The Company, which we will call Acme, required its sales managers to sign non-compete and non-solicitation agreements. The managers promised that for a period of two years after their employment with Acme ended they would not “[e]ngage in any activity which may affect adversely the interests of [Acme]” including, but not limited to, soliciting any of Acme’s customers.
Our readers will know from an earlier blog that these types of agreements are called restrictive covenants.
Now consider two of Acme’s top sales managers. Within hours of submitting their resignations, the managers, who had been employed by Acme for years, launched their new, competing business and solicited their first Acme customer. Within days, the managers were providing services to several of Acme’s customers. After three months, they had generated over $1,000,000 in revenue from Acme customers—nearly 90% of the new company’s total revenue.
It’s a good thing Acme had the restrictive covenants. A court would surely require the managers to return their ill-gotten gains, right? Well, the court did not, because Acme overreached.
The managers acknowledged that they violated the restrictive covenants. They argued, however, that the covenants were void and unenforceable because the prohibitions were unreasonably broad. A federal judge agreed.
Restrictive covenants are enforceable only if the restraint on the employee is no greater than reasonably necessary to protect a legitimate business interest. When drafting restrictive covenants two questions must be considered: (1) What business interest may be protected; and (2) What restraints are reasonably necessary to protect that business interest?
Not all business interests are legally protectable. The law will not enforce a restrictive covenant when, for example, its aim is to prevent a competent, efficient employee from becoming a competent, efficient competitor. Stifling competition is not a legally protected business interest.
The law will, however, enforce a restrictive covenant aimed at preventing departing employees from taking with them the customer goodwill they helped create for the employer. Business owners have a legally protected interest in stopping employees from using the contacts they established during employment to pirate the employer’s customers.
After identifying a legitimate business interest for protection, the duration and scope of the restrictive covenant must be considered.
A restraint must be confined to limits that are no wider than reasonably necessary to protect the interest. No one size fits all businesses. Consider, for example, the duration of a restrictive covenant.
The duration of a restrictive covenant should be tied to the amount of time needed for the employer to reestablish the goodwill generated by a departing employee.
A laundry service company might interact with its customers on a weekly basis whereas a tree care company might do so once or twice a year. Consequently, a laundry service company should need less time for a new salesperson to establish good relations with its customers than the tree care company.
Therefore, a three month non-solicitation restriction may be a reasonable duration for a salesperson from the laundry service company. For the tree care company, a two year duration may be more appropriate.
Like the duration of a restrictive covenant, the scope of a restrictive covenant should logically connect to a legitimate business interest. The scope of the restraint should bear a relationship to the employee’s actual client contacts and job duties.
For example, a non-solicitation agreement prohibiting an accountant from soliciting any of her firm’s clients, including those with whom she never had contact and who first became clients after her departure, begs a question. What goodwill could the accountant have established with a client she never met, let alone performed services for? Such a restriction likely serves an interest aimed at stifling competition, which the law does not permit.
Likewise, a non-compete agreement that prohibits an employee from working for a competitor in any position without reference to the employee’s job duties is problematic. No legitimate business interest is served by prohibiting a Ford salesperson from going to work on Chevy’s assembly line.
Similarly, consider a company that conducts business nationwide. A non-compete agreement prohibiting the company’s Pacific Northwest sales manager from working for a competitor on the East Coast may well be overly broad and unenforceable. If the employee never provided services to the company’s East Coast customers, then the scope of the restraint is likely broader than reasonably necessary to protect the goodwill generated by the departing employee.
Remember Acme. For want of an enforceable restrictive covenant, its sales managers walked away with more than $1,000,000 of Acme’s business.
If you would like help writing restrictive covenants for your business, or would like to know whether the employment agreement you are currently using is enforceable, please contact Jim Astrachan at 410-783-3520 (firstname.lastname@example.org), Chris Lyon at 410-783-3547 (email@example.com) or Elizabeth Harlan at 410-783-3528 (firstname.lastname@example.org).