Protecting Trade Secrets: Part II (Using Non-Compete Agreements)

In last month's legal alert memo, we explained how employers can prevent trade secret theft by requiring employees with access to confidential information to sign non-disclosure agreements and covenants not to compete. We devoted last month's memo to a discussion of nondisclosure agreements. This month we address covenants not to compete.

Enforceability Of Covenants Not To Compete

Covenants not to compete are the "disfavored cousin" of non-disclosure agreements. This is because non-disclosure covenants simply prohibit employees from disclosing the trade secrets of their employers or former employers, while covenants not to compete, by their nature, restrict competition and may deprive employees of their ability to earn a living in a certain geographic area or field of endeavor once they leave the employer. As a result, in both North and South Carolina, a covenant not to compete will be strictly construed against the employer and enforced only if it is:

1. necessary to protect a legitimate business interest of the employer;
2. reasonably limited as to time and territory;
3. not unduly harsh in curtailing the legitimate efforts of the employee to earn a living;
4. reasonable from a public policy standpoint; and
5. supported by valuable consideration.

If a covenant not to compete fails to meet any one of these five criteria, it may not be enforced.

Implications For Employees

Legitimate Business Interest. An employer has a legitimate business interest in protecting its investment in any specialized training provided to its employees (at the company's expense) by making sure that employees do not use the information for their own benefit or that of competitors once their employment ends.

An employer also has a legitimate business interest in preventing former employees from interfering with established customer and employee relationships. To be enforceable, covenants not to solicit customers should relate only to customers who had an existing relationship with the employer or who were being solicited at the time the employment terminated. Employers should be aware that some courts have decided that covenants not to solicit customers or employees do not prevent former employees from passively accepting business or applications from the former employer's customers or employees.

Time and Territory Limitations. Time restrictions should be limited to the period reasonably necessary to protect the employer's business interests. If the employer's interest is in preserving customer relationships, a court considering whether to enforce a covenant not to compete will ask how long it should take for the employer to place a new employee in the departing employee's position and for the new employee to demonstrate his effectiveness to customers While there is no general rule as to the reasonable length of a restriction on competition, courts rarely refuse to enforce otherwise valid restrictions lasting no more than one year.

Territorial limitations should be no broader than the area in which the employer is engaged in active marketing efforts. If the employer does business nationwide, nationwide protection may be appropriate, especially if the employee has contact with customers nationwide. But even a countywide restriction may be overbroad if most of the employer's business comes from a small city.Acovenant not to compete can be valid without a geographic restriction; courts in both Carolinas have recognized that a restriction on contacting and soliciting customers may be an appropriate substitute for a territorial limitation.

Not Unduly Harsh. Courts may consider a covenant unduly harsh if it applies to an employee who did not have access to confidential information. Also, a covenant that prohibits an employee from doing any work for a competitor may be unduly harsh if the employee performed only a specific type of work for the employer. For example, in 1995, a South Carolina court refused to enforce a covenant that prohibited a Hilton Head bland facial spa employee who performed "facials" from working on the Island for three years in any business that competed with the spa. The employee left the spa, and following a two-month maternity leave, went to work for a competitor as a manicurist. The court concluded that the covenant was not enforceable because it would prevent the employee "from earning a livelihood through legitimate means."

Reasonable From A Public Policy Standpoint. The courts have recognized that covenants not to compete often impact the public at large. If the impact is detrimental, for example, if enforcement would prevent the public from being able to access certain products or services, the covenant may not be enforced. Public policy issues frequently affect the enforcement of non-compete agreements in the medical profession. When medical practices seek to enforce covenants not to compete against specialists who leave to join competing practices, courts typically look at several factors, such as any shortage of specialists in a particular area, the impact on the public if an emergency situation arose, and the ease of access to second opinions, in deciding whether a noncompetition covenant should be enforced.

Consideration. The employee must receive "consideration," or something of value, in exchange for signing a covenant not to compete. As far as a new hire is concerned, a job offer is sufficient consideration. In North Carolina, employees already on the job must receive something other than continued employment in exchange for signing a covenant not to compete. In South Carolina, continued employment of an at-will employee has been held to be sufficient consideration for a covenant not to compete signed after employment has begun. To be on the safe side, however, employers in both states should consider offering "something extra," such as a promotion, a pay increase, or a bonus when a current employee is asked to sign a noncompetition agreement.

Additional Provisions. Finally, additional provisions can be added to put more "teeth" into employment contracts, or covenants not to compete, and provide further protection for the employer's trade secrets and confidential information. These include:

1. A "liquidated damages" provision that requires the employee to pay the employer a specified amount of money as compensation for lost sales or profits if customers leave the employer and become customers of the former employee's new employer during a certain period of time after the employee's departure.
2. A "forfeiture" provision that requires an ex-employee to forfeit severance payments or other post-termination benefits if he or she competes against the employer within a certain territory or solicits the business from the employer's customers during a certain period of time after the employee leaves the employer.
3. An "ideas and inventions" provision that obligates the employee to disclose and assign to the employer any ideas, inventions, products, or processes relating to its business that the employee develops during his or her employment.

In conclusion, because overly broad covenants not to compete are usually struck down, leaving the employer without any protection at all, we encourage employers to take a close look at the business interests they are attempting to protect, and to determine the least burdensome restrictions that will protect their interests. If you have further questions about using covenants not to compete, please do not hesitate to let us know.