Much Ado about Non-Competes

In energy, technology, healthcare and other key sectors of the economy, employers increasingly insist their employees agree to non-competes and other post employment restrictions. Yet when the employment relationship ends, the restrictive covenants are either ignored by both the employee and the employer or fought out in court with the outcome both uncertain and costly.

Employers have legitimate interests in protecting their confidential business information and key customer relationships developed at significant expense. Consequently, many employers require new employers to agree to contractual employment and post-employment restrictions on their activities and conduct. Such restrictive covenants may be a part of an employment agreement or set forth in a separate non-compete and non-disclosure agreement. New employees eager to start out on the right footing are inclined to sign whatever documents are presented to them in connection with the hiring process. Later, if the relationship ends questions arise as to the enforceability of the restrictions. Understanding the basic legal principles applicable to enforcement of restrictive covenants can help both parties.

Courts in most states that enforce post employment restrictive covenants recognize employers have legitimate protectable interests in (i) trade secrets and other confidential information; (ii) unique skills and knowledge developed at the employer’s expense and (iii) customer relationships and goodwill. Ultimately the enforceability of a restrictive covenant will be determined by courts on a case by case basis balancing the employer’s right to protect a legitimate interest against the former employer’s right to pursue a livelihood and the general public interest in unfair restrictions on free and open competition.

Confidential Information Restrictions
Restrictive covenants with confidentiality provisions prevent disclosure or use of the employer’s trade secrets and other confidential, proprietary information. Most states including Pennsylvania, have provided statutory protection to trade secrets by adopting a variation of the Uniform Trade Secrets Act. In Pennsylvania, a trade secret is any information that “[d]erives independent economic value … from not being generally known to … other persons who can obtain economic value from its disclosure or use.” 12 Pa. Cons. Stat. Ann. § 5302 (2005). A trade secret may consist of any formula, pattern, device or compilation of information that is used in one’s business, and gives that person an opportunity to obtain an advantage over competitors who do not know or use it. Felmlee v. Lockett, 466 Pa. 1, 351 A.2d 273, 277 (Pa.1976). On the other hand, information that can be obtained from sources outside of the business or are generally known within the industry are not considered trade secret or protectable as proprietary information of the employer. A customer list is a classic example of business information that may or may not be considered proprietary.

Non-solicitation Restrictions
Non-solicitation provisions prohibit a former employee from soliciting or doing business with customers of the former employer. To be reasonable, the restriction must be limited in duration, geographical scope and no broader than necessary to protect the employer’s legitimate interest. For example, if the employer has invested substantial resources in the development of the employee’s skills and expertise such that the employee has acquired unique talents at the employer’s expense, then limiting that person’s ability to exploit those relationships to the detriment of the former employer has been recognized as reasonable by courts. On the other hand, if the individual established customer relationships before becoming an employee, then the employer cannot legally prevent the former employee from soliciting such customers after his employment ends.

Noncompete provisions
The essence of a noncompete provision is that the employee cannot go to work for a competitor of the employer after ending employment, however again, the limitation must be reasonable in duration, geographical area and scope of activity. If the employer operates globally and the employee had very broad responsibilities, then a global noncompete for a reasonable period of time, such as one or two years may be found to be reasonable. On the other hand, where the employee did not have responsibility beyond a limited geographic area, the noncompete should be similarly limited in scope.

Tips for employees
If you are beginning a new job and required to sign a written agreement containing any type of restrictive covenant, you should take the time to carefully read and understand the restrictions. If they seem reasonable in relation to your new job description, then signing the agreement may very well be appropriate. However, if the provisions of the restrictive covenant seem to be one sided, overbroad or unreasonable in any way, then think twice before signing. You have a right to negotiate the terms of a restrictive covenant just as you would negotiate any other term of your employment. If you have concerns, voice them and see whether the new employer understands your concerns and responds in a way that you believe to be fair under the circumstances. Just because the restrictive covenant is “standard” or “customary,” doesn’t mean you should sign even if they don’t fairly reflect your individual circumstances. If your new employer insists you sign the restrictive covenant without addressing the things you believe are unreasonable, then be sure to make a written record that you raised concerns which the employer rejected. After you sign and begin your employment, ask the personnel office to put a note in your file reflecting that you asked for certain changes in the restrictive covenant which were rejected and that you signed without the changes because it was a condition of your employment. At a minimum prepare a written summary of your oral dealings with the employer about the issue because after employment ends, if a dispute arising about the restrictive covenant, you may be able to demonstrate that the employer’s conduct in insisting on overbroad restrictions was unreasonable.

Tips to Employers
While it is always tempting to have your counsel draft restrictive covenants as broadly as possible to maximize your legal protection, increasingly courts are evaluating the fairness of every aspect of restrictive covenants because of the strong public policies favoring the right of everyone to pursue a livelihood and the strong public policy favoring unfettered competition. To be reasonable and enforceable, restrictions must be no broader than necessary to protect your legitimate business interests.

In practical terms this means that a noncompete should be narrowly drawn to prohibit the employee from working for a direct competitor in a position that is the same or similar to the position held with your company. The restriction also should be limited to a confined geographical area and for a reasonably short period of time. In Pennsylvania, for example, a two year limitation had been judicially approved, but one year is more customary. Confidential information restrictions must also be narrowly focused on categories of information that are truly proprietary such as customer purchase histories, marketing plans, projections, and trade secrets. Whatever you consider to be proprietary information, you should be able to show is not readily known within the industry or available from public sources. If it can be “Googled”, it can’t be confidential and proprietary to you and shouldn’t be included in your restrictive covenant. Nonsolicitation provisions also need to be limited to the relationships that you introduced to your employee and that you expended money to develop and maintain.

Understanding and acknowledging the talents and experience a new employee will bring to your organization means, among other things, being willing to negotiate the scope and specific terms of restrictive covenants. For example, if the new employee has developed client or customer relationships that you know about and hope the new employee will capitalize on for the benefit of your organization, then revise your nonsolicitation provision to exclude relationships developed before becoming your employee. If a post-employment dispute arises over enforcing your restrictive covenant, being able to show you negotiated and revised the restrictions to accommodate concerns voiced by the individual and to reflect the realities will greatly strengthen your prospects of enforcing the terms of the restrictions.

Courts increasingly are not sympathetic to enforcing post employment restrictions that are obviously overbroad and appear to reflect overreaching or dominating conduct by the employer at the beginning of the employment relationship. A quirk of Pennsylvania law is that enforcing a noncompete is much more difficult in the case of employees terminated for cause.

As one federal court explained:

Courts are skeptical when an employer seeks to enforce a non-compete agreement for a terminated employee based only on customer goodwill, as the employer’s termination suggests that the employer does not find the employee to be a competent salesperson, and thus, is not a competitive threat.

InterMetro Indust. Corp. v. Kent, 2007 WL 1140637 at *7 (M.D. Pa. April 17, 2007).

Understanding the pitfalls of overbroad restrictive covenants may help employers craft restrictive covenants that can actually be enforced if the need arises.

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