Protect Your Company With Restrictive Covenants

Post-employment disputes, litigated for nearly 400 years, remain a hot topic today. Employees privy to proprietary or confidential information flit from job to job with startling regularity. A reasonable employer may hesitate to entrust valuable information to an employee, absent some assurance the information will not be divulged to a competitor. But employees want freedom to pursue a career, and bristle at the prospect of being hamstrung by oppressive restrictions.

New York law imposes a duty of loyalty on employees. They must perform job duties in good faith, and cannot seek direct or indirect advantages from third parties for such performance. This bars an employee from misappropriating a company opportunity or trade secret, or diverting it to a competitor.

But loyalty has its limits. For example, absent a contractual restriction, during the course of employment an employee can secretly form a company with a view to post-employment competition, provided he uses his own time and money to do it. Once the employee leaves, he is free to compete, subject to a few limitations. He can even solicit his former employer's customers, as long as he does not use a customer list he copied, stole, or intentionally memorized.

An employer seeking to restrict post-employment competition from employees can do so by means of contractual restrictive covenants. Such covenants typically fall into three categories: non-compete, non-disclosure, and non-solicitation. An employer can require a prospective, current, or departing employee to consent to one or more restrictions as a condition of employment or severance pay. (Sample clauses can be found on the internet, click here.)

An employer should consider requiring restrictive covenants from any prospective, current, or departing employees privy to proprietary or confidential information, and from employees whose services are unique or extraordinary. Generally, a prospective employer has the best bargaining leverage, and can negotiate the most favorable terms. An employee will be most prone to agree to restrictions at the outset, as a condition of employment.

In contrast, an existing employee may naturally perceive a restrictive covenant requested as a condition of continued employment as an adverse change in job conditions. Coupling such a restriction with a promotion or salary increase is often helpful; it fosters the perception that the benefits are offered, in part, in exchange for the restrictions, or that the new responsibilities are important enough to require restrictions.

A departing employee will be most concerned with future employment opportunities, and perhaps at his most adversarial, hence least amenable to restrictions. If the severance or other termination benefits offered are generous enough, the employee will usually sign, albeit with reluctance. An employer's biggest challenge will be to persuade an employee who intends to compete to agree to any restriction.

An employer should be prepared to discuss and, where appropriate, respond to an employee's concerns about imposing restrictions. Where an explanation alone will not suffice, the employer has a number of options: refuse to hire a prospective employee, fire an existing one, ignore the issue and hope for the best, or limit the information or opportunities to which the prospective or current employee has access. Upon learning that access will be limited, a reluctant employee may realize that opportunities for advancement will also be limited. This may be sufficient incentive for the employee to accept the restrictions, or accelerate departure.

An employer faced with a reluctant employee can also offer a better position, an increase in salary, stock options, or a bonus, in return for executing a restrictive covenant. In such a case, the agreement should clearly state the nature and amount of additional consideration and that it is given in exchange for the restriction. Such an agreement can further provide that the employee forfeits the additional compensation if he competes.

If the restrictions leave a former employee ample room to ply his trade, he might comply for fear of being sued; in such cases, enforceability is not an issue. The problem with using boilerplate restrictions, however, is they may prove unenforceable.

Many employers must sue to enforce restrictive covenants. New York courts, champions of free enterprise, are suspicious of restraints on trade. Thus to be enforceable, a restrictive covenant must be drafted carefully. A court will void a patently unfair restriction. However, provided the employer negotiates the restriction in good faith, without overreaching, a court will likely sever unenforceable aspects of a restriction and grant partial enforcement of the viable aspects.

An enforceable restriction must balance the employer's right to protection from unfair competition with the employee's right to pursue his career. For example, a court might protect an employer against a former employee's competitive use of client relationships acquired on company time, at company expense, or by use of confidential company information. But this protection generally does not extend to clients the ex-employee brought to the company, or found on his own time.

Non-competes
An enforceable non-compete must pass a rigorous three-part "reasonableness" test: First, it must be narrowly tailored to protect the employer's legitimate interests. Second, it must not impose an undue hardship on the employee. And third, it may not be adverse to the public interest.