Do's and Don'ts For Managing Your Restrictive Covenants In a Recovering Economy

As a preliminary matter, you should ensure that you have signed noncompete, nonsolicitation and confidentiality agreements for your key employees. Often, employers believe that an employee previously signed a noncompete agreement, only to find that he or she never returned the agreement, or that the employee is unable to locate the signed document.

You should also take the opportunity to review existing restrictive covenants for reasonableness and enforceability. What may have seemed reasonable at the time may have changed as the scope and extent of the employee's duties and responsibilities have shifted over time. What might be adequate with respect to a lower-level salesperson may no longer offer enough protection if that salesperson has been promoted to upper management. It might be time to have those employees who have moved up the corporate ladder sign new agreements commensurate with their positions.

DON'T Over-reach

Often, employers try to use restrictive covenants as a way to handcuff employees to prevent them from leaving or from ever working for a competitor. Doing so virtually guarantees that your restrictive covenants will be challenged in court. Restrictive covenants are a defensive shield, not an offensive weapon. Most states look at noncompete agreements with disfavor, and will only enforce them to the point reasonably necessary to protect the employer's legitimate business interests. If the employer has overreached, and has sought to restrict the employee beyond what is reasonably necessary, the court might refuse to enforce the agreement at all.

To avoid this, you should use the type of agreement that offers your company the protection it needs, without gratuitously restricting the employee. Courts are more willing to enforce nonsolicitation agreements than noncompete agreements, and will almost always enforce a confidentiality agreement. Therefore, if a confidentiality agreement or a nonsolicitation agreement offers adequate protection, you should opt for those agreements over a full noncompete agreement.

For example, because companies are presumed to have a legitimate interest in protecting against solicitation of their customers by former employees, nonsolicitation agreements do not have to have geographic limitations and can offer protection on a nationwide or worldwide basis. Often, nonsolicitation agreements offer the best protection against departing salespersons, since such an agreement will prevent them from capitalizing on the relationships that they developed with your customers. However, for a vice president or chief engineer, a full noncompete is often necessary to guard against disclosure of your company's accumulated information and know-how.

If you must use a noncompete agreement, you should make sure that it is narrowly tailored in terms of duration and geography. For example, if you do not have customers or significant business on the West Coast, do not use a nationwide noncompete. Similarly, if your sensitive information becomes obsolete after 18 months, use an 18-month noncompete period. The narrower your noncompete is tailored, the easier it will be for you to enforce it when necessary. The key is to find the balance between your company's legitimate need for protection and the scope of the restrictions within the noncompete.

DO Use Clear, Plain Language and Avoid Legalese Where Possible

It is imperative that you use unambiguous language in your noncompetes that can only be interpreted in one way ' the way you intend it to be. In other words, say exactly what you mean, and say it clearly. All states view restrictive covenants as restraints of trade and will construe them strictly against enforcement. If your noncompete agreement contains an ambiguous provision that could be interpreted to have multiple meanings, a court will construe the provision in favor of the employee and against enforcement of the covenant. Furthermore, a restrictive covenant must clearly define what the employee can and cannot do. Courts are reluctant to enforce clumsily drafted agreements that do not clearly set forth the restrictions against the employee.

Ambiguity in restrictive covenants often leads to expensive, protracted litigation. An unclear, ambiguous restrictive covenant can give departing employees all the motivation they need to challenge the enforceability of the agreement. Often, these challenges can cost the employer leverage in reaching a favorable settlement or force the employer to defend the agreement in court. Even if the employer is successful in court, the result is often a pyrrhic victory due to the time and money expended.

DON'T Skimp on Consideration

Another problem that often leads to expensive litigation arises when an agreement is challenged for lack of consideration. Often, employers who require that existing employees sign restrictive covenants will either forget to provide proper additional consideration or will substitute a non-monetary “benefit” such as “training,” “access to customers,” or “additional responsibilities.” Do not fall victim to this trap. If the employee is valuable enough to be worth restraining, the employee is valuable enough to warrant a bonus, raise or some additional form of compensation to which he or she would not otherwise be entitled. With respect to restrictive covenants, money talks.

Remember that continued employment will not provide adequate consideration in many states. Where continued employment is sufficient, the employee generally must remain employed for a substantial period of time after signing the covenant, a situation which the employer cannot control. Thus, unless the employee signs the restrictive covenant at the inception of employment, the employee must receive something of value in exchange for agreeing to the restrictions, especially if the employee is signing a noncompete agreement. By offering the employee a significant cash payment, the employer can avoid challenges to the agreement and expensive litigation over whether the employee received a benefit of real value. A few thousand dollars in consideration can save a few hundred thousand in litigation costs. In other words, an adequate monetary payment for a restrictive covenant can often pay for itself.

DON'T Forget That if You Terminate, the Agreement May Not Be Enforceable

As the economy remains in flux, many companies continue to make adjustments in personnel to account for reduced demand or to cut costs. Typically, these cuts begin with those who have failed to perform. If your company is forced to terminate one or more employees for performance or financial reasons, you should be aware that, in many states, including Pennsylvania, courts may refuse to enforce noncompete agreements against those employees. Often, the courts reason that by terminating an employee for performance or financial reasons, the employer has deemed the employee “worthless,” and, therefore, has no legitimate interest in preventing that employee from competing against it. Additionally, courts may find it inequitable or unfair to prevent an employee from working when that employee has been terminated involuntarily from his or her prior job.

In many cases, employers are generally content to let such employees join competing firms. However, you may find yourself confronted with a soon-to-be-terminated employee who, despite failing to perform for your company, could nevertheless harm your company if he or she is hired by a competitor. For example, your company might be forced to terminate an underperforming salesperson, whose contacts and relationships with your customers would prove valuable to a competitor, even if the salesperson is not soliciting those customers directly. Likewise, certain employees laid-off for financial reasons may have intangible confidential information that would give your competitors an edge if disclosed.

If you must terminate an otherwise valuable employee for financial or performance reasons, but still wish to restrain him or her from competing against your company, consider entering into a new, post-termination restrictive covenant with the employee in exchange for a severance payment to which he or she would not otherwise be entitled. Courts are more willing to enforce restrictive covenants against terminated employees where the employee accepted severance, since the payment of severance shows that the employee had some value to the employer, and provides a financial cushion for the employee during the restricted period. Make sure, however, that any severance pay intended to provide consideration for a noncompete agreement is in addition to any other separation payments that the employee would have received in the absence of the noncompete.

DO Consider 'Inevitable Disclosure'

When all else fails, and your most valuable employee, who has refused all requests to sign a noncompete agreement, tenders a notice of resignation and intends to join your largest competitor, consider whether the inevitable disclosure doctrine is available to you. Inevitable disclosure is a controversial doctrine, recognized in some form in most states, that can prevent employees with access to confidential information or trade secrets from going to work for a competitor. The doctrine recognizes that certain employees possess intangible confidential information that cannot be returned to the company at the end of their employment, and that these employees cannot go to work for a competitor without “inevitably” disclosing this confidential information in their new position. As a result, inevitable disclosure can act as a sort of de facto noncompete agreement in your favor.

Employers should not rely on inevitable disclosure as a viable alternative to noncompete agreements, as courts are loathe to restrain employees who never explicitly agreed to the restrictions. Rather, it should be used only as a last resort, and only then against key employees who possess very valuable, highly sensitive information, the disclosure of which would severely harm the company. Generally, the doctrine may apply when the employee leaves to go to a direct competitor, takes a position substantially similar to her prior
position, and had access to intangible confidential and trade secret information in her prior position, which would be highly valuable to her new employer. Courts are also more willing to apply the doctrine and restrain an employee where the employee departs in bad faith.
Consequently, employers seeking to employ the inevitable disclosure doctrine should carefully examine the departing employee's computer to see if the employee took any confidential information at the time of his or her departure.

Conclusion

As the economy rebounds, employers can expect to see increased mobility in the employment sector and heightened turnover in their own ranks. Many valuable employees who have patiently waited out the recession will begin seeking opportunities for advancement. Companies looking for a competitive advantage and to speed their recovery will welcome your employees with open arms. Restrictive covenants provide employers with a tool to prevent this from occurring, but they must be used appropriately and with restraint. When used effectively and appropriately, employers can not only protect themselves against competition from their own employees, but can decrease their anticipated litigation costs in the process.

Jonathan Cavalier is a member of the Labor & Employment group of Cozen O'Connor in Philadelphia. He has defended employers against claims of discrimination in state and federal court, prosecuted and defended non-competition covenants, resolved electronic discovery disputes, and litigated ERISA employee benefits issues.

One of the few benefits to employers in a down economy is that they can typically count on a relatively stable workforce. During a recession, employees are generally less willing to jeopardize their current employment by looking to change jobs, and are less able to find open positions even if they are willing to switch. However, as the economy recovers, you can expect that to change significantly, especially for key employees whom competitors may look to hire as a way to jump-start business by poaching your company's customers or knowledge base. Recently, there has been a significant increase in litigation involving noncompete agreements as companies look for quick and easy ways to gain market share and increase revenues. Hiring a key employee from a competitor is an easy, cost-effective way for the competition to eliminate a competitive advantage in an instant, and as a result, companies can be expected to be more willing than ever to fight for the right to hire their competitors' most valuable employees.

You can prevent this from happening to your company by using well-drafted, specifically targeted restrictive covenants that will help you avoid litigation where possible and win it when necessary. With that goal in mind, this article provides helpful “do's” and “don'ts” to be used in constructing and evaluating employees' noncompete, nonsolicitation and confidentiality agreements.

DO Review Your Existing Noncompete Agreements

As a preliminary matter, you should ensure that you have signed noncompete, nonsolicitation and confidentiality agreements for your key employees. Often, employers believe that an employee previously signed a noncompete agreement, only to find that he or she never returned the agreement, or that the employee is unable to locate the signed document.

You should also take the opportunity to review existing restrictive covenants for reasonableness and enforceability. What may have seemed reasonable at the time may have changed as the scope and extent of the employee's duties and responsibilities have shifted over time. What might be adequate with respect to a lower-level salesperson may no longer offer enough protection if that salesperson has been promoted to upper management. It might be time to have those employees who have moved up the corporate ladder sign new agreements commensurate with their positions.

DON'T Over-reach

Often, employers try to use restrictive covenants as a way to handcuff employees to prevent them from leaving or from ever working for a competitor. Doing so virtually guarantees that your restrictive covenants will be challenged in court. Restrictive covenants are a defensive shield, not an offensive weapon. Most states look at noncompete agreements with disfavor, and will only enforce them to the point reasonably necessary to protect the employer's legitimate business interests. If the employer has overreached, and has sought to restrict the employee beyond what is reasonably necessary, the court might refuse to enforce the agreement at all.

To avoid this, you should use the type of agreement that offers your company the protection it needs, without gratuitously restricting the employee. Courts are more willing to enforce nonsolicitation agreements than noncompete agreements, and will almost always enforce a confidentiality agreement. Therefore, if a confidentiality agreement or a nonsolicitation agreement offers adequate protection, you should opt for those agreements over a full noncompete agreement.

For example, because companies are presumed to have a legitimate interest in protecting against solicitation of their customers by former employees, nonsolicitation agreements do not have to have geographic limitations and can offer protection on a nationwide or worldwide basis. Often, nonsolicitation agreements offer the best protection against departing salespersons, since such an agreement will prevent them from capitalizing on the relationships that they developed with your customers. However, for a vice president or chief engineer, a full noncompete is often necessary to guard against disclosure of your company's accumulated information and know-how.

If you must use a noncompete agreement, you should make sure that it is narrowly tailored in terms of duration and geography. For example, if you do not have customers or significant business on the West Coast, do not use a nationwide noncompete. Similarly, if your sensitive information becomes obsolete after 18 months, use an 18-month noncompete period. The narrower your noncompete is tailored, the easier it will be for you to enforce it when necessary. The key is to find the balance between your company's legitimate need for protection and the scope of the restrictions within the noncompete.

DO Use Clear, Plain Language and Avoid Legalese Where Possible

It is imperative that you use unambiguous language in your noncompetes that can only be interpreted in one way ' the way you intend it to be. In other words, say exactly what you mean, and say it clearly. All states view restrictive covenants as restraints of trade and will construe them strictly against enforcement. If your noncompete agreement contains an ambiguous provision that could be interpreted to have multiple meanings, a court will construe the provision in favor of the employee and against enforcement of the covenant. Furthermore, a restrictive covenant must clearly define what the employee can and cannot do. Courts are reluctant to enforce clumsily drafted agreements that do not clearly set forth the restrictions against the employee.

Ambiguity in restrictive covenants often leads to expensive, protracted litigation. An unclear, ambiguous restrictive covenant can give departing employees all the motivation they need to challenge the enforceability of the agreement. Often, these challenges can cost the employer leverage in reaching a favorable settlement or force the employer to defend the agreement in court. Even if the employer is successful in court, the result is often a pyrrhic victory due to the time and money expended.

DON'T Skimp on Consideration

Another problem that often leads to expensive litigation arises when an agreement is challenged for lack of consideration. Often, employers who require that existing employees sign restrictive covenants will either forget to provide proper additional consideration or will substitute a non-monetary “benefit” such as “training,” “access to customers,” or “additional responsibilities.” Do not fall victim to this trap. If the employee is valuable enough to be worth restraining, the employee is valuable enough to warrant a bonus, raise or some additional form of compensation to which he or she would not otherwise be entitled. With respect to restrictive covenants, money talks.

Remember that continued employment will not provide adequate consideration in many states. Where continued employment is sufficient, the employee generally must remain employed for a substantial period of time after signing the covenant, a situation which the employer cannot control. Thus, unless the employee signs the restrictive covenant at the inception of employment, the employee must receive something of value in exchange for agreeing to the restrictions, especially if the employee is signing a noncompete agreement. By offering the employee a significant cash payment, the employer can avoid challenges to the agreement and expensive litigation over whether the employee received a benefit of real value. A few thousand dollars in consideration can save a few hundred thousand in litigation costs. In other words, an adequate monetary payment for a restrictive covenant can often pay for itself.

DON'T Forget That if You Terminate, the Agreement May Not Be Enforceable

As the economy remains in flux, many companies continue to make adjustments in personnel to account for reduced demand or to cut costs. Typically, these cuts begin with those who have failed to perform. If your company is forced to terminate one or more employees for performance or financial reasons, you should be aware that, in many states, including Pennsylvania, courts may refuse to enforce noncompete agreements against those employees. Often, the courts reason that by terminating an employee for performance or financial reasons, the employer has deemed the employee “worthless,” and, therefore, has no legitimate interest in preventing that employee from competing against it. Additionally, courts may find it inequitable or unfair to prevent an employee from working when that employee has been terminated involuntarily from his or her prior job.

In many cases, employers are generally content to let such employees join competing firms. However, you may find yourself confronted with a soon-to-be-terminated employee who, despite failing to perform for your company, could nevertheless harm your company if he or she is hired by a competitor. For example, your company might be forced to terminate an underperforming salesperson, whose contacts and relationships with your customers would prove valuable to a competitor, even if the salesperson is not soliciting those customers directly. Likewise, certain employees laid-off for financial reasons may have intangible confidential information that would give your competitors an edge if disclosed.

If you must terminate an otherwise valuable employee for financial or performance reasons, but still wish to restrain him or her from competing against your company, consider entering into a new, post-termination restrictive covenant with the employee in exchange for a severance payment to which he or she would not otherwise be entitled. Courts are more willing to enforce restrictive covenants against terminated employees where the employee accepted severance, since the payment of severance shows that the employee had some value to the employer, and provides a financial cushion for the employee during the restricted period. Make sure, however, that any severance pay intended to provide consideration for a noncompete agreement is in addition to any other separation payments that the employee would have received in the absence of the noncompete.

DO Consider 'Inevitable Disclosure'

When all else fails, and your most valuable employee, who has refused all requests to sign a noncompete agreement, tenders a notice of resignation and intends to join your largest competitor, consider whether the inevitable disclosure doctrine is available to you. Inevitable disclosure is a controversial doctrine, recognized in some form in most states, that can prevent employees with access to confidential information or trade secrets from going to work for a competitor. The doctrine recognizes that certain employees possess intangible confidential information that cannot be returned to the company at the end of their employment, and that these employees cannot go to work for a competitor without “inevitably” disclosing this confidential information in their new position. As a result, inevitable disclosure can act as a sort of de facto noncompete agreement in your favor.

Employers should not rely on inevitable disclosure as a viable alternative to noncompete agreements, as courts are loathe to restrain employees who never explicitly agreed to the restrictions. Rather, it should be used only as a last resort, and only then against key employees who possess very valuable, highly sensitive information, the disclosure of which would severely harm the company. Generally, the doctrine may apply when the employee leaves to go to a direct competitor, takes a position substantially similar to her prior
position, and had access to intangible confidential and trade secret information in her prior position, which would be highly valuable to her new employer. Courts are also more willing to apply the doctrine and restrain an employee where the employee departs in bad faith.
Consequently, employers seeking to employ the inevitable disclosure doctrine should carefully examine the departing employee's computer to see if the employee took any confidential information at the time of his or her departure.

Conclusion

As the economy rebounds, employers can expect to see increased mobility in the employment sector and heightened turnover in their own ranks. Many valuable employees who have patiently waited out the recession will begin seeking opportunities for advancement. Companies looking for a competitive advantage and to speed their recovery will welcome your employees with open arms. Restrictive covenants provide employers with a tool to prevent this from occurring, but they must be used appropriately and with restraint. When used effectively and appropriately, employers can not only protect themselves against competition from their own employees, but can decrease their anticipated litigation costs in the process.

Jonathan Cavalier is a member of the Labor & Employment group of Cozen O'Connor in Philadelphia. He has defended employers against claims of discrimination in state and federal court, prosecuted and defended non-competition covenants, resolved electronic discovery disputes, and litigated ERISA employee benefits issues.