Restrictive Covenants & Non-Compete Agreements

Restrictive Covenants, also called Non-Compete Agreements, are generally intended to prevent an employee or independent contractor who is working for one business, from leaving and setting up a competing business. Often these agreements also have provisions protecting business confidential information. When I receive an initial telephone call or e-mail from a client, whether employer or employee, concerning these issues, I usually respond, “in practice, these are ‘grey’ areas of the law. There are not many black and white answers because the application of legal rules depends on so many different facts and circumstances unique to each situation.”

The starting point is to understand what business confidential information is, because business confidential information is protected by law even in the absence of any written agreements between employers and employees. What can be known or determined from available public records is not confidential – so if your customer list is the fifteen largest banks or automobile dealers in the area, that information can never be protected. However, if you have a written list of 5,000 potential customers or vendors, including names, telephone numbers and e-mail addresses, which would take substantial time and money to reproduce even in part, that is confidential. The specific prices you charge for your work are confidential – the general price range for a product, known to people in your particular industry, is not confidential. If you have truly proprietary business methods, that may be confidential, but methods known to many experienced people in your industry (even if your methods have a little different ‘twist’ to them) are not confidential. Employees can never walk out the door with written lists of customers, vendors or marketing plans (confidential), but the general skill, knowledge and contacts someone acquires when working for years in a particular trade is not confidential. Apart from intellectual property law involving patents and copyrights, lawyers can usually reach agreement about surrendering or using confidential information without litigating in court.

But when an employer wishes to stop someone from competing even without the use of confidential information, that is, stop that person from working in the field altogether for a defined period of time and (usually) a defined geographic area, then a written restrictive covenant or non-compete agreement is essential. Courts are usually not fond of these non-compete agreements. However, they are essential when someone is buying a business; no one wants to pay a substantial price for a business and then see the former owner set up shop across the street; almost any court would enforce non-compete provisions in that context.

When an employer attempts to bind a former employee from competition, then the enforceability of such provisions becomes subject to a host of questions. Was the non-compete signed at the outset of employment, when the employee was considering whether to take the job and had some bargaining power, or was it ‘rammed down the employees’ throat’ later on as a requirement of keeping his or her job? If the non-compete was signed later, was there additional consideration for the employee (e.g., a promotion to a more senior position with more pay and more access to confidential business information), or was it part of a business ‘push’ to get everyone to sign a non-compete, so that the agreements are handed out to every employee at a particular time with the requirement that they sign and return them by a particular date? How senior was the employee and what was he or she being paid? Did the employee have access to customer lists, pricing and confidential information? Do the customers represent long-term repeat business, or is each customer a once-and-done type of business transaction? Did the employee leave voluntarily to compete, or was the employee fired and is now simply trying to stay gainfully employed? Is the employee truly directly competing and using confidential information, or is the employee simply working in a related field? Even with a written agreement, enough negative answers to questions like the foregoing will make it more difficult for an employer to enforce such an agreement, even if the agreement is in writing and properly supported by legal ‘consideration’ (the employee got something they didn’t already have in return for giving up his/her right to compete). Usually employers will not spend a lot of money in litigation to stop an employee who is not doing real business harm, even if the theoretical right to do so exists. On the other hand, if enough answers suggest that the employee had choices, voluntarily accepted the restrictions spelled out in writing for consideration, was senior in pay and responsibility, is directly competing, etc., then a written agreement may (it’s still not a slam-dunk) be enforced by a court, usually in the form of a preliminary injunction.

Non-compete agreements arise in many different contexts. Tense litigation frequently occurs when two or more employees leave simultaneously to set up a competitive business or an employee conspires with a new employer to bring business with him/her. In that case, the former employer may have a good argument that it is being injured and the questions in the foregoing paragraph, tending to make courts sympathetic to employees, are balanced with other questions. Were any, all or only some of the departing employees bound by non-compete agreements? Have the departing employees been systematically contacting customers and vendors to induce them to switch their business allegiances? This scenario frequently leads to a ‘poison the well’ debacle: each side contacts all the existing customers and vendors attempting to gain support, refute what it sees as misrepresentations from the other side, and gather witnesses for the upcoming court fight. The customers and vendors want no part of it, and not surprisingly make the decision to not do business with either the old employer or the new business entity. Both sides in the fight incur big litigation costs, while the business prospects for each are run into the ground. The outcome of this scenario may well be business dissolution, the topic of another article.

On a more positive note, on occasion I have had clients say in essence, ‘I know I am bound by this non-compete, but it will be so profitable for me to go into business on my own that I am willing to take the risk.’ In cases like that, we discuss what the litigation may cost, what the potential results may be, but the client may make a rational business decision to accept the risk of litigation, and even the risk of tendering a substantial settlement to end the litigation, because the dollars are just too good to pass up. Almost all decisions involving the prospect of business litigation involve questions: How expensive is the litigation expected to be? What is the value we are litigating over? Can a non-monetary settlement be reached? The first role of a business lawyer is to give candid advise at the outset, so the client can plan accordingly. Planning in the context of non-compete agreements is never a certainty, but an attorney can explain the overall parameters of the legal rules and the broad range of possible outcomes, to help the client shape his or her future conduct.