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 the conduct of his new duties—so valuable that his previous employer sued for violation of confidentiality and nondisclosure agreements, and illegal use of trade secrets. The results were costly cash settlements against the executive as well as the new employer who had encouraged use of stolen material.
If that story sounds familiar, it’s no accident. Similar cases occur regularly around the country. Conflicts that arise when a star employee moves from one business to another 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 had been done to the original employer,” says Theodore J. St. Antoine, Degan Professor Emeritus of Law, University of Michigan Law School, Ann Arbor. “There may also be an injunction prohibiting the losing party from continuing an illegal practice. 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.”
The moral of all this is clear: Businesses must take steps to ensure they do not lose valuable information when employees leave for competing firms. At the same time, employers need to protect themselves from costly lawsuits when poaching top performers from competitors.
Protecting business interests has become more important with recent changes in the work environment. The employment relationship is less stable than in the past, high level talent is in demand and recruiting is aggressive. Intellectual property—easily carried between companies—is more valuable than ever before. Customer information, pricing data, business plans, and proprietary marketing strategies are all at risk.
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.
“Most employers have confidential, proprietary, or sensitive information,” says Joon Hwang, Shareholder in the Tysons Corner, Va., office of Littler Mendelson, P.C., the nation’s largest law firm defending employers in labor and employment disputes. “Or they may have certain employees with desirable skills, experience, training, or intimate knowledge considered integral and invaluable to their businesses. Restrictive covenants, drafted properly, can be a powerful tool for protecting all of this valuable information.”
There are two sides to the trade secret coin. Incoming personnel must also be quizzed about any restrictive covenants signed at their former employer. And they must be prohibited from bringing along customer lists, marketing plans, financial records, confidential information, or anything else that might be determined to be the former employer’s property.
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 do counsel my clients to have non-competes, certainly with their higher-level employees,” says Jeffrey A. Dretler, a partner at Rubin and Rudman, 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 these covenants: The possibility 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. “The wider the covenant goes geographically, and the longer the term of the restriction, the less likely the court will uphold it as reasonable,” cautions St. Antoine. An example of a very reasonable covenant would be one that calls for a one-year moratorium on working for a competitor, within the radius of one mile of the original employer.
Achieving the right balance is a tricky proposition, not only because each employer-employee relationship poses unique circumstances but also because no federal law provides a common nationwide playing field. Everything depends on state law, and that can differ substantially.
“Fifty states have fifty permutations of what employers can lawfully restrict with written agreements,” says Mathis. “Many states allow restrictions for reasonable periods from six months to two years. Some states are more employee friendly than others. In California, employers generally cannot have any kind of restrictions.”
The challenge is becoming greater because in many states the law is trending toward greater worker protections. “The world is changing very rapidly,” says Dretler. “States are trending toward limiting non-competes. Many federal, state, and local initiatives, legislation, and news commentaries are asking whether there should be limits put on them. Are they anti-competitive? What's really protectable? There's a lot of litigation about these issues.”
Employers, then, need to avoid over-reach that can backfire when an unfavorable court decision removes the protections that were thought secure. “Another reason to avoid overreach is because it may reduce the employer’s credibility with the court when seeking to enforce the non-competes that really matter,” adds Dretler. And he notes one more potential pitfall of unreasonable non-competes: Some valuable prospective employees may decide not to join a company out of fear they will be bound by a too-onerous non-compete when the time comes to leave.
As the above comments suggest, non-competes can backfire when they fail to hold up to a court challenge. Very often that means an employee who has jumped ship is free to conduct business without any restrictions. And that can leave the former employer in a bad competitive position.
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.
“An agreement not to solicit customers is often easier to defend than a covenant not to compete,” says Joseph Y. Ahmad, a founding partner in the Houston law firm of Ahmad, Zavitsanos, Anaipakos, Alavi & Mensing. “That’s because it is narrower in scope, allowing the employee to work for a competitor.” Courts like the fact that these agreements preserve the ability of the individual to continue to earn a livelihood while protecting the rights of the former employer.
What if a former customer tracks down the departed employee at his or her new employer? Even then the terms of the non-solicit agreement usually hold. “The employee has to say ‘no, I can't help you’ and the former customer needs to contact another employee,” says Ahmad. “Occasionally one can go further than that and actually specifically direct them to a person who can help them. But the safest thing is to not give the previous customer much direction at all.”
Again, though, employers need to be careful about over-reach that can void the agreements. Not only should the terms specify a reasonable time limit, but they should also avoid prohibiting the solicitation of all customers served by the current employer.
“There usually needs to be some relationship between the employee and the customers, in terms of previous interactions,” cautions Ahmad. “The exception would be if you could argue, for example, that the employee had confidential information about your margins on certain products and that information can be leveraged at any customer. You can often make that argument work.”
There’s another kind of non-solicit. Often called an “anti-raiding provision,” this one keeps departing employees from luring co-workers to the new employer. “I don't know of anything that triggers litigation more than a high level employee leaving a company, and then is suspected of being the Pied Piper and causing a bunch of other employees to leave,” says Ahmad. “Many times that gets articulated as some type of raiding claim, even though not every state has protections specifically for that.” Having a well-written non-solicit of employees, he adds, can help protect against this situation.
As the comments so far suggest, sometimes the old adage “less is more” can be a smart business posture: Employers may get more value from less restrictive covenants. Just as a non-solicit may be more effective than a non-compete, one more less onerous restrictive covenant—the confidentiality agreement—can in some circumstances be the most effective of all.
“A confidentiality or non-disclosure provision prevents the departing employees from disclosing or using the proprietary or confidential information of their ex-employers, or that of their employers’ customers,” says Hwang. 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.”
Because the legal system of every state recognizes the right of businesses to protect their sensitive information, confidentiality agreements are generally highly defensible in court. Attorneys advise that they be signed by any employee who has access to sensitive business information. They provide valuable evidence that an employer has taken steps to communicate the importance of discretion to employees.
Luring star performers
Now for the other side of the coin. Employers need to be careful about 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 scare people into behaving as desired,” warns Mathis. “Employers with deep pockets can cause a lot of trouble.”
Attorneys advise taking some prudent precautions during the hiring process. Ask what agreements the employee has signed with his current employer. The individual who never signed a non-compete might have signed an agreement not to solicit the certain customers or to recruit coworkers.
“When a new employee is hired it's a good idea to get a verification or agreement the individual is not taking confidential information from somewhere else,” says Ahmad. “And also that that employee is not subject to a restrictive covenant that they have not made the new employer aware of.”
When determining the risk involved in poaching, employers also need to examine their conscience: If the goal is not to attract a skilled employee but to cripple a competitor by grabbing trade secrets, hiring the individual can be actionable in court.
"You may simply see a very talented person performing for another firm and you think you can give that individual a better deal," says St. Antoine. "That won't give rise to a cause of action. But you can be the target of litigation if you have some other element in the picture, such as an effort to get insider information."
Employers should also avoid tarnishing the picture by spreading false and damaging information about the employee’s current company. “If an employer falsely tells a coveted person that his current employer is going out of business, that is ‘trade libel,’ a special form of ‘libel and slander,’” says St. Antoine.
Non-competes, non-solicits and confidentiality agreements form a three-legged stool of defense for employers looking to protect valuable business information. But restrictive covenants must balance the needs of the employer with those of the employee. At the same time, employers must periodically review such agreements to ensure they continue to comply with state laws that are becoming more protective of workers by imposing new and tighter restrictions on what employers can prevent them from doing.
“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,” says Hwang. “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.”