A Brief Guide to Restrictive Employment Covenants - High Swartz LLP

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A Brief Guide to Restrictive Employment Covenants
Thomas D. Rees, Esquire High Swartz LLP 610-275-0700 We've all heard that Pennsylvania is an employment at-will state. This rule allows both employer and employee to end the work relationship at any time, for any reason or no reason, unless a contract limits the parties' freedom. The employment at will rule also gives the employee great freedom once the employment relationship ends. Without a restrictive covenant, an at-will employee may compete freely with a former employer after leaving a job. The departing at-will employee may do a lot to prepare to compete even before leaving. For example, the employee may form a corporation, obtain bank financing, sign leases, and even schedule appointments with potential customers. To be sure, the departing employee may not misuse the employer's trade secrets or confidential information. Nor may the employee solicit customers or take other actions that damage the employer before leaving. But these limits only illustrate the many steps that the exiting employee can take to compete. What's an employer to do? The best antidote to destructive competition is to require the employee to sign a restrictive covenant. This restrictive covenant can prevent the employee from working with a competitor or soliciting or dealing with customers or employees for a limited period of time in a limited geographic area. A cautionary note is necessary, however. Restrictive covenants are not favored in Pennsylvania. These covenants are restraints of trade that prevent a former employee from earning a living. Therefore, the employer needs to avoid overreaching, both in drafting and enforcing the restrictions. The courts will interpret restrictive covenants against the employer, especially if the employer drafts the covenant without input from the employee. There are several distinct types of restrictive covenants. Non-competition covenants, or "non-competes", provide the strongest restrictions. Non-competes typically prohibit an ex-employee from working for a competitor for a given duration after employment. A kinder, gentler version of the non-compete allows the employee to work for a competitor but bars the ex-employee from serving the ex-employer's customers. Non-solicitation covenants typically prohibit the ex-employee from soliciting (i.e., initiating any contact with) customers of the employer or former co-employees to buy from or work with the ex-employee's new organization. Non-solicitation covenants put less of a burden on the exemployee, and are therefore more likely to be upheld by courts. But non-solicit clauses are harder for the ex-employer to monitor, because an ex-employee may accept business from customers without violating the contract- as long as the employee did not initiate the customer contact. Both the non-compete and non-solicitation covenants must not go overboard. In an action to enjoin the employee from violating a covenant, the court will only enforce reasonable limitations on the employee. Although each case is unique, a one year restriction, limited to an employee's actual customer base or sales territory, is likely to be upheld as reasonable. A third type of restrictive covenant- the confidentiality/non-disclosure agreement- protects information that the employer finds important, rather than preventing an employee from working for a competitor. Confidentiality agreements prohibit the employee from disclosing or using information or records or property that belong to the employer, other than for the employer's benefit. These covenants may also require the employee to return all property to the employer upon termination. These covenants often define the employer's proprietary information broadly. Strictly speaking, confidentiality agreements are not as necessary to an employer as non-competes or non-solicitation contracts. The law allows employers to prevent employees from using confidential information - agreement or no agreement. But confidentiality agreements help to define information that the employer wants to protect, and provide a fallback for an employer whose non-compete may not be enforceable. A fourth type of agreement is the assignment of intellectual property rights. In most cases, this type of agreement is used to assign to the employer the right to patent any invention that the employee may develop.

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2/22/2011

A Brief Guide to Restrictive Employment Covenants - High Swartz LLP

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At what point in the employment process should an employer obtain a restrictive covenant from an employee? The employer is in the strongest legal position when the employer obtains a restrictive covenant at the start of employment and tells the employee of the requirement to sign the restriction when offering employment. In this situation, the courts will uphold the covenant as ancillary to the employment relationship. Under the law, employment is enough of a benefit to support the burden that the restrictive covenant imposes. If the covenant is obtained from a current employee, the Pennsylvania employer must give the employee enough additional benefits in the form of salary or tenure or stock to offset the burden from the restrictions. A Pennsylvania employer will not be able to enforce a restrictive covenant from a current employee who is told "Sign or be fired." Since most employment in Pennsylvania is at-will, the continuation of employment is not enough of a benefit to support a noncompete or nonsolicitation agreement. What are the key elements of a non-compete or non-solicitation covenant? At a minimum, the covenant should mention the circumstances of entry into the agreement; the activities that are prohibited; the duration of the restrictions; and the geographic scope of the restrictions. The employer should tailor the restrictions to its particular needs and to its industry. For example, in a customer-driven industry, a restriction on dealing with customers may make more sense than geographic restriction. It is necessary to include an explicit clause that the restrictions assignable to a new employer if the contracting employer sells its assets. It is advisable to provide that the restrictions will begin at the end of the employee's employment, because an employee's contract of employment may expire before employment ends. It is also advisable to provide that, if the covenant is violated, the restrictive period will begin only after a court issues an order prohibiting the violation; this prevents the restrictive period from expiring while the court is still considering the case. What happens when an ex-employer finds out that an employee is violating a restrictive covenant? First, the ex-employer may want to send a "cease and desist" letter telling the employee to stop the violation. If the ex-employee does not stop the violation, and the parties cannot settle their dispute, the ex-employer will have to sue to enforce the restrictive covenant. In most cases, the employer will seek a preliminary injunction prohibiting the violation of the restrictions. The court will only issue an injunction if the court finds that the covenant is reasonable and that the employer will suffer irreparable harm without an injunction. When ruling on an injunction, courts in Pennsylvania may modify the covenant by reducing or eliminating unreasonable restrictions (this is called "blue penciling" the covenant). But an employer that forces an employee to sign an overbroad covenant may end up with no protection at all. One such employer argued that it had the right to prevent the ex-employee from working anywhere but "Tibet and the North Pole". The court was not impressed by this overreaching and struck down the entire non-compete. Courts have also refused to enforce restrictive covenants when the employer has discharged an employee through no fault of the employee (e.g., in a layoff or for inability to reach sales goals). In this case, however, the ex-employee still must refrain from misusing the former employer's confidential information. The cost of restrictive covenant litigation, the uncertainty of enforcement, and the serious consequences of an adverse decision all lead to the early settlement of many restrictive covenant suits. The reasonable use of restrictive covenants provides employers with a way to prevent unfair competition by ex-employees. It is important for the employer not to overreach in enforcing too broad a restriction, and important for the employee to find new career opportunities without violating a restrictive covenant. In a future column, I will discuss the ways to deal with competition by an ex-employee where there is no restrictive covenant, or where the courts have refused to enforce the covenant. Thomas D. Rees, Esquire is a partner at High Swartz LLP in Norristown, where he practices employment law.

http://www.highswartz.com/articles-white-papers.php?action=view&id=38

2/22/2011