How to Create an Enforceable Non-Compete Agreement

How to Create an Enforceable
Non-Compete Agreement
By Thomas B. Lewis, Esq., Mark F. Kowal, Esq., and Lalena J. Turchi, Esq.
Executive Summary
Today, downsizing and the reality of transient employment relationships have forced employers to
protect their economic interests. The departure of well-trained, highly productive employees creates a
potential threat to business. Employees often have significant knowledge of the company, which they
could share with a competitor or use to start their own business and directly compete. To defend their
business and not jeopardize continued, long-term success, one valuable approach is to have employees
enter into a series of restrictive covenants with the employer.
Restrictive covenants take many forms, some of the most common include: (1) non-competition
agreement; (2) non-solicitation agreement; (3) garden leave agreement; and (4) confidentiality
agreement. Each of these types of agreements is generally scrutinized by the courts.
A non-competition agreement (“non-compete”) is a type of restrictive covenant sometimes contained
in an employment agreement that forbids an employee from participating in some particular activity
for a specific period of time and in a specific geographical region. When improperly drafted, however,
non-competes can be the subject of legal attack, thereby offering little or no protection.
To ensure enforceability of a non-compete, employers must balance the necessity of protecting their
legitimate business interest with the fair interests of the employee. Each agreement should be judged
independently, paying close consideration to the status of the business, the employees involved, the
interests of the business to be protected, and the laws of the state interpreting and enforcing the
agreement.
My Strategy
We take the time to identify the specific needs of our clients by identifying the nature of the business,
and the nature of the interest the employer is attempting to protect. Then we identify key competitors,
geographical information and review other information available related to the employers business,
including statistical evidence relative to employee retention and turnover. Finally, we take the time to
listen closely to our client, rather than to anticipate or assume what we suspect the client needs to
accomplish.
The Definition of a Covenant Not to Compete
A covenant not to compete is a promise by an employee wherein to not compete with his or her present
employer for a specified period of time, in a specific place, and in a particular manner. A covenant not
to compete is also often referred to as a non-compete. In most instances, a non-compete is included as
part of an employee’s employment agreement, or in some cases a non-compete is a separate contract
between the employee and their employer.
The Necessity of a Proactive Business Interest
Most courts will enforce a non-compete if it is reasonable and protects an employer’s legitimate
business interest. In most jurisdictions a business’s legitimate business interest includes customer
relationships, trade secrets and confidential business information. Confidential business information is
generally defined as information that consists of any formula, pattern, device or compilation of
information which is used in one’s business and which gives him an opportunity to obtain an
advantage over competitors who do not know or use it. It can also be any information that can be used
in the operation of a business or other enterprise and that is sufficiently valuable and secret to afford a
potential economic advantage over others. Thus, an employer must determine whether the information
she is attempting to protect is:
1)
2)
3)
4)
a customer relationship, trade secrets, or information consisting of a formula, pattern, device
or compilation of information which is used in their business;
information that gives her an opportunity to obtain an advantage over competitors who do
not know or use it;
information that is sufficiently valuable and secret; or
information that affords a potential economic advantage over others in the field.
What Employees Should be Subject to in a Non-Compete
In addition to the necessity of a protectable business interest, employers must determine what
employees should be subject to in a non-compete agreement. In this regard employers should consider:
(1) the employee’s ability and intent to compete should his employment end with the employer; (2) the
employee’s relationships and contacts with those who have expertise in the business; and (3) the
employee’s relationships and contacts with customers. Thus, an employer must know whether:
1)
2)
3)
4)
the previous employee will have the ability to compete against the employer in his new
position (in other words, is the previous employee going to work in the same industry, in the
same region, doing the same job, calling on the same clientele, etc.?);
there is reason to believe that the relationship with the previous employee could end poorly,
giving the previous employee reason to want to compete against the employer;
the previous employee already possesses or will possess, by virtue of his employment,
relationships and contacts with individuals who have expertise in the field that could benefit
from the information the previous employee knows; or
the relationships that the previous employer has with customers are in good standing, and the
employee could solicit their business away from the employer.
Whether the Employee is a Candidate for a Garden Leave Provision
Garden leave is a growing provision being included in American non-compete agreements. Garden
leave was originally created by English businesses. Garden leave, unlike a restrictive covenant,
requires that the employee provide the employer with a specific notice period before terminating
employment.i During this notice time, the employer normally does not have the employee work.
Instead, the employee is paid salary and sometimes benefits, often with the expectation of not working
for the resigned-from employer. Since the employee remains employed, he cannot work for a
competitor, nor can he do anything else to harm or violate their duty of loyalty to the former employer.
Garden leave provisions possess many of the same benefits as traditional non-compete provisions.
Garden leave will generally protect the employer from misappropriation of confidential proprietary
information as well as direct competition created by the departing employee. Moreover, because the
employee is still employed, he still owes a duty of loyalty to their employer. In addition, since the
employee is no longer in the office, he will likely be unable to access sensitive business information,
and any information in the employee’s possession often becomes out of date and of limited value when
the employee resumes working for a new employer. Garden leave provisions, like traditional noncompete provisions, are driven by principles of contract, allowing employers the ability to seek
injunctive relief and damages if an employee breaches the garden leave provision.
Because employers must pay the salary to their employees during the garden leave period, prior to
including a garden leave provision in any employment contract employers need to determine:
1) the type of employee that necessitates a garden leave provision (for example, is the employee
a high-producing employee with significant access to confidential business information and
customers?);
2) whether a garden leave provision would reduce the value of the confidential information the
employee possesses when the employee returns to work for a new employer;
3) how many employee contracts will possess a garden leave provision (because the employer
will be required to pay salary to these employees while these employees are no longer
producing revenue for the business); and
4) because of the potential costs associated with multiple employees simultaneously being on
garden leave, the likelihood that one or more employees could be on garden leave at any one
time.
American Courts’ Interpretation of Garden Leave Provisions
American employers have begun including garden leave provisions in the employment contracts of key
employees. However, as garden leave is a relatively new phenomenon, there is limited case law
addressing enforcement. In Baxter International, Inc. v. Morris, one of the first cases to examine the
enforceability of a garden leave provision, the Eight Circuit affirmed a district court ruling, refusing to
stop a research scientist from working for a competitor even though his previous employer was willing
to pay him during the duration of his one year non-compete agreement. The Circuit Court held, “if
Microscan (Morris’ previous employer) paid Morris’ salary for the year he would be forbidden to work
by the covenant, Morris would suffer undue hardship.ii
Since Baxter, several cases involving garden leave have occurred in New York courts. These courts
have upheld non-competes with safety net clauses as well as non-competes with provisions remarkably
similar to traditional English garden leave provisions.
A New York court found the restrictive covenant reasonable “on condition that plaintiffs continue to
receive their salaries for six months while not employed by a competitor.”iii
A New York court upheld a six month restrictive covenant, placing significant reliance on the
employee’s full compensation of salary and payment of health and life insurance premiums.iv
The Second Circuit, applying New York Law, upheld a six month non-competition agreement that did
not contain any post-employment payment provision. The court held that the employer’s provision of
the employee-salesman’s annual compensation of $600,000, contingent upon the employee-salesman’s
agreement to abide by his contractual post-employment restrictions, was equivalent to the postemployment payments in Maltby, thereby alleviating the policy concern that non-compete provisions
prevent a person from earning a livelihood.v
A New York court upheld a 30-day notice provision which was combined with the 90-day noncompete provision, holding that the safety-net payment provision made “virtually non-existent [the]
concern that the former employee could lose his livelihood.”vi
Finally, a New York court upheld a restrictive covenant containing a “sitting out” clause. The court
granted the employer a five-month enforcement period of the restrictive covenant, holding that the risk
to the former employee-executive of a loss of livelihood was mitigated by the continual payments of
his salary.vii
Drafting Concerns for the Employer With Regard to Garden Leave
Notwithstanding the limited case law from New York addressing the enforceability of garden leave
provisions, there remains no clear judicial guidance describing the elements of a properly drafted
garden leave provision in the vast majority of the states.
Recognizing that in some courts the enforceability of a garden leave provision will be a case of first
impression, the most prudent approach to ensure the enforceability of the provision would likely be to
draft the provision in a manner that requires the employee to give a defined period of notice before
resigning, and in exchange, the employer should be required to maintain the employee’s full
compensation during the leave period. There can be, however, variations on this premise. Employers
can determine the length of notice required, the compensation to be paid during the leave period and
the individual’s employment status during the interim. For example, a garden leave agreement that
provides for 30 days’ advance notice sounds like a notice provision. However, if the required notice
period were one year, something that is common for non-competes, a court might be persuaded to
employ the restrictive covenant paradigm and find the garden leave provision to be unreasonable and
unenforceable. Likewise, if there is a great disparity in compensation levels during the leave period, it
may expose the employer to the argument that the restraints imposed upon the employee are more like
post-employment restrictive covenants than they are like garden leave agreements, thus being
unreasonable.
These possibilities are more acute in agreements which can be appropriately characterized as
noncompetition agreements with pay. Simply put, the more that employer drafts the restraints in a way
that resembles a restrictive covenant, as opposed to a garden leave provision, the more arguable it
becomes that the provision should be analyzed according to the restrictive covenant enforcement
paradigm.
Once a decision is made regarding which employees should be afforded garden leave, the garden leave
provision should include the following:
1)
2)
2)
3)
4)
a statement giving the employer the authority to place the employee on garden leave;
a statement which reserves the employer’s right to exclude the employee from the
workplace;
a statement prohibiting the employee from contacting customers and clients and accessing or
using the company’s proprietary information;
terms indicating what, if anything, the employee is required to do while on garden leave
(remembering that the less an employee on garden leave is required to do for their employer,
the more likely the provision will be enforced); and
terminology stopping the employee from engaging in employment with any other employer
for the duration of the garden leave.
Enforceability of a Non-Compete Depends on State-Specific Law
Once an employer has determined that she has a protectable business interest and has determined what
employees will be subject to a non-compete, and/or garden leave provision, an employer should
determine whether the jurisdiction (State) that the employee is located in enforces non-competes. In
those states that do recognize non-compete agreements, non-competes are enforceable when they are
reasonable. In these jurisdictions, a court will scrutinize a non-compete to determine whether the noncompete (1) protects an employer’s legitimate business interest; (2) is reasonably limited in time, scope
and geography; and (3) if enforcement of the non-compete will prove harmful or unduly burdensome
to the public. Thus, an enforceable non-compete must:
1)
2)
articulate a protectable business interest;
endure for a reasonable period of time. Generally, one to two years following an employee’s
employment terminating is reasonable, and any time in excess of two years may be
considered unreasonable;
3)
4)
be narrow in scope and protect only that information that is a protectable business interest of
the employer. Any additional information an employer attempts to protect through the use of
the non-compete may be unenforceable in regard to that additional information; and
create a geographical area of enforcement that is reasonable in size. For example, a noncompete with an enforcement radius of 100 miles from the employer may be found
enforceable, while a non-compete agreement encompassing the entire United States may not
be found enforceable.
The Necessity of Consideration in Enforceable Non-Competes
In addition to protecting a legitimate business interest of the employer and being reasonable in time,
scope and geography, non-competes are generally part of an employment agreement and are governed
by contract law; consequently, there should be adequate consideration. Consideration under contract
law is usually defined as anything of value promised to another when making a contract. Many states
hold that the signing of a non-compete at the inception of employment is sufficient consideration. After
the employment relationship has begun, and the employer requires the employee to sign a noncompete, however, the necessity of consideration becomes more important and more susceptible to
variances in state law. Many states hold that a positive change (promotion or change in compensation)
in the employee’s position in exchange for the signing of the non-compete is sufficient, while other
states hold that continued employment is sufficient consideration for an enforceable non-compete.
Therefore, when requiring an employee to enter into a non-compete employers must:
1)
2)
be aware of the law in the state that the employee is located in with regard to what
constitutes adequate consideration when requiring an employee to enter into a non-compete
at the inception of employment;
be aware the law in the state that the employee is located in with regard to what constitutes
adequate consideration when requiring an employee to enter into a non-compete after
employment has commenced.
Attorney’s Fees in Non-Competes
Generally, each party to a lawsuit must pay its own attorneys’ fees. This rule notwithstanding, when
two parties sign a contract, such as a non-compete, the parties can agree that if a dispute regarding the
enforceability of the non-compete arises at some time in the future, the losing side in the dispute will
pay the prevailing party’s attorneys’ fees and costs.
Merely because an employer includes an attorneys’ fees provision in a non-compete, however, an
employer cannot assume that the clause will be enforced. Courts will typically judge any type of
contract, including a non-compete, for fairness and may change the terms of the contract if the court
decides that doing so is a more equitable solution. For example, if a court finds that it would be
inequitable to enforce an attorneys’ fee provision that requires only one party (usually the employee) to
pay the other’s attorneys’ fees (usually referred to as a “one-way provision”), or finds that one of the
parties was forced into signing the non-compete, a court could cancel the requirement or change the
amount of fees to be paid. If the court determines, however, that an attorneys’ fees provision is
reasonable and that it was negotiated by two parties with equal bargaining power, the court will likely
enforce it. With these principles in mind a prudent employer should always include a reasonable
attorneys’ fee provision. Thus, when drafting an attorneys’ fee provision of a non-compete, an
employer should consider:
1)
2)
drafting the attorneys’ fee provision in a mutual fashion, which will enable either party to the
non-compete to recover attorney fees if they win in an enforcement action;
recommending that the employee review the terms of the non-compete, including the
attorneys’ fee provision with an attorney.
Blue Pencil
As previously noted, a court can cancel or change the language in a contract, including the language
contained in a non-compete. When a court does this, the court is applying the “blue pencil” rule. Under
this approach, courts will strike or modify overbroad or vague provisions from the contract or noncompete agreement and enforce the other terms. Whether a court will apply the blue pencil rule,
however, is generally governed by state-specific law. Thus, an employer must be aware the law in the
state in which the employee has entered into the non-compete agreement. Some states such as
California and North Dakota will not blue pencil; instead, these states will consider the entire
agreement unenforceable if a term violates the law. Other states will simply strike the overbroad or
vague provisions of the contract and enforce the remainder of the contract. Still others will rewrite the
overbroad or vague provisions of the contract to render these provisions more equitable. Therefore,
when drafting a non-compete agreement, a prudent employer will be aware the blue pencil law in the
state that the employee is located in with regard to:
1)
2)
3)
whether a court in their jurisdiction will render an agreement with overbroad or vague
provisions unenforceable;
whether a court in their jurisdiction will strike overbroad or vague provisions from the noncompete and enforce the rest of the agreement; and
whether a court in their jurisdiction will rewrite overbroad or vague provisions from the noncompete to render those provisions more equitable.
Frequently Asked Questions
Would my business benefit from the implementation of a non-compete/garden leave provision in
employee contracts?
Identify legitimate business interests by asking probing and pointed questions. What works for one
company may not work for another. The standards and requirements may vary significantly depending
upon several factors. For example, the components of a restrictive covenant will vary from industry to
industry and from state to state. Therefore, it is important that you take the time to identify the specific
needs of your client by asking probing questions. Such probing questions will identify the nature of the
business, key competitors and other human resource information available, including statistical
evidence relative to employee retention and turnover. Take the time to listen closely, rather than to
anticipate or assume what your client needs to accomplish. Only after you identify your client’s
specific objectives can you effectively consult with your client on the contents of the restrictive
covenant.
What conduct can I (the employer) restrict with a non-compete/garden leave provision?
Identify the conduct that should be restricted. Types of conduct that an employer would choose to
restrict during employment, and for a definite or indefinite period of time after employment ends,
include the disclosure of the employer’s trade secrets or confidential information, solicitation of
customers or employees, competition with the employer and development or ownership of ideas and
inventions.1 The entire agreement should be drafted while keeping this ultimate goal in mind.
Do I (the employer) have a protectable business interest?
Prepare a checklist of the interests to be protected. Types of protected interests include trade secrets
and confidential business information, customers and employees of the company, protection from
competition, reputation and goodwill of the company, and development and ownership of inventions
and other intellectual property. Your client will likely have a combination of protected interests.
Therefore it is important that a list is clearly defined to ensure that the agreement is all-encompassing.
What individual employee(s) should I require enter into a non-compete/garden leave provision?
Identify all individuals with access to the protected interests. All individuals with access to confidential
information, and those in a position to damage an interest of the company, must be identified. The
employer should consider each employee’s ability and intent to compete, their relationships and
contacts with those who have expertise in the industry and the employee’s relationships and contacts
with customers.2 This may include sales personnel and sales managers, other management employees,
high-level executives, any employee likely to develop intellectual property and independent
contractors. Moreover, this includes any individual in a position to damage the reputation of the
company by making disparaging statements.
Is the non-compete/garden leave provision reasonable and do I need to provide the employee
consideration for entering into the non-compete/garden leave provision?
Draft the restriction reasonably and provide any necessary consideration. It is important to be familiar
with the law in the state that the employer intends to enter into the employee agreement with the
employee. Employers must be mindful that non-competes will generally be enforced only if they are
reasonable in time, scope and geography. In addition, because the requirements of consideration often
vary, employers must be cognizant of the requirements of consideration with regard to a new employee
and the requirements for a veteran employee being asked to revise his/her current non-compete, or to
enter into a non-compete.
1
The Practical Guide to Federal and New Jersey Employment Law: The Employer’s Resource, at p. 131, 138.
2
See Platinum Management, Inc. v. Dahms, 666 A.2d 1028 (N.J. Super. Ct. Law. Div. 1995).
Case Studies
The software development intern: the often overlooked junior employee.
Our client is a major software company. An intern in the software development department decides to
work for a competitor upon graduation from college, and while still employed by our client, the
employee made available to the new employer certain trade secrets belonging to our client. Our client
became aware of this and successfully brought substantial litigation for damages, an injunction and
costs against the competitor. The former employee was asked to sign a restrictive covenant upon his
hire into the intern program because of his access to certain trade secrets and to other confidential
information. Our client did not ignore and overlook the danger of a confidentiality breach, despite the
junior status of the intern’s position within the company.
Our client understood that despite his status as an intern in the software development department, the
former employee had access to trade secrets and was in a position to develop intellectual property in
the future. Additionally, as a less sophisticated and inexperienced employee, the intern was more likely
to share this confidential information inadvertently, and be less aware of the ramifications of doing so.
Our client, however, was astutely aware of the importance of non-competes based upon the access an
employee had to trade secrets and confidential information, regardless of the employee’s employment
status. Therefore, our client did not miss the pitfall often overlooked with regard to junior level
employees.
The departed senior advisor.
Our client is a large player in the financial services industry. All senior financial advisors employed by
our client sign an employment agreement that includes a garden leave provision requiring 60 days’
notice of resignation and a non-compete agreement with a non-solicit provision. In this instance, after a
senior financial advisor submitted his resignation, the provisions of his employment contract required
him to abide by the language of his non-solicitation covenant, go on garden leave, and not to breach his
fiduciary duty to his previous employer while on garden leave.
As noted earlier, senior financial advisors are more often candidates for a non-compete that prohibits
solicitation of accounts and sometimes containing a garden leave provision because they are high
producing employees with significant access to the company’s customers and confidential business
information. While on garden leave, the value of the confidential information a financial advisor
possesses is reduced prior to the employee commencing with his/her new employment and the
employee cannot breach his fiduciary duty to his previous employer.
Here, our client had the security of knowing that the senior financial advisor was precluded from
harming the company or working for a competitor during his garden leave, and from soliciting the
company’s customers during the garden leave period.
The issue of reasonable geographic scope in non-competes.
Our client is a provider of various general services to the healthcare industry, who calls on any and all
healthcare facilities in New Jersey, New York and Pennsylvania for business. A former employee in
our client’s New Jersey office went to work for a competitor located 25 miles away, in the state of
New York. Our client learned from various loyal customers that the former employee had used
customer lists that were available to him during his employment to solicit new business for his new
employer. Despite having a signed restrictive covenant, the agreement was not enforceable in the state
of New York because it did not protect the company from competition outside the state of New Jersey.
Therefore, our client was without recourse.
Our client then retained us to draft a new restrictive covenant. We drafted a restrictive covenant that
reasonably expanded the geographic area to a 50-mile radius, thereby protecting the company from
competition by the former employee outside the state of New Jersey.
Supplemental Documents
RESTRICTIVE COVENANT CHECK LIST
 Is there a protectable business interest this restrictive covenant intends to protect?
 Is this an appropriate employee for a non-competition agreement?
 Is this employee an appropriate candidate for a garden leave provision?
 Is this employee an appropriate candidate for a non-solicitation agreement?
 Is this employee an appropriate candidate for a work for hire/intellectual property transfer
agreement?
 Is this employee an appropriate candidate for a confidentiality agreement?
 Is the non-compete drafted to comply with the state law that governs the restrictive covenant?
 Is the restrictive covenant reasonable as to duration?
 Is the restrictive covenant reasonable as to scope?
 Is the restrictive covenant reasonable as to geographical region?
 Is there sufficient consideration given to the employee to enter into the restrictive covenant?
 Is there a reasonable attorneys’ fee provision included in the restrictive covenant and/or
employment agreement?
Restrictive Covenant Chart
TYPE OF RESTRICTIVE PROTECTABLE
SUITABLE EMPLOYEES
COVENANT
INTEREST
Non-Solicitation Agreement
customers and employees of any employee, most often
the company
senior management, Sales
personnel, Sales Managers
Non-Competition Agreement
protection
against
direct Any employee, most often
competition
high level executives, senior
management, sales personnel,
sales managers
Garden Leave Agreement
customers, protection against generally executive employees
competition,
confidential and
officers,
senior
business information
management, high producing
sales personnel, managers
Confidentiality Agreement
trade secrets and confidential any employee, independent
business information
contractor(s) having access to
company trade secrets and/or
confidential
business
information
Work for Hire/Intellectual development and ownership of any
employee,
including
Property Transfer Agreement
company
inventions
and independent contractors who
intellectual property
will be involved with the
development of company
inventions and/or company
intellectual property
i
Greg T. Lembrich, Garden Leave: A Possible Solution to the Uncertain Enforceability of Restrictive Employment
Covenants, Colum. L. Rev. 2291, 2292 (Dec. 1992)
ii
Baxter International, Inc. v. Morris, 976 F.2d 1189, 1197 (8th Cir. 1992)
iii
Maltby v.Harlow Meyer Savage Inc., 633 N.Y.S. 2d 926, 930 (N.Y. Sup. Ct. 1995)
iv
Lumex Inc. v. Highsmith and Life Fitness, 919 F. Supp. 624, 629-36 (E.D.N.Y. 1996)
v
Ticor Title Insurance Co. v. Cohen, 173 F. 3d 63, 71 (2d Cir. 1999)
vi
Natsource LLC v. Paribello, 151 F. Supp. 2d 465, 472 (S.D.N.Y. 2001)
vii
Estee Lauder Companies Inc. v. Batra, 430 F. Supp. 2d 158, 182 (S.D.N.Y. 2006)