When employees leave for positions elsewhere, valuable trade secrets can go out the door with them. Employers can protect their customer lists, marketing plans, and pricing data from ending up in the hands of competitors by having key employees sign restrictive covenants that prevent them from sharing sensitive or proprietary information. By the same token, those poaching top performers from your competitors need to avoid lawsuits for violating restrictive covenants.
Making the Move to a Competing Employer: Trade Secrets Revealed
Here’s an example: A California sales executive who jumped ship for a competing employer took along a folder of customer lists and marketing plans. Those items proved valuable resources for conducting his new duties—so valuable that his previous employer sued for violation of confidentiality and nondisclosure agreements and for illegal use of trade secrets. The results were costly cash settlements against the sales executive and his new employer who encouraged use of the stolen material.
Similar cases occur regularly around the country. When a star employee moves from one business to another, taking proprietary information with him or her, the resulting conflicts are often resolved in court.
“This area of law is growing quickly,” says Ben Mathis, an Atlanta attorney and managing partner of the nationwide law firm of Freeman Mathis & Gary. “There are two competing interests at stake. The first is that of employers who have a right to protect their information from having people walk off and take it all with them. The second is that of the individual’s right to compete against his earlier employer.”
Resolving those competing interests can hit profits hard. “Court remedies usually involve financial damages for harm that has been done to the original employer,” says Theodore J. St. Antoine, Degan Professor Emeritus of Law at the University of Michigan Law School, in Ann Arbor. There may also be an injunction prohibiting the losing party from continuing an illegal practice, he adds, if the losing party ignores the injunction and continues to do the prohibited activity. “The result may be additional fines for contempt of court, or even jail time in extreme cases.”
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What Is a Restrictive Covenant? Three Most Common Types
Businesses looking to negotiate this rocky terrain have a valuable tool at their command: restrictive covenants. These written agreements can keep departing employees from competing against former employers, soliciting the same customers or employees, or using a former employer’s sensitive information for their own ends.
Here are the most common restrictive covenants:
1. Covenants not to compete
The most powerful restrictive covenant prohibits the employee from accepting employment at a competitor. Called “covenants not to compete,” or “non-competes,” these agreements specify a period of time for the prohibition and a geographic area where the prohibition applies. They usually also prohibit the individual from serving as an independent contractor for, or having any ownership interest in, a competitive organization.
“I generally counsel my clients to have non-competes, certainly with their higher-level employees,” says Jeffrey A. Dretler, a partner at the law firm of Rubin and Rudman, in Boston. “I think it's a very important and effective tool for protecting company confidential information and relationships in which they have invested.”
So far so good. But employers need to be wary of a not-so-secret vulnerability of non-compete covenants: The possibility that they will be deemed invalid by a court of law. That’s because such covenants raise concerns about limiting the capacity of employees to earn their livelihoods.
Employers can help improve the enforceability of their non-competes by ensuring the terms balance the concerns of the employer with the reasonable interests of the employees.
2. Non-solicit covenants
As noted above, non-competes that are too restrictive can backfire if challenged in court. There is a solution to this problem, and it comes in the form of another restrictive covenant. Often referred to as “non-solicits,” these covenants are designed to keep an employee who moves to a new business from soliciting a former employer’s customers for a set period of time.
Again, though, care must be taken to not overreach. A non-solicit covenant should specify a reasonable time limit and should only prohibit the solicitation of customers previously serviced by the employee—not all of the employer’s customers.
3. Confidentiality agreements
Just as a non-solicit may be more effective than a non-compete, an even less onerous restrictive covenant—the confidentiality agreement—can in some circumstances be the most effective of all.
A confidentiality or nondisclosure provision prevents the departing employees from disclosing or using the proprietary or confidential information of their ex-employers, or that of their employers’ customers. After defining the nature of the organization’s sensitive information, the agreements state that the signers will take measures to keep it secret. “The information in dispute does not have to be a ‘trade secret,’ but must simply be confidential, proprietary, or not publicly available,” says Joon Hwang, shareholder in the Tysons Corner, Va., office of Littler Mendelson, the nation’s largest law firm defending employers in labor and employment disputes.
Hiring Right: How to Attract Star Performers Without Violating Restrictive Covenants
Finally, employers must be aware of the other side of the coin and take care to avoid violating a competing business’s restrictive covenants when luring away a star performer.
The legal fees and time required to defend one’s actions can be costly, even when a court strikes down the first employer’s covenants as unreasonable. “Some employers draft restrictive covenants knowing they will not be enforceable, but will still scare people into behaving as they desired,” warns Mathis. “Employers with deep pockets can cause a lot of trouble.”
Attorneys advise taking some prudent precautions during the hiring process, such as asking what agreements the candidate has signed with his or her current employer. The individual who never signed a non-compete may have signed an agreement not to solicit certain customers or to recruit co-workers.
To be effective, restrictive covenants must balance the needs of the employer with those of the employee. And they must conform to state laws—no federal law provides a common nationwide playing field.
“The viability and enforceability of a company’s restrictive covenants, particularly non-competes, are more likely to be the subject of rigorous review today than in the past,” Hwang says. “To ensure enforceability when it counts, employers should review the scope and terms of such documents to ensure they are sufficiently and narrowly defined to meet their legitimate business interests.”
COVID-19 Layoffs Heighten Risk
With some companies suffering layoffs in the wake of the COVID-19 pandemic, many of those individuals will take positions with competing firms.
Employers may be tempted to overlook the terms of restrictive covenants so terminated workers can earn a living, but doing so may jeopardize the employer’s future profitability.
“Employers that choose not to seek enforcement of restrictive covenants during this time should understand that failure to do so may hinder later enforcement,” cautions Joon Hwang, shareholder in the Tysons Corner, Va., office of Littler Mendelson. He points out that future employees who breach restrictive covenants may assert a waiver argument—that the employer’s prior forbearance proves a lack of legitimate business interest to support enforcement of the agreements.
There is a solution to this conundrum. Hwang suggests employers take steps to minimize the risk their well-meaning inaction among laid-off employees may have by rationalizing their inactions, such as:
- A lack of resources necessary to enforce the agreements due to the impact the pandemic has had on the employer's business
- A decline in business from certain clients, or their bankruptcy
- Model records of former employees for whom restrictive covenants have been unenforced, including the fact that the individuals returned all confidential information and agreed not to solicit customers serviced.
Hwang offers another tip: “It would be helpful for employers to explicitly state that the decision not to enforce at this time should not be interpreted as a waiver of any future right to enforce the restrictive covenants against other former employees.”
Phillip M. Perry is an award-winning freelance writer based in New York City. His byline has appeared over 3,000 times in the nation’s business press.