September, 2016

Restrictive Covenants: One Size Should Not Fit All

As employers strive for that little edge to stay ahead of their competitors, restrictive covenants – clauses that limit an employee’s ability to work for a competitor, solicit and/or service their employer’s customers, contract with their employer’s vendors, and/or entice away their employer’s staff – have become increasingly common in all types of work environments and for all levels of employees.  From my business clients I know that these clauses are valued for their deterrent effect, even if the employer does not intend to actively enforce them in most situations.  But from my representation of departing and departed employees, I have also seen the dark side of such covenants, with employers who threaten departed employees and imperil their status with their new employer by claiming a breach of covenants that are of questionable enforceability.

Such abusive practices are gaining attention, particularly with legislative bodies and government enforcement agencies. Over the past three months, New York State Attorney General Eric Schneiderman has announced agreements with three different companies – a legal news media company, a sandwich shop franchisor, and a national medical services information provider – to cease or limit their use of non-compete agreements. The Attorney General particularly excoriated the use of such agreements for rank-and-file workers, and characterized New York law as prohibiting such agreements except in very limited circumstances, such as when an employee has unique skills or access to trade secrets.

Connecticut placed restrictions on physician non-competes effective this past July 1, Illinois has enacted a new law effective January 1 that will prohibit private sector employers from entering into non-compete agreements with low wage earners, and the Massachusetts legislature has been debating a prohibition on non-compete agreements. The U.S. Treasury Department and the White House each issued reports this past spring criticizing non-compete agreements as, among other things, harmful to workers and economic growth, inhibiting innovation, and depressing wages.

In this climate, employers would be well-advised to evaluate their approach to restrictive covenants. Such a review should consider:

  • the scope of the restrictions imposed,
  • their duration, and
  • the employees to which they are applied.

The objective should be to assure use of the clauses is within the bounds of reasonableness and consistent with the legitimate interests they are authorized to protect.

Legal Parameters
New York is one of the few states that does not have a law defining the permissible scope of restrictive covenants, but the courts review such agreements on a case-by-case basis, with due consideration to whether the restrictions impose an undue hardship for the employee, are no greater than necessary to protect the employer’s legitimate interests, and are harmful to the public. BDO Seidman v. Hirshberg, 93 N.Y.2d 382, 388-89 (1999); Reed, Roberts Assocs. v. Strauman, 40 N.Y.2d 303, 307 (1976); Sutherland Global Servs., Inc. v. Stuewe, 902 N.Y.S.2d 272 (N.Y. App. Div. 2010). The legitimate purposes of such clauses are to protect:

  • an employer’s trade secrets or confidential customer information,
  • the employer’s goodwill that it has cultivated with clients, and
  • against the loss to a competitor of an employee whose services are “special, unique or extraordinary”.

The courts have repeatedly upheld restrictions that endure for a year or less, that are limited in their geographic scope, and that are tailored to foreclose only a subset of employment opportunities that most directly correlate with the competitive threat to the former employer.

Far more suspect are clauses that stray outside those parameters. Clauses that effectively prevent an employee from pursuing gainful employment in his/her chosen occupation without relocating or commuting great distances are unlikely to be enforced by a court.

Practical Application

Employers that wish to strike the appropriate legal balance between protecting their business interests and allowing employees adequate alternative employment opportunities should avoid rolling out off-the-shelf agreements for all employees, as the standards of reasonableness may differ based on the industry and the type of role. For example, an agreement restricting an employee from soliciting or providing services for any client or prospective client with whom the employee had contact in the year preceding termination may be reasonable and enforceable if the relevant client/prospective client base is limited and there are abundant alternative prospects available to the former employee. But in a small industry dominated by a handful of companies, the same restriction may effectively bar the former employee from continuing to work, and may therefore prove unenforceable.

Clauses that purport to apply nationally or globally are similarly suspect. While such a broad geographic scope may seem necessary to provide the employer adequate protection, it should be tempered by limiting the scope of the restrictions in other respects. Such limitations might involve restricting the range of clients or activities that are subject to the clause’s protections.

Some employers care less about legal balance and may seek to hold former employees to overly broad restrictive covenants on the theory that such individuals are unlikely to seek legal protection. While junior or mid-level employees, or even unexpectedly unemployed senior employees, may lack the economic resources to legally challenge such clauses, the NYS Attorney General’s recent enforcement actions should cause such employers to reconsider their risk analysis. It costs an individual nothing to lodge a complaint with the Attorney General, while the cost to the employer in responding to a government inquiry may be considerable. As the pendulum swings toward placing additional limitations on employers’ ability to restrict the post-employment competitive activities of former employees, employers would be well-advised to consult with legal counsel on a balanced approach to the drafting, implementation and enforcement of restrictive covenants.

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