What exactly are “Restrictive Covenants”?
“Restrictive Covenants” is a term used to describe provisions in an agreement that purport to restrict an employee from doing certain things after she leaves the company.
The two most common forms of Restrictive Covenants are “non-competes” and “non-solicits.”
- A non-compete is a provision that precludes the employee from working for a competitor for a period of time after she leaves the company.
- A non-solicit is a provision that precludes the employee from attempting to hire company employees for a period of time after she leaves the company. Non-solicits can also preclude the employee from trying to get business from the company’s customers for a period of time after her employment with the company ends.
So, are Restrictive Covenants enforceable?
Where and What Law?
It depends a lot on where the employee is and what law governs (or purports to govern) the agreement. Restrictive Covenants are governed by state law so enforceability can differ from state to state. For example, with very narrow exceptions, a non-compete is not enforceable in California.
In other states, non-competes are generally disfavored but will generally be enforced if there is a real connection between the position the employee held and a key business asset of the company. Key assets may include customer good will, trade secrets or confidential information. Courts are likely to enforce reasonable non-solicitation provisions.
Quit or Fired?
In these states, another factor that can impact whether a Restrictive Covenant will be enforced is the reason the employment ended. If the employee quit or was fired for doing something really egregious, then a court is more likely to enforce the Restrictive Covenant. If, however, the employee was fired because of a reorganization or even poor performance, courts will be less likely to enforce the Restrictive Covenant.
Breadth & Depth
The other key component that factors into enforceability of Restrictive Covenants is their scope. Scope means both how long the Restrictive Covenant lasts and how broad it is. As you might guess, the shorter the time and narrower the scope, the more likely the Restrictive Covenant is to be enforced. Courts don’t like to see provisions that try to tie someone up for an unduly long time and/or try to squeeze them out of making a living in a broad field.
Assuming the rest of the provision and the surrounding circumstances favor enforcement, Restrictive Covenants limited to one or two years are generally viewed as reasonable. Longer periods are more likely to be enforced when the Restrictive Covenants arise out of a merger or similar transaction where there is a wholesale transfer of company good will and assets.
In terms of breadth, Restrictive Covenants that overreach may be held unenforceable. For example, if an employee only deals with customers in certain states, it may be hard to enforce a Restrictive Covenant that purports to cover the entire country. Similarly, if an employee really only deals with one of the company’s product lines, a Restrictive Covenant that purports to prevent her from taking a job in another area just because the company has a competing product in that area may be hard to enforce.
Common Restrictive Covenant Issues
I want to hire someone who is subject to Restrictive Covenants, how do I know if they are enforceable?
The answer will often depend on which state’s law will or arguably could govern. An employee may work in one state currently but you want to hire her to work for you in another state and the Restrictive Covenant agreement may say it’s governed by the law of yet another state.
The unfortunate reality is that enforceability is often murky. If you are in an uncertain situation, give thought to whether there may be room for compromise with the other company. For example, is there another role the employee could hold for you for a shorter period of time that may allay some of the prior employer’s concerns? Are there customers you could agree to restrict the new hire from soliciting or working with for a period of time? Approaches like this often can tip a brewing dispute into a workable solution instead of litigation.
I can hire her and if the other company makes a big deal out of it, it’s her problem, not mine, right?
Maybe, maybe not. If your company is aware of the Restrictive Covenant, the other side may be able to assert claims against your company for interfering with a contract or for unfair competition. Also, if your new employee faces a claim for breaching a non-solicit provision, based on her conduct after she joined your company, state law may require you to pay for her defense.
What can a company do to enforce a Restrictive Covenant?
Whether you’re concerned about enforcing your own Restrictive Covenants or are facing a dispute because you hired someone arguably subject to restrictions, it is important to understand what can happen and when. Unlike a lot or areas of litigation, enforcement of Restrictive Covenants is an area where courts are more willing to consider making a preliminary decision that will lock the parties in until the lawsuit is finally decided. This means a court could rule very quickly that the Restrictive Covenant is or isn’t enforceable and that ruling will apply until the case is finally decided, which may not take a year or more. Often this is done by issuing a Temporary Restraining Order or a Preliminary Injunction. These types of decisions can come within a month or less of one side filing a lawsuit.
The key is to recognize that threats about enforceability need to be taken seriously no matter what side of the equation you’re on. Things can move quickly.
In short, Restrictive Covenants can get complicated on both sides of the equation, i.e., whether you want to have your employees restricted or want to hire someone who may be subject to a restrictions. Go into this area with your eyes open and an informed understanding of the issues.