee from soliciting other employees of the employer for a period of time after termination), and confidentiality provisions (limiting the employee's use of trade secrets or other confidential information during and after the period of employment). Employers may break up these clauses in the hope that if a court refuses to enforce one of the variations of these clauses, it may still enforce a more limited provision included in the agreement.
Enforcing Restrictive Covenants
Post-employment restrictive covenants are only useful to the employer if they can be enforced. Continued payment of severance often provides the employer with leverage when trying to enforce restrictive covenants in an employer's contract. If severance is not at issue, enforcement of a restrictive covenant usually requires the employer to seek the assistance of an appropriate court or in some cases arbitration.
An employer may seek a preliminary injunction, money damages, or the payment of compensation to cure breaches that have already occurred or to preclude the ex-employee from further breaching the restrictive covenant. Irrespective of the remedy sought, the employer is required to demonstrate that the covenant at issue is valid and enforceable. Generally, the employer must be in compliance with the employment contract. If the entire contract is deemed unenforceable, the covenant itself will probably be invalid as well.
Avoiding the Application of Restrictive Covenants
Poaching talented employees from the competition is hardly an uncommon practice. However, employers who hire from their competition should ask for and review any employment contracts governing the prior relationship. If a restrictive covenant exists, it is important to consider whether the employment can proceed without violating the provision, whether the provision is enforceable, and the likelihood that the former employer will take action if there is a breach.
The bottom line is that employers must carefully craft employment contracts which contain non-compete, non-solicit, and non-disclosure provisions if the employer ever tends to legally enforce the agreement. Employers that elect to include broad restrictive language in employment contracts are likely to receive a hostile reception in the courts.