A Primer on Restrictive Covenant Agreements
The basic definition of a restrictive covenant agreement is a contract between an employer and employee, or between two businesses or business partners, that restricts the employee or business from participating in their current business for a period of time after leaving or from competing with the company they just recently left . Depending on the specific terms and conditions set forth in the agreement, a restrictive covenant agreement can prohibit an employee from disclosing confidential information, non-compete clauses, or non-solicitation agreements designed to limit the employee’s interaction with customers and former associates of the company.
Different Kinds of Restrictive Covenants
Restrictive covenants can come in many forms, and most employment agreements contain – or at least implicitly contain – more than one of these restrictive covenants.
The most well known variety of restrictive covenant is the non-compete clause. A non-compete clause is basically a promise that you will not work for a competing business or start your own competing business with certain geographical limitations and for a certain period of time after your employment with your employer ends. For example: "Employee agrees that he or she will not compete with Company for a period of one year in the Charlotte, NC area following the termination of Employee’s employment."
Non-compete clauses are the most common type of restrictive covenant and they are also the most likely to be enforced because the employer has to prove enforceability by convincing the judge that the restriction on competition is reasonable. It is possible to work around non-compete clauses by doing business outside the restricted area or for different types of businesses that do not compete with former employers. Unfortunately, there are plenty of businesses out there that have no qualms about hiring someone who is subject to a restrictive covenant, forcing the employee into a dilemma and violating the employee’s freedom of choice and movement.
This leaves the employer stuck with a choice of muddling forward with its non-compete clause against a competitor that isn’t worried about the enforcement aspect of the clause, or actually enforcing the non-compete clause and either getting sued or getting sued by the former employer that the company was hired to help circumvent.
The next most common type of restrictive covenant is the non-solicitation clause. A non-solicitation clause is a promise that you will not solicit a former employer’s clients or employees for a certain period of time after leaving the job. For example: "Employee agrees that he or she will not solicit or attempt to solicit any clients, employees or agents of Company for a period of one year following Employee’s termination of employment."
Some employers use a non-solicitation clause that also states that the employee will not provide competing services to the former employer’s clients for a certain period of time. In that case, the clause may overreach to the point that it would be deemed unenforceable even if the arbitrary time period is reasonable, but the arbitrarily chosen time period makes the clause looked upon unfavorably by judges.
A confidentiality clause is another common type of restrictive covenant. A confidentiality clause is very common and usually enforceable, depending on how overbroad it is. A confidentiality clause prohibits an employee from disclosing a former employer’s proprietary or confidential information for a certain period of time. For example: "Employee agrees that he or she will not at any time disclose or make use of any confidential information of Company without the prior written consent of the Chief Executive Officer of Company."
A confidentiality clause is harder to get around because it can apply to all the knowledge that you gained while working. Business methods that are valuable to a company are often considered company "trade secrets." Coming up with a totally different way of doing something may be difficult without accessing your former employer’s confidential information and trade secrets.
Restrictive Covenants’ Enforceability Under the Law
The legal enforceability of restrictive covenant agreements varies depending on the jurisdiction and is often the subject of much litigation. Because every state has its own laws and unique case law, it is difficult to establish a set of rules for what is enforceable in every situation. However, common sense tells us that the scope and duration of non-compete clauses should be limited if a court ever examines the reasonableness of the agreement.
Non-competes: Non-compete agreements are only enforceable in states that recognize them. Not all states acknowledge non-compete agreements as enforceable. Even states that do recognize the enforceability of non-compete agreements place limits on their enforcement. In some states, such as California, non-compete agreements are virtually never enforceable. California Civil Code section 16600 states: "Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void."
If an employee moves to another state where a non-compete agreement is enforceable and a court chooses to apply the law of the new state instead of the employee’s former state of employment (often called the lex loci laboris) or the choice of law provision in the agreement, the non-compete may be enforceable in the new state.
Reasonable scope: Even if the courts in certain states are inclined to find non-compete agreements enforceable, the courts will look carefully at the scope of the restrictions (describing in detail what is prohibited) and reasonableness of the geographic area contained in the agreement. Courts have refused to enforce non-compete agreements that are unreasonable in these aspects. The scope should be limited to the employers’ legitimate business interests and trade secrets that the employee may possess. The geographic scope should be limited to the area that the business has opportunities and can offer reasonable alternatives of employment to the employee. Post-employment restrictions should be carefully tailored to fit the need.
Duration: Similarly, any post-employment restrictions should be time-limited so that the agreement does not become a restraint on the employee’s ability to work elsewhere in the future. Courts have refused to enforce non-compete agreements for extreme periods of time. Non-compete agreements that last a few months are generally found reasonable.
The Impacts of Restrictive Covenants on Both Employees and Employers
From an employee’s perspective, restrictive covenants can be very beneficial and detrimental. It is beneficial to the employee in the sense that it (i) creates the expectation for the employer to train the employee; and (ii) because they are expected to receive training, they will (or should) receive additional compensation, promotions and mobility within the company, especially if the company has a history of requiring restrictive covenants from employees. However, restrictive covenants are detrimental to the employees because often times there are unintended consequences to who the employee defines as potential competitors. For example, oftentimes, on the employee’s first day of employment, they will be given the restrictive covenant to review. While everyone knows that the employee does not read the restrictive covenant and does not understand the implications, the employee is asked to sign the restrictive covenant and does. The employee will fill in the blank that defines the "unitary business or businesses" that the restrictive covenant applies to. As an example, let’s assume Business X requires the employee to sign a restrictive covenant. Let’s assume also that Business X’s competitor is Business Y. Business X is a division of Business Z. Business Z has competitors Business A, B, C X, Y and Z. What is important to note here, is that it is possible that Business Z could be successful in their claim against an employee who left Business X for Business Y, but Business Y has competitors that are basically the same as Z because they are in fact a division of Z. Thus, the result may be to make it economically infeasible for the employee to ever leave Business X because all the competition in that area are basically the same businesses so long as Business Z exists. Moreover, it is possible that the employee could be hired by Business Y and be forced to hire attorney’s to defend against Business Z which could result in fees and costs of over $100,000.
From the employer’s perspective, again from a general sense, it is beneficial because they (i) can now define their competitors; (ii) it takes the power away from Business Y to hire employees from Business X; and (iii) it keeps the business from being poached. From the employer’s perspective, it is detrimental however because it (i) may alienate employees who may not feel that it is fair; (ii) because they may not feel it is fair, it may inhibit teamwork and loyalty from employees; and (iii) Business Z cannot hire employees from Business X without violating Business X’s rights.
Negotiating for Restrictive Covenants: Tips and Advice
Negotiating restrictive covenants: Strategies for contract negotiations
Employer Perspective: Given the imbalance of power that exists between employers and employees, it comes as no surprise to find that most restrictive covenant clauses in employment contracts are non-negotiable. An employer can always refuse to employ someone who is not prepared to sign its standard non-compete and no-poach clauses. It is, therefore, important for an employee to read and digest their employment contract and sort out which aspects they are prepared to accept and which they are not. In most cases, this is not something you can do when you are first offered the role because, unless you are very lucky, signing your employment contract will be one of the last stages of a recruitment process. By this point, both you and the prospective employer will have invested significant time and costs so it is unlikely you will walk away at this late stage. This means you may be forced to accept conditions you are unhappy with. However, there are steps an employee can take to help mitigate the effects of these.
You can insist on a trial period: Where there are no express express provisions in the contract to this effect, an employee can make a request that the contract becomes effective only once you are sure you are satisfied with it. For example, under the Canadian contract law doctrine called "bilateral conditions precedent", the employer may request the employee sign the agreement or face immediate termination. On the other hand, the employee also has the right to request a trial period during which they can decide whether or not the contract is acceptable to them. If the trial period is not satisfactory to either party , they may withdraw from the agreement without any repercussions.
If possible, try to negotiate the restrictive covenants from the employer’s perspective: Going through or proposing a hypothetical situation that questions the interpretation of a particular clause can suggest an amendment. From a prospective employee’s point of view, this makes a lot of sense because it will show the employer that you have adopted their thought process and limitations and that you are not trying to be unreasonable. It is also helpful to consider the employer’s perspective when it comes to the scope and duration of the restrictive covenants. For example, if an employer is entitled to have non-compete clauses for a period of six months post-termination, and the employee is not willing to accept anything more than three months, then perhaps consider suggesting four months instead. This shows a willingness to compromise and may make it more likely that the employer will be similarly inclined.
Minimize the cons: You may want to think again about signing your contract if you fear that you will be putting yourself at financial risk by agreeing to the terms contained in it. Employees often seek to negotiate their contracts in order to increase pay or improve benefits. Otherwise, it may not be worth the potential risk. Therefore, if you need to have post-termination restrictions in the hope of getting a higher salary, this should be offset by getting a clearer idea of exactly what the restrictive clauses will entail.
Below is a regularly used list of clauses that are often considered too broad or unfair by employees, but which employers will often try to include as part of a non-compete clause.
Common Problems With Restrictive Covenants and How They Are Solved
Disputes concerning restrictive covenants are commonly brought in the District Court for the District of Columbia under D.C. Code § 16-550. Almost all cases filed under D.C. Code § 16-550 are for enforcement. However, some cases arise in the context of an employee seeking a declaration that a post-employment restriction does not apply. Such disputes also can arise in the context of a state law claim for violations of fiduciary duties by a departing employee when focused on the employee’s use or disclosure of confidential information. In circumstances where there is a question whether certain activity violates a restrictive covenant, the parties potentially can resolve the matter without a court order. The departing employee may request an advisory opinion from the employer regarding the employer’s interpretation of the restriction; if this is done, the employer’s eventual position concerning a potential violation by the former employee may be advanced or hampered depending on the circumstances. Alternatively, both parties may seek an advisory opinion from an independent arbitrator, consultant or attorney. In either case, however, the advice will not be binding on a court, which is free to decide the dispute based on the facts and evidence presented to it. Some restrictive covenants require that binding arbitration be used to resolve any disputes. This requirement obligates the parties to resolve differences without resort to litigation in court, and the Federal Arbitration Act will govern such an attempt to resolve disputes without litigation. Thus, in the event damages are sought, both parties will have to incur substantial costs associated with discovery, witness selection, and so forth. Only the ultimate decision will rest with the arbitrator, not a judge. Delaware courts uphold such arbitration clauses and, thus, it is likely that such an approach would be followed elsewhere.
Recent Developments and Trends in the Law Regarding Restrictive Covenants
The continued growth of the gig economy and independent contractor employment relationships have raised questions on the enforceability of restrictive covenants. Courts in some jurisdictions have adopted an "entire agreement" approach to determining the terms of an individual’s employment relationship, such that an offer letter that states any subsequent restrictive covenants the individual agrees to shall be deemed null and void if they are not executed at or prior to their start of employment will trump a restrictive covenant which is executed three years after employment begins. While some judicial opinions decline to interpret the restrictive covenant as a standalone contract, courts have enforced agreements stating that acceptance of employment is conditioned upon executing future restrictive covenants.
At the federal level , the National Labor Relations Board (the "NLRB") issued final rules ruling that non-disclosure and non-solicitation covenants are valid in certain circumstances under the National Labor Relations Act (the "NLRA"). The final rules contain standards for companies to evaluate the reasonableness of the scope and use of non-compete and other restrictive covenants and the impact of these agreements on an individual’s ability to utilize information regarding a business during its period of employment and thereafter. These final rules are in stark contrast to the NLRB’s previous position that non-competes were illegal because the agreements interfere with an employee’s Section 7 rights to engage in concerted activity.