Tips for Effective Drafting and Enforcement of Restrictive Covenants

The speed of business in the 21^st Century has undoubtedly placed tremendous burdens upon employers seeking to enforce restrictive covenants in the modern business world.   In today’s fast-paced and high-tech society, trade secrets can be lost with the click of an iPhone camera and customer information can be mined from protected databases and stolen through the use of an inexpensive flash drive.  Often, the only protection available to prevent further harm is the legal construct known as the restrictive covenant.  Yet, the restrictive covenant’s status as the great elixir is directly linked to its ability to be enforced.  The past decade has ushered in an era of tremendous conflict in connection with the relationship between employers who seek to hold employees accountable for agreements that control the end of the parties’ economic relationship, and the ability of employees to escape the enforcement of such agreements.   This article will explore the methods used in drafting and enforcing restrictive covenants.    

The Basics:

Restrictive covenants in the employment context seek to protect business interests of a corporation by limiting post-employment engagements of an individual or individuals who has moved on from the company.  As a general rule in all jurisdictions, our country’s courts will not allow a company to enforce restrictions if such enforcement will not benefit the legitimate business interests of the ex-employer. See, Guardian Fiberglass Inc. v. Whit Davis Lumber Co. 509 F.3d 512 (8^th Cir. 2007).  This notion stems from the fact that our judicial system considers restrictive covenants to be a restraint upon trade by their nature.  This is of course balanced against the parties’ inherent freedom to enter into a contract, which has led courts to a common ground in most jurisdictions.   In large part, most jurisdictions will not issue a blanket prohibition against restrictive covenants and will uphold restrictive covenants to the extent that: 1) the restriction is fair and reasonable and; 2) protects a legitimate business interest.   In determining what constitutes a legitimate business interest, courts usually identify trade secrets, confidential proprietary information, goodwill and special training as protectable property of the business.  With these protectable interests in mind, it becomes essential for the employer to identify how to protect each interest and specifically tailor the agreement to meet its specific needs.   Stated another way, there is no “one size fits all” restrictive covenant.   Business owners and employees must narrow their proposed agreements to match their specific needs.  Doing so requires an understanding of the various types of agreements that are classified as follows:

Non-Competition Agreements:  A Non-Competition Agreement prohibits a former employee from engaging in an employment or ownership affiliation with a competing separate entity or group.

Non-Solicitation Agreements:  These agreements protect against employees who solicit current and or former customers. 

Non-Disclosure Agreements:  These agreements prohibit the employee from utilising and or disclosing trade secrets and confidential information belonging to the employer.

Non-Poaching Agreements:   Non-Poaching Agreements are also commonly referred to as “anti-raiding” covenants and bar employees from hiring away employees to join a new entity.

Given the various types of restrictions available to business owners, it is critical at the outset for the drafter to identify, with particularity, what specific business interests the company seeks to protect.  After identifying the company’s needs, the framework of the agreement may be constructed in a manner that avoids the common pitfalls that have a detrimental effect upon the enforcement of restrictive covenants.  Aside from these agreements, one should be mindful of the separate common-law duty of loyalty in many jurisdictions which prohibits employees from acting in a manner that is contrary to the best interests of the employer during the employment relationship.

Effective Enforcement of Restrictive Covenants Begins with The Drafting of An Effective Agreement – What Every Business Owner Should Know:

When drafting a restrictive covenant, the practitioner must always be mindful of the notion that courts in all jurisdictions historically characterise restrictive covenants as a restraint upon trade.  Because of the judiciary’s conceptual concerns over the restraints presented in this setting, the drafter must be especially mindful of the fact that the agreement must be precise in its scope and more importantly, should only go as far as necessary to protect specific business interests.  Drafters of restrictive covenants should take great care in avoiding the common mistake of creating a covenant that will not stand judicial scrutiny on account of the overbroad nature of the restrictions placed upon the departing owner or employee.  A hallmark of an effective agreement achieves a delicate balance between the protection of the business’ legitimate interests and fairness to the departing individual(s).  

Avoid Broad Geographic Restrictions At All Costs

One of the most critical errors in the process of drafting a restrictive covenant occurs when a party attempts to inject an overly protective limitation on the area in which the departing party may operate a business.  A restrictive covenant must be reasonable in its geographic area.  Generally, this limitation is defined as the area where the existing company does business.  Depending upon the nature of the specific business at issue, the geographic areas often vary and are best described as economies of scale.  While there is no bright-line rule per se, it is generally accepted that geographic restrictions contained in restrictive covenants can restrict an area as small as a few miles as in the case of a “mom and pop” business, or can span the continent as in the case of a large corporation.  Because of the uncertainty attached to geographic limitations, recent strategies in drafting restrictive covenants often de-emphasise a detailed geographic restriction in favour of protecting confidential information and or trade secrets.  By focusing on the information, not the location of the business, the covenant is more likely to be found to be a reasonable protection of a legitimate business interest as opposed to an unreasonable restraint on trade.   Through careful craftsmanship of a targeted and precise geographic restriction, or alternatively focusing on confidential information, (not location), the restrictive covenant is more likely to withstand any challenge, and will likely be enforceable.

Avoid Lengthy Periods of Restriction

Because excessive restrictive periods will not be enforceable, the drafting of an enforceable restrictive covenant requires the infusion of a reasonable time period controlling the former employee or co- adventurer’ conduct toward existing or former customers and the handling of confidential information.  Typically, these the types of restrictions: 1) aim to control the length of time that an individual must refrain from soliciting the employer’s clients or customers and; 2) prohibit the use of  business’ confidential information.   With regard to the former, the duration and the nature of the customer relationship are critical factors in determining whether the prohibition from soliciting customers is reasonable.  In these instances, the duration of the restriction is generally reasonable only if it is no longer that necessary for the former employer to put a new employee to work as a means to demonstrate his or her skill-set in satisfying the former employer’s clients and customers.

In the case of confidential information, the focus shifts to the type of information being protected, not geography. A key consideration in this regard is the length of time the information remains confidential before it becomes part of the public domain or stale and unusable.  The longer the time the information retains its confidentiality, the longer the restrictive period will be found to be reasonable.   By examining the nature of the relationship between the customer or client and the identification of the of information being protected, the period of the restriction set forth in the agreement can be gauged appropriately which will protect the terms of the agreement from collateral attack.

 Identify Whether the Agreement Contains Proper Consideration

Because it is a contract, a restrictive covenant must have adequate consideration (a bargained for exchange) for the covenants to be enforceable.   The most common form of consideration is contained in a services agreement, such as an employment agreement where the owner receives services from the employee in exchange for salary.   In a variety of states, the act of requiring a new employee to sign a restrictive covenant at the commencement of employment as well as conditioning an employee’s continued employment upon execution of the agreement are considered valid consideration.   However, the concept of employment as consideration is not universally accepted in each state and it is imperative for the practitioner to be aware of the jurisdiction’s treatment of employment as adequate consideration.  For example, New Jersey courts hold that employment is valid consideration in a restrictive covenant, whereas Pennsylvania courts hold that mere continued employment is not sufficient consideration and will not enforce a restrictive covenant absent some additional consideration.  See, A.T. Hudson, 216 N.J. Super. at 431-32 (non-compete signed at hire supported by adequate consideration) But See, Socko v. MidAtlantic Systems  of CPA,  105 A.3d 659 (2014) (holding that continued employment is not sufficient consideration to support a restrictive covenant under Pennsylvania law.)   Because of these conflicts of law, drafters must be keenly aware of their state’s handling of employment as consideration to avoid challenge to the sufficiency of the entire agreement.

Be Cautious With Choice of Law and Forum Selection Provisions

Choice of law and forum selection clauses can present significant risks in the context of restrictive covenants because not every jurisdiction treats restrictive covenants in the same manner.  There exists a strong possibility that selection of a choice of law clause could have unintended consequences which prove fatal to the enforceability of the agreement.  For these reasons, parties drafting these types of agreements must exercise due diligence and familiarize themselves with the procedural and substantive law of the foreign jurisdiction.  For example, restrictive covenants are void as a matter of law in California except for a small number of limited circumstances expressly authorized by statute, e.g., where owner is selling goodwill of business. California Business and Professions Code § 16600.  Similarly, not all states honor forum selection clauses, effectively rendering the parties’ intent moot.  To avoid the latent dangers associated with these provisions, it is extremely important for the parties to familiarize themselves with relevant state law in both choice of law and forum selection settings.  Otherwise, these seemingly innocuous provisions could have potentially devastating ramifications upon the enforceability of the agreement.

 The Importance of Confidentiality Agreements

 As mentioned above, a confidentiality agreement protecting the company’s confidential information is independent of  the tighter restrictions of non-competes.  For this reason, it is worthwhile to explore the utility in drafting a confidentiality agreement in tandem with a restrictive covenant insofar as the confidentiality provisions may withstand scrutiny when a restrictive covenant fails.

Strategies For Enforcing Your Agreement

Armed with an agreement that adheres to the foregoing characteristics and honed to the particular laws of the relevant jurisdiction; a party seeking to enforce the agreement by obtaining a remedy for a breach of the agreement can confidently pursue an action at law and equity in several ways:

The Injunction

In a majority of jurisdictions, injunctive relief fashioned to prevent further violations of a restrictive covenant is available under specific circumstances where the relief is necessary to prevent irreparable harm, meaning that the damage cannot be remedied by monetary damages.  For example, acts such as disclosing confidential trade secrets and interfering with customer relationships have been recognised as conduct that sufficiently rises to the level of irreparable harm in various state and federal courts.

Money Damages

Monetary damages may be recovered against a former employee who violates a valid and enforceable restrictive covenant as a means to place the injured party in the position it would have been in but for the action of the party who breached the agreement.  In determining the amount of damages that may be recovered, courts will typically review what the expectations of the parties were at the time of the agreement and will analyse the foreseeability of the harm caused by the breaching party in setting the amount of monetary damages.

Having an agreement that comports with the above principals will

The Blue Pencil Doctrine:

In many jurisdictions, even where = certain portions of the parties’ agreement may be found to be unreasonable, all may not be lost.  Restrictive covenants containing certain unenforceable provisions may still be enforced to the extent reasonable under the circumstances.  In various jurisdictions known as “Blue Pencil States”, the courts have broad equitable power to grant partial enforcement of a restrictive covenant both by removing offensive terms and by adding limiting language in order to grant an employer only that protection which the court deems necessary; to protect what the court’s deem to be legitimate business interests.  This principle allows courts to redraft an unreasonable restrictive covenant to make it reasonable and, therefore, make it enforceable based on the equities in the case.  The doctrine, known as the “Blue Pencil Doctrine” is not universal and must be analysed on a state by state basis.

While the restrictive covenant is not the perfect elixir on all occasions and in all locations, if properly utilised, it can be the best line of defence against threats to the very existence of a business.  However, because of the various state by state idiosyncrasies associated with laws governing the enforceability of restrictive covenants, it is fundamentally important to familiarise one’s self with the particular state law in the jurisdiction at issue and not simply assume that the “cookie cutter” restrictive covenant will suffice.